The Joe Walker Podcast - What I Learned In 2020 - John Hempton

Episode Date: December 21, 2020

John Hempton is co-founder and Chief Investment Officer at Bronte Capital.Show notesSelected links Follow John: Blog | Twitter 'Approaches to Studying Policy Representation', paper by David Broockman 'Indebted Demand', paper by Atif Mian, Ludwig Straub and Amir Sufi Topics discussed Lessons from past market cycles. 4:51 Astarra-Trio. 10:43 Retail investors: Welcome to the party. 24:14 When John met Jim (Simons). 28:13 Can you predict market tops? 33:00 Are there any good reasons for believing this time really is different? 40:37 The Dunning-Kruger effect is everywhere. 52:18 A behavioural model of the coronavirus. 55:45 The illusion of the political centre. 1:10:19 How inequality may be distorting monetary policy, and vice versa. 1:23:00 SPAC attack. 1:26:03 The puzzle of Middleby. 1:31:15 Bull masturbating. 1:33:01 2020: a year of puzzles. 1:42:30 See omnystudio.com/listener for privacy information.

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This is an episode with founder and chief investment officer of Bronte Capital, John Hempton. If I sound a little flat in this one, to be frank, although my name is Joe, it was because I had several Christmas drinks the night before. But let's be honest, when you're interviewing my friend, John H Hampton, you don't really have to do that much work. I consider John an unofficial national treasure who is as loquacious as he is bodacious. One of the many reasons I enjoy speaking with John is that John is someone who is relentlessly capable of separating ought from is. When you talk to John, you can leave virtue signaling and fear of causing offense at the door. For example, you can chat about what makes big old dirty tobacco companies great businesses without second guessing each other's ethics. You can, if only for a while, just have a conversation about the world as it is, with

crystal clarity, and I find that very refreshing and productive. If you want to learn more about John and his background, I can recommend episode number 75 of this podcast. In the conversation at hand, we focus on 2020. And John tells me what he learned from a year that served up a toxic degustation of bushfires, a probably one in 50 year pandemic, the Black Lives Matter protests and the events that triggered them, a presidential election in which the losing candidate refuses to concede, and a stock market that's acting like, to borrow Mark Cohoda's colourful phrase, a pig on LSD. We also speak about the Dunning-Kruger effect, a syndrome all too familiar to your host as he charges headlong into new topic areas, as well as why the notion of a political centre

may be an illusion. If you can hear the sound of crashing waves in the background, you're not going mad. This was recorded at John's beach house and the Pacific Ocean was beckoning from right over his shoulders. Before I throw to the conversation, this will obviously be one of the last episodes of the year, certainly the last before Christmas. I hope that you and the people you love have a lovely Christmas together. Swagmen and Swagettes, without much further ado, please enjoy my conversation with the great John Hempton. Mr. Hempton, welcome back to the show.

Thanks. Glad to be here. So, we are going to start by talking about some lessons from the last market cycle. And which ones come to mind? Well, I'm 50-something. So, in my my life I've seen three market cycles. I've seen a very tech telecom heavy one in 1999-2000. I've seen a very housing finance led bubble in the period up to sort of 2007. And I've seen this which is as close to the everything bubble as I've ever seen in my life there are certain things that are not bubblicious some raw value stocks may not be bubblicious some property in obscure places may not be bubblicious but this is as close to the everything bubble as I've ever seen and there are things that

repeat and things that rhyme and there are things that are different this time and I haven't a clue about all of them but let's go back to sort of the tech bubble one of those jokes if you look at the great tech stocks of the world, Microsofts and that man, Microsofts and Oracles, et cetera, which are the great stocks or Cisco, all of those stocks are now trading above where they were in 1997. But it took years and years and years before they broke the 1998 value. Cisco has never, for instance, recovered its all-time high. But if you look back with the retrospective scope, it was a bargain in 1997, and it was already bubblish by 1998, and it went on for another two years.

Now, at the end of that bubble, there were sort of two waves. The first wave, Cisco and Microsoftrosoft peaked and that has a date it's march 14 2000 and then there was a sort of second wave in the bubble and the second wave in the bubble stocks that everybody has forgotten the name of like i2 technologies and jds uniphase were the sort of super champions after that there was a denouement and the denouement had two big aspects. One is just a whole lot of tech stocks, crappy tech stocks went to zero and they went to zero fast and that's because they never really had business models. The second denouement was mostly in telecos where the sector was completely and utterly riddled by fraud.

And it was actually a sort of competitive fraud on the way up. If you were a teleco and you weren't faking your accounts, then WorldCom, who had a giant stock price, would buy you. And the net effect of which was that at the end, everybody that was left was faking their accounts. And the whole place was run by madmen and it unwound. It was competitive fraud. If you wanted to be stable and boring in that time you effectively got defunded. Either your shareholders left and your stock wound up in play or you were fired by

your board who replaced you with somebody more aggressive. And then in the next bubble we saw the same thing but it wasn't exactly the same thing. This time it was mostly in things like regional banks. And the way I think about the regional banks that cycle was that they all went nuts. And they went nuts for a very specific reason which is that if you didn't go nuts your stock was bought by another regional bank that did go nuts and at the end of that bubble the whole

banking sector was run by madmen there were exceptions there's a little regional bank in New York called Astoria Financial which still had family ownership and it was a very big asset for the family and the family was risk averse and the bank was never going to be sold because the family had some heirloom value to this asset and it was never going to behave crazy because the family was there with a 50 year or or 100-year view. And the story of financial underperformed and underperformed and underperformed all the way up to 2006, but it was never taken out because the family was a rock-solid shareholder. And then it outperformed and outperformed and outperformed

as the crash came. And net-net, they did all right. But it was, they only did all right. They didn't do spectacularly. But the same pattern happened, which was as the bubble went on, the madmen replaced the sane people. And if you're a fund manager, for instance, that wasn't playing ball with the bubble, money left. And at the end of the bubble, certain things happened, this time more strongly, things like retail investors

were a giant phenomena at the end of the 2000 bubble and they're a giant phenomena now. Now, the areas that I know best are fraud related. I mean, I'm not expert in a lot of things, but I'm genuinely expert in how people steal from other people in financial markets. And generally, my view of this is there's a lot of it. I don't like it, but at least I can short sell whatever the crooks are selling. And that mostly works okay. But it reminds me a little bit of all the...

I get reminded all of the crappy stuff that happened last time and where the structural problems haven't been changed at all. Now, sometimes it also happened that there was a bubble in safety. I mean my particular example which irks me still partly partly because I was very close to it was an Australian fraud called Astara Trio which in fact was in every sense the Madoff of Australia. Astara Trio looked like a fund of very conservative funds. It looked like a very professional outfit. It produced very stable results like Madoff.

Madoff's numbers were plus 6%, 7% every year, and he actually dropped his return, but people actually referred to Madoff as a sort of high-yielding bond. And it was bullshit. And Astara Trio looked a little bit like this, but it was sold through financial planners in unsophisticated areas,

Wollongong, the Eyre Peninsula in South Australia, sort of second-tier industrial towns is the way I would think about it. And it just fleeced them, right? It wasn't a Ponzi, it was a theft organisation. Most of the money was in fact taken offshore to people that looked like organised criminals. The Australians who ran it, or the Canadian who ran it and lived in Australia, had at the age of 26 set up a bank account in Liechtenstein and was receiving commissions on the money he stole in Liechtenstein.

Now, at the end of this, I also got a sort of taste for just how much financial fraud hurts people I went and sat in on the several of the legal things including the sentencing of Sean Richard who was the criminal the Canadian criminal who ran it and afterwards I went out to lunch with the old ladies from Wollongong who'd had their life savings stolen and it was very sad they were they were mostly women they were sort of 70 something they owned a little house probably a weatherboard house somewhere five seven kilometers from the beach on the south coast of New South Wales. Nothing flash, particularly. And they had two to three hundred thousand of superannuation. In fact, they lived quite a nice life. And now they had their weatherboard house, maybe.

And every penny of their superannuation had disappeared. And I remember their disgust at the fact that the crook got wrapped over the knuckles, partly I, and you know, went away with a two and a half year sentence. Right. Their thought was, well, if he'd knocked two of us over for our handbag, he'd have got two and a half years. And the whole process made me cognizant that bad behavior and bubbles and their aftermath have very large human costs. And some of those human costs, I feel very little sympathy for. There are plenty of 25-year-olds who blew their money on tech stocks last time. And there are plenty of 25-year-olds who blew their money on tech stocks last time, and there are plenty of 25-year-olds who are going to blow their money on biotech or gold or crypto this time. And frankly, you know, it's a waste of resources, but it's not really all that sad. But when you see the 70-year-old

who has blown up large amounts of money and they were reaching for safety in a world full of fraud and the reach for safety got them fraud as well, it's kind of sad. Anyway. Sorry, quick digression on the craft of short selling. Didn't you confirm the Astara Trio fraud by realising the income from their currency hedges was too stable?

Yeah, there was that too. I find that interesting. Oh, OK. This is a lovely technical explanation for people that want to understand how you read accounts. Imagine I'm an Australian investor and I invest in Microsoft. It's a US dollar stock. Every time the Australian dollar goes up I'm going to lose money because the Australian

dollars gone up and then Microsoft is a US dollar asset. Every time the US, the Australian dollar goes down, I'm going to make money. And so when I buy the Microsoft stock, partly I'm buying Microsoft exposure, but partly I'm buying Australian dollar exposure. Now, you could go out there and currency hedge this. You could go and buy a whole lot of Australian dollars versus US dollars, and every time the Australian dollar goes up, I lose money on the Microsoft stock, but I make money on my hedge.

And that money is paid to me in cash. And every time the Australian dollar goes down, I make money on the Microsoft stock, but I lose money on my hedge because I belong the Australian dollar versus the US dollar. And the net effect of it, and I have to pay cash out. And the net effect of which is that I get to hedge my asset value at the cost of destabilizing my cash balance.

It's not possible to hedge both the asset value and the cash balance. And I went and looked at this company investor or Starat trio invested almost all the money offshore. So I went and got their GAAP accounts. And I went and looked and said, okay, presumably because they're invested in foreign assets, they must have an Australian dollar volatility. And that's not evident in their return. So they must be hedging the Australian dollar. So there must be a cash volatility and there was no cash volatility and therefore I figured they must be a fraud and it took like five minutes to prove now I wrote that out for the regulator and I'm not sure that that was the convincing argument for them but it was the convincing argument

for me incidentally this also tells you one of those classic things that investment bankers and brokers missell. I cannot tell you how many times I've heard people saying, oh, well, you can just hedge the asset volatility, or you can just hedge the currency. Well, it doesn't work that way. There were a whole lot of Australian funds that bought infrastructure assets around the world prior to the last crisis. So they bought some infrastructure assets in America and they bought some infrastructure assets in New very good reason. It's long-term stable cash flows that meet the long-term pension obligations of their beneficiaries. But they didn't like the currency hedge, so they went and currency hedged them. And if you remember, the Australian dollar in the last crisis dropped very suddenly from about $0.90 to about $0.60. And so what happened was that these people had massive currency losses going it right. Because if you've got a third of your asset, if you've got your assets offshore

and your currency hedged, suddenly you get a cash call for a third of your value. And they got that cash call in, dare I say, March 2009. And lo and behold, they are forced by their currency hedging to sell their very good assets at the exact bottom of the market to meet the currency calls. And investment bankers must have told them 100 times that don't worry about investing offshore, you're going to be currency hedged. And then they discovered that the currency hedge itself is what destroyed them.

Now, if you want to amuse yourself, go have a look at the annual report of QBE in 2009. There's a shareholder letter and it says something along the lines of, in early 2009, we our long-standing practice of hedging our foreign assets. And QBE is a giant global insurance company headquartered in Australia but with 75% of its net capital offshore. And it hedged it all back from pounds and dollars into Australian dollars. And as it came, as that year unfolded, those hedges put a $2 billion cash drawer on the parent company. And eventually,

QBE abandoned their policy of hedging the foreign assets because they couldn't handle the cash draw. And if you go look at the accounts then, what happened was the Australian dollar decided to go from 60-something all the way back to 90. It was very fast. And that $2 billion was unhedged, so it went straight to their shareholders' equity. So they had a $2 billion cash draw on the way down and a $2 billion shareholder equity hit on the way up. They lost both ways. It's one of the great hedging corporate debacles of Australian history and nobody commented on it at the time.

It's actually one of the reasons why QBE has been a terrible stock for the last 10 years. And that's because they had a $2 billion cash hit from fucking up their hedging into the crisis. Now, that idea, and I know you raised it because it's one of my bugbears, but the idea that hedging solves your problems is an idea that is missold to you by investment banks. And it's also missold to clients of hedge funds by hedge fund managers. And I'm a hedge fund manager and I try not to missell my clients on the idea.

Hedging just swaps one set of risks into another set of risks and introduces all sorts of weird cash draws. Now, we occasionally even get hit on these. At the moment, we are short a lot of what might be colloquially on the internet called stonks. Stonks being bullshit stocks beloved by retail investors gambling on Robinhood. And to be blunt, stonks are going up, or as the Twitter slogan is, buy stonks. In fact, the crappier the stock, the more it's going up. This is actually not very dissimilar

to sort of the middle rally of the year 2000, where the crappiest tech stocks were the ones that went up hardest, right? But this is a buy stonks period. Well, unfortunately, I'm short stonks. And every time these stonks go up, I get a cash call. And those cash calls are unpleasant. They can force me not only to buy back the stonks,

but actually to sell real good businesses in order to pay the cash call. And whilst, you know, if you look at our last month, in US dollars we were down 70 bps, but the headline, and people will misquote this headline, is we, during the month, bought $130 million worth of shares with our clients' money, thinking that those shares would be worthless. Right? And that's a neat transfer of $130 million

to the promoters of bullshit stocks. And mostly we make money shorting them. But at the moment, the stonks are going up too hard and we had to cover some and cover some really means taking good money and buying bad stocks and even worse than that we had to sell some of our good stocks to fund the losses and this is very unpleasant it's the QBE problem, not on the QBE scale, but it was still the QBE problem.

And you can overstate this. We're sideways in that period. And it has happened to us before. There's a letter from us on the internet for our January 2012 numbers. And we explained what happens when you're short a whole lot of crappy stocks and the crappy stocks go up. It's not pleasant, but it's the same hedging loss that QBE had, and it's the same hedging loss that I expected to see in Astara's accounts, but didn't see. We have it because we're real, and we manage it because we know it's there. But manage it isn't

the same as avoid it. It's just avoid too much of it. Now, on retail investors flooding into the market, I think it might have been in your April 2020 letter, you had a couple of screenshots of the google search trends for buy stocks online and how to buy stocks yeah this was we underestimated this too there was in one of the things that happened in the crisis of march was that, in fact, everybody was staying home and incomes didn't fall, right, at least for a lot of people. In a lot of countries, Australia in particular, but in other countries, there were either, there were job subsidies or subsidies for keeping jobs or employers were paying people for working from home. And incomes didn't... GDP collapsed, you know, fell a lot,

but a large number of people had no fall in income at all, right? And quite a lot of people had incomes up 5% or 7% in the crisis. The second thing is expenditure did fall a lot, right? If you...restaurants fell, entertainment fell, all sorts of things fell. The net effect of the disposable income rose for a lot of people by a lot. There's an offset, of course, which is that the government balance sheet got a lot worse, right? Personal balance sheets actually in aggregate got better during the crisis. I didn't expect that, but that's what happened. You can see it in credit card numbers,

where credit card performance is remarkably good this year, despite the fact that the economy looks like it's a dog's breakfast. Then, for a large number of people, work from home really means less work from home. It's very hard to monitor your staff. It's also very hard to know what they're doing at any particular amount of time or at any particular time of the day. So a lot of people had their entertainment denied. And then just to add insult to injury, the sports betting market and all sorts of betting markets disappeared. And so what she was seeing was mass betting on stocks on a scale that I didn't think I would see again in my lifetime. The last time I saw mass betting on stocks was on internet brokers

during the dot-com period, where E-trade used to advertise continuously about babies that were getting rich by playing with the keyboard and accidentally buying stocks right like it was so easy that even a stupid baby could do it but this time you're seeing it again and you're seeing it in unsophisticated platforms like robin hood and you're seeing it in fairly sophisticated platforms like interactive brokers interactive brokers number of accounts has doubled this year. I don't know the Robinhood numbers but I think that the last I saw that they'd gone from 5 to 13 million active accounts. It's even sharper. Incredible statistics. I don't know the source of it but Jim Chanos tweeted a while back out the idea that there

were currently 40 million active retail investment accounts in the United States. This is multiples of what it was in 2000, and it ended badly in 2000 for most of those retail investors. But it ain't ending badly for them now. Almost all those people are outperforming me and not by a little bit but by a lot. And the Dunning-Kruger effect is very strong in them. They think that they know what they're doing and the stock market returns that they're getting a very good think that they know what they're doing and the stock market returns that they're getting a very good evidence that they know what they're doing and a large number of them are

idiots. How do you think about the question of timing market tops? Is it impossible? Can we get to that later? Because I've got lots of thoughts, but yes yes it is impossible yeah I wanted to sort of go past my one and only ever chat with Jim Simons the famous Jim Simons Jim Simons runs a fund called Renaissance Technologies he may well have been the greatest living mathematician in the world in 19 when he was 39 and decided to give up mathematics and go be a finance guy. Renaissance Technologies returns all of its profits to its unit holders now, and it has sacked all of its external unit holders. The only unit holders left are people who work at Renaissance Technologies. So the number I'm going to give you is unfair because it's not obtainable.

But $1 invested in Renaissance Technologies when it started is now worth about 400 million. It's by far the greatest return money machine ever invented on Wall Street and it's a black box and I promise you, no matter how hard I digged, Jim Simons wasn't going to tell me what was in it. That said, Jim, he was at this dinner with three German mathematicians. When was this? About six years ago. And there were a bunch of famous people at this dinner. It was quite an

amusing dinner. The other person that was very famous at the dinner was a gay Muslim politician from the UK called Lord Ali, who had, amongst other things, funded ASOS, but knew enormous amounts about how reality TV worked. His boyfriend, for instance, had been the developer of the Survivor platform. And then other things that you didn't expect, like how online saree sales worked in India. And he had genuine expertise in the subject of how online saree sales worked in India. It was quite fascinating, but completely out of my world and life experience. But Jim was there with three mathematicians, all of whom won Veblen medals, which is sort of the Nobel Prize for geometry, and with their very dull German wives. And they were completely unworldly, and everybody else at the table was incredibly worldly.

But Jim was obviously, you know, with his friends and his friends are mathematicians, not finance types like me. And he wasn't talking much to me, but we chit-chatted a little bit about how I found Crooks. And I said, well, you know, one of the earliest things I did was I went to this investment conference in Florida. And this was an investment conference where it was free to attend but you paid to present and almost all of the people who actually attended were above average wealth but below average financial sophistication elderly people in florida and the people presenting were the widest collection of scumbags you could possibly imagine. It was just, if you want to go find fraudulent people, this was the place. So that's right. You got to collect business cards.

So I went and collected business cards. I followed almost all the people. I've tried to pair them back. And this was a good start to our database of scumbags which we used to track shorts and He sort of got it and I then I said, you know, it was the sort of place where five years ago they would have been selling day trading systems and Then Jim's lights eyes lit up And this is a guy who was playing the professional mathematician until then. But you could see the greed. And it was like, I wish they'd do that again.

Right. Now, Jim's dreams are coming true. Right. Jim's looking at all of these retail investors who are trading, who are to me unpredictably stupid, but to him are predictably stupid. He seems to be able to work out with his black box where tops in individual stocks are or where directions of individual stocks will be. And he looks at a mass of what is sort of, I guess, mathematically modelled idiotic consumer human behaviour

and solves for it. And I look at this idiotic mass of human behaviour and I decide to short too early and I lose money. So you asked me, can I predict the top? And the answer's no. And I've got good evidence to that effect. Can it be predicted or can the idiocy of human behaviour be predicted? The answer to that is yes and I've got good evidence to that effect, but Jim won't tell me how it's done. But there are all sorts of indications of just sheer bloody-minded stupidity.

I saw a very well-known venture capitalist, who will remain nameless, tweeting out instructions on how various companies should behave when their stock is trading at 60 to 80 times revenue. I saw this on Twitter. Yes. Yeah. And the comment which just sort of made my jaw drop is, you know, stock prices will normalise. They'll one day go back to 20 times revenue.

Right. There's a famous quote from the last cycle from i think jim mcneely who's the ceo of sun which was after the event and he says you know when our stock was trading at 60 what were you thinking right um at 60 it was 10 times revenue well you know if you want to get a 10 return out of that, I've got to have 100% margins, which is rather difficult when I have 27,000 staff. And I've got to do no R&D, which is rather difficult if I want my returns to be sustainable. Oh, and I've got to pay no tax, which is kind of illegal.

And I've got to pay it all out in a dividend. Now what are you guys thinking right i mean i used to think of 10 times revenue as the insanity number and now very well known venture capitalists are warning on twitter that stocks might fall back to normal levels like 20 times revenue so there's that sort of behaviour that says... And then there are other behaviours. Like, I went to visit my son at university and one of his friends is a computer science student

at age 20, asks me, what is a stock option and how do you trade them? Right? And do they really want that amount of leverage? And then there's other behaviours. There was a period when I used to get into Ubers and I would talk about what I was doing and they would ask me about crypto stock, crypto. And they weren't asking me about Bitcoin, they were asking me about crypto coins whose names I didn't know and still don't

know. Non-top five crypto coins. And then there was a period six months later where not only were they asking me about non-top five crypto coins, but they were recommending particular crypto coins to me. And every one that they recommended is down 99.9. And sometimes they were recommending them to me because they were the cons trying to sell their crypto coins. But more often than not, I suspect they were the cons trying to sell their crypto coins but more often or not than not i suspect they were recommending me the those cryptos because they had in turn been recommended those cryptos and they were pumping them right you know or believing in them and i haven't seen that indication of a top right um i'm not not catching many Ubers this day and age. You know, coronavirus has taken away that test on the world. But I'm not being given

tips by the bellboy yet, right? And, you know, that's a very famous sort of indicator of a top when the bellboy gives you tips. There are other indicators that puzzle us. The one that puzzles me most is actually the good IPO one. If you go have a look at the IPOs done at the bottom of markets, in 1991, I think it was, it might have been 1992, there were only two big IPOs in Australia. They were Cochlear and CSL. They're in one year. And both of them are basically hundred baggers.

Two of the greatest companies ever IPO'd in Australia. If you go to the year 2000 and look at the IPOs in America, they were all garbage. They weren't a little bit garbage. They were garbage after garbage after garbage. None of them had a business that was there. Go back two years, there were still good tech companies being IPO'd. This year, they're not all garbage. I don't know what Airbnb is worth. I'm kind of surprised its market cap one day after IPO is $100 billion

but it's not a garbage company I'd be very surprised if we woke up in 15 years and Airbnb was still not an important player and so that doesn't look like a top. Now it's a little bit different this time in that this time is more of an everything bubble and there are huge liquid markets in unlisted companies. So that venture capitalists are able to keep an Airbnb until it's a $100 billion company,

whereas once upon a time, the total amounts in venture capital pools were single-digit billions or $20 billion. It was actually a very small industry and they just didn't have capacity. And the idea that they would keep an Airbnb this late marks this cycle as different from say the year 2000 cycle.

So, and we argue a lot at work about whether it's over or not. In other words, whether this is say, June 1998 or June 2000. And in June 2000, there wasn't that long left. But in June 1998, if you were to play the short, the bubble stocks, you got yourself smashed like crazy. Now, we have just had the worst month in about six, in eight years.

And we were for sideways, right? But sideways was still not pleasant because we had to sell good quality companies to fund losses on crap. And this month is panning out exactly the same way. We're selling good quality companies to fund losses on crap. And this month is panning out exactly the same way. We're selling good quality companies to fund losses on crap. And as a fund manager, getting your hedges wrong is very, very unpleasant. and I wish I could make the unpredictable uncertainty of, you know, unpredictable insanity of all these retail investors predictable. I genuinely envy Jim Simons who seems to know how to do that. To take the other side of the argument, what are the best reasons for believing this time is different?

Well, there's really only one, right? There are a lot of reasons we talk about why this time is different. But the only one that seems to make sense to me is a willingness to devalue currencies forever and interest rates that look like they're zero or negative forever. We used to talk about the global glut of savings and the idea that there was a glut of savings which I probably first heard in 1994, seemed so improbable to me that I had to sort of automatically dismiss it. But it's in fact obviously true now. There aren't that many good capital-intensive investment ideas out there. If you go have a look at the Dow Jones constituents from the 20s,

there were things like Goodyear Tire, American Rubber, US Steel, all giant capital intensive companies. If you look at the giant companies now, by any historic standard, they are capital light and they're not very subject to competition. In the old days, if you had a steel company that had excess margins, somebody would just build another steel mill. These days, if you have Facebook and you have excess margins, somebody can't do it. I don't know how you would build another Facebook or another Google. And so the first sort of reason is this is not a capital intensive

game subject to competition and some profits could go up for a very long time. The second reason is that almost all the investments are not capital intensive, but we have ageing populations and ageing populations often have very high savings rates and in China in particular the savings rate is astronomical. But on a global basis, especially once you add in China, there are pretty clearly more savings out there than there are, to deploy capital well. I know I can't deploy capital well, right? It's just a bad market for that, but there's plenty of money. And if you have a situation where certain businesses have profits going up forever

because they're very hard to compete with and discount rates are going to be extremely low forever, then I guess you could put enormous valuations on those companies. The problem is that I'm seeing enormous valuations put on everything, including things that can be competed with. So to pick a reasonable example, Kinsale Insurance, which is a small, but as far as I can tell, very well run, brokered insurance company in the US, is now priced at 10 times revenue and 10 times book. And a brokered insurance company is essentially get a bunch of smart guys together who know how to underwrite certain risks, 10 times revenue and 10 times book. And a brokered insurance company is essentially get a bunch of smart guys together who know how to underwrite certain risks,

give their business card to 30 or 40 or 300 insurance brokers and put a bit of capital together. And this can be reproduced, right? There are hundreds of such institutions. And if they can be reproduced, right? There are hundreds of such institutions. And if they can be reproduced, all this excess capital should drive their returns to zero. But that stock is up and right and vertical as well, right? So I can actually understand why,

if I believe my story about competition being harder and the world being capital light, why certain things have gone vertical. But I can't understand why everything's going vertical. The second version of that is, of course, monetary policy. And monetary policy is just flat weird. I remember in 1992 doing Ted Sieper's macro course at ANU. I was just a kid.

And one of the implications of this macro course was that there was a thing called a liquidity trap where interest rates essentially went to zero, there was no inflation, and you could keep shoveling cash into the system and inflation wouldn't appear. And in every liquidity trap article, it turns out, model, it turns out, well, if you shovel enough in, inflation will appear, but you might have to shovel in ridiculous amounts and do non-standard methods of shoveling it in. And we even used to talk about the theoretical method of loading the cash into a helicopter,

flying over a city and throwing it out. And this was helicopter cash in a 1992 textbook. And it sounded impossible to me. The idea that the US central bank could go from $800 billion of cash on issue to $6 trillion of cash on issue seemingly overnight and not induce any real inflation looked to me like a theoretical possibility but bullshit. In fact, it's sort of the

quantum mechanics of economics, right. You can be showing all the quantum mechanic models and you can derive all the results and they match experiment but every time you look at them, every bone in your body is saying that's bullshit. But it's in fact not bullshit. It's just that the world doesn't work the way that you think it does. And we're now conducting the experiment. We've printed vast amounts of money, and asset prices have gone vertical. and clearly it seems that monetary supply has some effect on asset prices but the price of my milk

or the price of my Weet-Bix or the price of my car or not to mention the price of something where the prices are going down like televisions just hasn't been following that. Now, it turns out that goods prices, by and large, have got weaker and service prices, by and large, have gone up. And the extreme version of that is, say, private school fees in Australia

or university fees in America. Doctors' bills everywhere right though but still nothing that matches the amount of money supply why do you think that is why does quantum mechanics work i'm no i'm serious it's like i can explain i could pull out ted sieper's notes and I could explain the model to you and you can go and pull out any good macro textbook from the period and they'll explain the model to you. And when the model was explained to me at the time, I thought that was sort of a theoretical nicety, but bullshit.

And no, I've never understood why it works i mean even in the prior version of it when you know interest rates were normal say five percent um the federal reserve when it changed interest rates from five to say 4.75 might move 50 billion dollars at a window in New York converting 50 billion dollars of printed money into bonds or something like that just change its about and this is an economy that is at the time say 10 trillion dollars right and i don't need i don't need to tell you that there's a lot of differences a lot of zeros between 50 billion and 10 trillion and in this context of you know the total amount of debt in the society which might have been 10 or 12 trillion of mortgage debt 10 trillion of mortgage debt and another 2 trillion of mortgage debt and another $2 trillion of personal debt, it looks like

four-fifths of three-eighths of sweet fuck all. And yet that action clearly and observably changed people's behaviour. People would, as a result, start building more houses. And that was, if you ask me why does monetary policy work, I don't know. I can give you a theoretical model, but I genuinely don't feel it. It doesn't look right to me in the same way that why does quantum mechanics work? I don't know. I can give you a theoretical model. It doesn't look right to me.

I just have to accept that it does. And in every one of those theoretical models, there was an amount of money that you could print that would break the effect right generally you had to persuade people not to hold it and in the model and the way that you persuaded people not to hold it was that you distributed it recklessly right so the prescription and it's a serious, I blogged it at one stage and then Paul Krugman referred to the blog approvingly. But the idea was that if you wanted to actually make it have some effect on inflation, you had to put Ben Bernanke in a Hawaiian t-shirt and give him a bong. And what you needed was the credible promise to be reckless. Right? And your credible promise to be reckless could be done by throwing money out of a helicopter, literally,

or by having Ben Bernanke get on 60 Minutes and pull a cone in front of them. And it actually really disappointed me at the time because Ben Bernanke got on 60 Minutes in a suit and sounded responsible and I was hoping monetary policy would actually work right and so you know I was really hoping that he'd get on 60 minutes in a hawaiian shirt because that's what the model says he should do right it's not it's it's great you know what is the difference between america printing six trillion dollars and zimbabwe trending printing a trillion dollars and the answer is one of them looks credible and one of them looks reckless, right? And so if you actually want monetary policy

to induce a little inflation and have some kind of effect that way rather than just wind up in asset prices, be credibly reckless. What are some of the other big lessons you've learned during 2020? Oh, plenty. As a general rule, Dunning-Kruger effects rule my

life. Everybody has it. This is human nature. Any subject that you look at for a while that's a complicated subject, you'll first think that you know a fair bit about it. And there's a very steep relationship where a little bit of learning and a lot of confidence and then suddenly you work out that actually the more you know the less you know and your confidence drops off and then in order to get back your confidence you know need to know a shitload dunning kruger effects are everywhere. Now there are solutions in life to them. One solution in life is to just hire experts. So I wouldn't even pretend to know anything about plumbing really. I just hire a plumber. I actually pretend to know a lot about law, but if I was actually in any legal

trouble, I would hire a lawyer, right, and if you ask me, you know, how do you do something like be an activist shareholder in the US, I would recommend to you a very good law firm, right, and the reason I'd recommend it is that I, you know, Dunning-Kruger, I know my limits on Dunning-Kruger effects. The worst people for Dunning-Kruger effects are successful businessmen in non-financial businesses. If you're somebody who is the world leader at questions like, how do you design the outer wall of a skyscraper? You have a big business, you're successful, you've made many millions of dollars, people fornish your words, and then you go and talk about something else. And you have to drop all of that because you now sound like an idiot. And I cannot tell you how many hyper-successful businessmen

I know from non-financial businesses who walk out of their field and sound like idiots. Dunning-Kruger effect is the defining characteristic of those people. And it's not surprising. It's because of the way that they are experts in particular fields and think that their expertise goes anywhere else. The way I would describe them is that they're often three inches wide and six miles deep.

On the stuff that they know, they're flawless. On the stuff that they don't know, they're awful. Now, in financial businesses, it's not like that at all. Dunning-Kruger effects completely rule my life, but they're as obvious as hell, in that one day I might be talking about COVID vaccines, another day I might be talking about software engineering, and another day I might be talking about

how you make cosmetic ingredients. And I'm invested in all of those areas and quite literally. And there's absolutely no way that I can have expertise in all those areas. But there's plenty of ways I can think I have. And the beauty of my job is that you get bashed up all the time. So whilst, you know, Dunning-Kruger effects are an occupational hazard, they get beaten out of you pretty fast. That said, this year has been spectacular for Dunning-uger effects including for me the biggest one was of course coronavirus itself right and that you um along comes a vaccine a virus it's the biggest issue in the world

in short notice it's going it's obviously going to have massive effects and if you think you know what they're going to be you're probably talking through your ass and we bet on those massive effects and sometimes we got it right and sometimes we got it wrong the very big picture was in march or january and february this thing was stalking the world. We didn't know what its mortality was. We didn't know the age skew. The Chinese data originally, what data there was, was very sketchy. The age skew of the dead in the early papers in the Journal of the Medical... Sorry, in the Lancet, which had some studies from the hospital in China,

suggested that the mortality was averaging about 63 age, right? And that a lot of 50-year-olds were dying. And there weren't many 80-year-olds in their sample. So we got this idea that the skew wasn't much older than me. I'm 53 and I thought, grimace, it could be a bit older than me i'm 53 and i thought grimace it could be a bit older than me you could model a virus like you would model a phage going through bacteria or um myxomatosis going through rabbits and those models actually work right you can model the map the map the model that you would get from first principles and mathematics about the path of the virus going exponential rolling over and then exponentially declining sir model yeah yeah those work beautifully and in february and possibly into early march in some places those models fit reality extremely well.

And we were looking at the world in early March or in February and thinking this is going to be a disaster. We were wrong about the amount of the mortality, but we had a model in our head about how this thing was going to go. And if you'd asked me how many dead Americans there were going to wind up being, my answer would have at the time been about 3 million. Right? Which is a big number, much more than the probable end game. And we went looking for cheap downside volatility and we found it.

The place that we really went looking for it was insurance companies. So the very best trade we did was we bought for 92 cents each, a million put options on Allianz at 205. Allianz was at the time trading at about 230. The bottom was about 115. So if we had managed to time it perfectly, we would have made on that 920,000 deployed about 70 million. No, 90 million. We actually wound up making about 60 million. It was still an astonishingly good trade. And we got it despite the fact that we were fundamentally wrong about most things. If it weren't for that trade,

my year would have been very ordinary, right? Because I promise you my year's been pretty ordinary since. We had a bunch of other trades, but our results in March were extraordinarily good. And then the virus didn't behave that way at all. It didn't come close to behaving that way. And it took me fully six months, no, five months, to work out where I was wrong. And I guess if you were smart about it, you would have worked it out faster, but the Dunning-Kruger effect is strong in me too.

And the particular way I was wrong was a simple behavioural thing. And there's a very simple behavioural model of the virus, which doesn't fit reality either, but comes a lot closer than the model of a phage and bacteria, which is that people are risk adjusting. If the virus is running rampant and going out means you're going to get sick, then you're probably going to stay at home. If the virus, like it is in Australia at the moment, has effectively disappeared, then going out has very little risk, and so you're going to go out and go out.

And effectively what people will do is that they'll up and down the amount of risk they take in order to match the benefit of going out to the cost of going out. And the benefit of going out might be that they have a party or it might be that they have a job and can get fed. And the cost of going out might be that they get sick or that they sicken their parents or something worse like that. But the net effect of which is that you should expect the virus to run sideways.

That is, the shorthand is R0 goes to 1. If the virus is running rampant, people will behave a bit safer and the virus will drop. If the virus has dropped too far, then people will take more risk and they'll take out and the net effect is that the virus should go sideways for a long time with R0 at 1. And in fact, more or less that's what happened. Now there are some edges to that. For instance, the risk for young people is lower than the risk for old people. So you would expect young people to go out more than old people just because they're risk adjusting. The net effect of which is that the virus will start skewing younger and younger. One of the effects of the virus starting skewing

younger and younger is that your estimate of mortality winds up being wrong. I think the infection mortality of this is probably closer to 2% and certainly over 1%, but the infection mortality when you measure it against the people that are actually infected can be quite a lot lower, and the reason is that the people who are actually infected skew young and healthy. Another effect is that it answers a little bit about why sweden wasn't as awful as you might expect but the us is going to be worse than you might expect and that is in sweden the price for not going out is that you get to stay in a nice swedish home and have nice Swedish welfare. And the price for not going out in America if you're poor is that you starve because America doesn't have welfare in the same way.

So the net effect of which is that poor people will go out far more in America and the virus will spread far more in America. Another effect is that the virus will skew much poorer than you think. So originally in March, this was a virus of rich people, people who had gone to ski resorts in the Italian Alps and things like that. And now this is unequivocally a virus of poor people. The mortality, for instance, in the United States is a bit over eight basis points of the population, meaning just under one-tenth of one percent. But the mortality amongst African Americans is probably three times that.

I have a friend who is friends with some African-American politicians in regional America. And those politicians say that everybody that they know has had people that they know die of this virus. And that's just not the experience of rich white people? And it's not the experience of Swedish people who can afford to stay in their home. So one of the behavioural effects, if you believe my simple equilibration model, is that the virus will skew younger and it will skew poorer and it will skew towards countries that have poor welfare states.

Now, this model also had, if you think the virus spreads easier in winter than in summer, and I do, right, then you would expect as you go into winter the number of people with the virus to rise and the base level to rise because the level of riskiness just goes up but then you would expect it to go sideways at a higher level so at the moment you know the number of deaths per day in America has crept from sort of 1,500 to 3,000 but don't expect it to go to 15,000 it's getting worse right but it's getting worse because of the weather. And

it will go sideways at a higher level but not go exponentially a la the myxomatosis rabbit model. That's just not the way it will work. It will have bad economic effects, right. People will stay home, which is costly. And I want to talk about the policy solution. Because the policy solution to this is, I'm going to be blunt, when people, if you lock down, the virus will go away. But the problem with lockdown is it's very hard to get rid of the last bit of the virus. And the reason is that once you get to very low numbers, people start taking risks again because there's no risk of going out.

And so the actual only way to stop it is that if they're not scared of the virus when it's down to two cases or three cases you've got to make them scared of the police and it works i hate to say it you know what happened in victoria was that they locked down and there were anti-police riots and things like that but they weren't very large and people were scared of the police and there were complaints about the lockdown but done properly where the object is to get rid of every last piece of the virus it works and it led me to sort of a prescriptive view which is that you want there are two solutions to this one i think is better which is you go the whole hog and you do a victoria right and when people are no longer

scared of the virus you get rid of the virus by making people scared of the police and that has a civil liberties cost don't kid yourself otherwise and the alternative is you go sweden but if you go Sweden, you better also have the welfare state of Sweden, right? Because if we're going to say that, you know, please behave well and don't go out if you've got the virus and, right, if you're feeling sick, stay home, et cetera, then we better feed the people when they're feeling sick

and want to stay home, right? A very bad solution is Sweden with an American welfare state right um but it led me to the view if you look at what America's done it seems to have managed to do everything wrong it can't seem to convince itself that it actually has to crush human civil liberties for six weeks. And it can't seem to convince itself that if it wants good behaviour privately, if it's going to ask people to stay home if they're sick, it better pay them to stay home if they're sick. So that sort of... But the net effect of this was i just got it wrong right i really thought in march that we were going to catastrophe and we didn't now and we didn't because i got the behavioral thing wrong and it took me fully five months to get it right again an implication of your

behavioral model is that the right-wing commentators who are advocating that Sweden's approach be replicated elsewhere are actually secretly advocating for Swedish welfare. Yeah, but yes, the idea that Sweden is a bastion of economic freedom is an interesting idea. It is actually. I mean, Sweden is a well-designed welfare state. In a sort of big-picture political view, there was a consensus from Margaret Thatcher to about eight years ago that the way to get rich was free markets and good institutions and rule of law, but essentially freedom. And there was a right-wing view of that consensus which was

that oh you're getting rich and you're free what more do you want right hooray Margaret Thatcher and there was a left-wing view of that consensus which in Australia I would associate with Paul Keating but I'd also associated with Sweden which is, so now we're going to get rich, we can afford a decent tax system, a decent welfare system, a decent environmental protection, etc. And if you ask me where I place politically, I'm on the left-wing view of that consensus. Paul Keating is a private hero of mine. Unfortunately, as I say, the consensus is broken, right? On the right, they no longer actually seem to believe in good institutions and good rule of law, right?

That was not what Trump was about. It was a different sort of populism, and I'm not sure what they... I mean, I look at the left sometimes, and I don't think they believe it either, right? So, you know, here am I, somebody left of centre saying I'd happily have Margaret Thatcher back because at least I agree with half her agenda. Right. And that's not something that I say very comfortably. Now, there are other things I've learned this year.

My favourite one is an article in the New Yorker magazine about David Shaw, S-H-O-R, who's a political consultant for the Democrats. But he quotes papers from David Brockman, who's on Twitter, who's a political scientist, I think, at Berkeley. Yep. And this was an analysis of politics. And I should have got it instantly, but I didn't. The general rule of thumb in life is that Dunning-Kruger effects are everywhere and the way to avoid them is to hire experts, right? Because mostly you defer the decision to an expert

because getting genuine expertise yourself is expensive. And I understand that. I do it all the time. I don't do my own plumbing and I never will, right? But in fact, the observation was that most people do this with politics as well. So there are 30% of people on the conservative side who just believe whatever the conservative leader says. So if the conservative leader is a free marketeer like Margaret Thatcher,

they're suddenly free marketeers. And if the conservative leader is a protectionist like Trump, and I'm a free marketeer, get me, I'm on Margaret Thatcher's side of this, but if the conservative leader is a protectionist like Trump, they're suddenly protectionist. And if the free marketeer thinks that the right, if their conservative leader thinks the right defence policy

for Australia is to buy or build very big expensive submarines they'll believe they'll but they'll they'll want to buy or build very expensive submarines it's actually not a stupid way to behave right and the reason it's not a stupid way to behave is you find somebody that roughly aligns with your view and you defer the decisions to them. And that's actually the equivalent of hiring the expert. And it's a rational – and there's no way that a non-representative democracy can work because it's just too expensive to get expert on every subject. And there is, of course, somebody who does the same on the left of politics. So if the Democratic leader or the Labour Party

leader says, is suddenly a free marketeer, they'll be a free marketeer too. And if they suddenly don't like immigrants, they won't like immigrants. And if they suddenly think that immigrants create jobs, not cost them, they'll like immigrants. They'll follow the leader. That relies on your leader being responsible, right? Because despite any evidence to the contrary, Donald Trump, for instance, is telling people that this election was rigged in the US. And there's a sizable proportion of the population that believe it's rigged and they believe and incidentally if a democrat leader were to say that the election was rigged there would be a sizable proportion of the population that believed it was rigged and that's really corrosive for

for democracy at some point or other your leader has to decide that that power that they have, right, and that power that they have because people have delegated decision thinking to them can't be abused. Then there's a collection of people who look like they're in the middle. And I always assume that they're a bit like me. Now, politically, I am a left of centre swinging voter, right? I have voted for the right in politics a few times in my life, typically when the people on the left are corrupt. And I have a particular thing about corruption. I have genuine expertise.

And when I see the left on politics being corrupt, as they were at the last New South Wales Labor government, for instance. I will vote for the Conservatives. But I think of... I instantly thought of people in the centre as being a bit like that, right? Meaning, essentially, centrists. And I'm wrong. This paper by Brookman actually argues

that the people in the centre don't have centrist views, that they just have inconsistent views. So instead of being, say, a protectionist or not a protectionist, they might be a protectionist with respect to Chinese competition, but not a protectionist with respect to European competition. Or they might like immigrants but not immigrants that come from the wrong racial group. Or they might like a welfare state but not like taxation, right? Which not only, you you know can actually be genuinely inconsistent right and that politics the art of the political consultant is not about capturing

the middle it's about moving the rhetoric for the inconsistent views of that great group of people towards your side. I never understood it before. And I know I couldn't do it. I'm not a political consultant. And there's a good reason I'm not a political consultant to get genuine expertise in that would be a lifelong task. You shared Brookman's paper with me. I loved it. And just to recap again for people, I'll link to the paper in the show notes, but the high level summary is that pollsters and political scientists code beliefs that aren't either liberal or conservative as moderate, but that's because the bundle of beliefs isn't consistently liberal or consistently conservative. But if you actually drill down into any individual belief,

it could actually be an extreme belief. So someone could hold an extremely liberal stance on tax policy and simultaneously have an extremely conservative view on immigration. Or any other set of policies. And they would be coded as a moderate. Yes. But they actually hold quite extreme views. And usually they're not very well thought through.

Yeah. Right. The inconsistency is a key part of that. And I spent seven years of my life in the Treasury Department, and I have a very sophisticated view about how some parts of the policy sausage are made. So if you wanted to talk to me about business tax rules, I can suddenly get very detailed and very nuanced. And even then, I pass my decision-making process to the leaders on a lot of things, right? I genuinely have no

view about whether the giant submarine project Australia is undertaking is a good or bad defence policy position. It might be a boondoggle, right? I suspect it probably will be because big government projects with a lot of jobs and a bit of politicisation become bad, you know, badly run. But as a big picture, I'm not sure whether we need the submarines or not. I'm prepared to give that rather important defence decision to my leaders.

And to pick one that's actually really quite moral, Australia has a policy, for instance, of locking up certain classes of illegal immigrant. Instinctively, I think that policy is immoral right it makes me squeamish and my mother was a refugee right so i should be cognizant of the fact that there are genuine refugees and locking them up is unfortunate and unpleasant but even then when my when my actual personal morality finds an anathema, I'm not prepared to protest it. Even that I defer to my leaders,

although if it actually came up as being an issue on an election, I'd probably wind up thinking about how I vote on that issue. It's quite a... If you actually analyse it, it's quite disconcerting just how much you choose to behave like that on and how important the issues can be. And I know I have to because, you know, I can't understand cosmetic ingredients and, you know, how vaccines work in one week if I also have to concentrate on all the other issues in the world. is in fact just the argument about how people make decisions generally, which is you do a bit of research,

you discover you've got a Dunning-Kruger effect, maybe you're an idiot there, but maybe you're not. If you're not an idiot, there are two solutions. One is work really hard, and the other solution is defer to an expert. And a lot of the people in the middle here with their inconsistent views are being idiots, right? But that's also done in Kruger effect going on.

Yeah, if you take the definition of moderate that most people use, then Trump would be ideologically moderate. That was one of the arguments that... Yeah, well, certainly Trump doesn't align with Margaret Thatcher on very many issues, right? Margaret Thatcher was very extreme and Trump is a conservative leader,

but he doesn't look at all like Margaret Thatcher. No. Right? I look a lot... And I'm a left-winger, generally, and I look very like Margaret Thatcher on a lot of issues. This notion that there's this massive silent moderates out there, but that's actually an illusion, is that...?

Now I'm getting into Dunning-Kruger effect myself. I've read these papers. They make sense to me. But if you want me to answer detailed questions on them, I'm getting into Dunning-Kruger effect myself. I've read these papers. They make sense to me. Yeah. Right? But if you want me to ask, answer detailed questions on them, sorry. Yeah. Well, no, my question's more general. It's, is that tradable, that idea?

Why was it such a big insight for you? Because it was a whole lot of the world that I didn't understand at all. Yeah. Right? And now I sort of get. When I watch politicians doing things I don't understand and voters reacting ways I don't understand, I didn't get it at all.

And I have been thumped by it several times. I didn't think Trump would get elected. I didn't think Trump would get elected. I didn't think Brexit would get up. Both of those were genuine shocks to me. And they both looked irrational to me. And they still do, incidentally. I can understand why people object to the status quo, and both of those were objections to the status quo.

But if you were a small government right-winger and you were given the choice of Trump or Margaret Thatcher, you would take Margaret Thatcher every time. And yet, I suspect Trump gets more votes than Margaret Thatcher and certainly gets more passion than Margaret Thatcher so I you know I the the revelation to me was here's a model that explains what's going on when I don't right and? And that's always interesting to me because there are big parts of the world I don't understand and then suddenly I get a model that explains it

and the model's right. Read the paper. It's linked in the... Yeah. It's a great paper. Right. Any other lessons in 2020? Well, we should talk a little bit about monetary policy because

Sufi Amir, who's been a guest on this blog, on this podcast, and actually went out to lunch with me and you at one stage. He has a macro paper that actually explains what's going on in micro terms. And that is, there's a shortage of assets to invest in, and rich people tend to hold things as nominal assets. And so if you drill through the balance sheet of rich people, you actually find very large amounts of nominal assets underneath them. And sometimes it's not direct. In my case, you'll see a few hundred thousand dollars in the bank,

but you'll see a few million dollars sitting in the management company and you'll see that I own Google. And underneath Google is 10% of the market cap of Google is sitting there in cash as well. So if you drilled through my balance sheet, you see a lot of cash. You also see a lot of cash because I'm short things and there's giant cash balances associated with the short. So if you drill through my balance sheet,

there's an enormous amount of cash. But in fact, the Amir Sufi idea is that if you drill through the balance sheet of almost every rich person, you find, after you take away the corporate abstractions, large amounts of nominal assets. And those nominal assets have to be lent out. And what you're seeing is rich people with very low marginal propensities to consume lending vast amounts of money to poor people who have higher marginal propensities to consume, lending vast amounts of money to poor people who have higher marginal propensities

to consume, but the net wealth just winds up accumulating at the rich people. And the net effect of which is that you get an economy that only sort of fires when poor people get more indebted. Now, this is a Chicago economist. And Chicago economists are not known for being centrally planning socialist lefties. But there's, for a Chicago economist, an uncomfortable prescription here,

which is that if you actually want to fix this economy, what you have to do is tax rich people and redistribute the money. We'll link the paper as well. But again, that's one of those papers which feels wrong but when you actually look at it, matches the data perfectly and is probably right. It's a very modern paper in that sense and it's data consistent.

And it's consistent with things that i didn't understand in the world so that was sort of a revelation for me as well and i know that was a revelation i got originally by listening to this podcast and hanging out with joe walker right but it's still fun to get that revelation i should also talk about you know what's happening in the markets now um because we're talking about because the monetary policy is clearly different this time yeah right it's it is more effective at pushing up asset prices and less effective at stimulating the economy than in any other time in human history. We have models for it. I'm not sure I believe them.

Another thing that has turned up is SPACs. The hottest craze on Wall Street at the moment is the Special Purpose Acquisition Company. Now, if you go look at bubbles in all of history, except maybe the last one a recurring feature is companies where you are deferring to the management the right to invest there was a very famous one from the south sea bubble which literally was called and joe's going to read the name because he's marked it up because i've been talking it about it him. It was called A Company for Carrying on an Undertaking of Great Advantage, but Nobody to Know What It Is. That was the literal name of the company.

Well, that history rhymes. And there were a series of what were called blank check companies in the 1970s boom. There's a wonderful book on the 70s boom called The Go-Go Years, and the blank check companies turn up again and again and again. And blank check companies had a terrible history. And the basic problem with a blank check company was that you handed the money over and then you lost complete control. And if you did this on a grand enough scale, the money was stolen or was invested in assets

that belonged to friends of the promoters, which means it was stolen. And there are 50 other different ways it was stolen. And so this cycle, people invented the SPAC, which is somewhat different from a blank check company. There's a tradition. It comes out at $10. It usually has an attached warrant, which gives you some upside if the stock should trade above $12.50. It has to do a deal within two years or the money is returned. So you'll get your ten dollars back if it doesn't do a deal

and it gives you a vote when the deal comes as to whether you actually want to consummate this deal so presumably if the deal is good the stock will be trading above ten dollars and you'll vote yes and if the deal is no good the stock will be trading below ten dollars and you'll vote yes and if the deal is no good the stock will be trading below ten dollars and you'll vote no so buying your SPAC looks like a one-way bet right either you're going to get your money back or the stock will trade above ten dollars and so you have reputable fund after reputable fund after reputable fund buying vast numbers of SPAC at IPO. And I sort of understand it. They've solved the problem of how do I get somebody to fund my company to undertake a great undertaking

but nobody to know what it is. But the long history, even of this new SPAC, is if you go look at the SPACs with this new structure that were done prior to 1997 or sorry 2007 2017 just three years ago they've all underperformed there's a SPAC shop that's associated with people that I would regard as organised crime. I have an agenda for a meeting where the people who did the Astara Trio fraud were in Pattaya, Thailand. It was given to me by the federal police. It's a really nice agenda. And I can't mention all the names on it because it's extremely defamatory. This is a really strange business meeting where

people at the business meeting actually had trips to brothels in the business meeting. So, you know, not only were you having a business meeting about regulatory issues, but the afternoon was a session at Sabidee Pattaya. And it's not safe for work, don't go look up seb id pataya but you can understand what it was and one of the lawyers at that meeting is now a spec promoter right and yeah i'm shorty specs right but he's been a spec promoter for years and his SPACs haven't worked out very well and nobody gives a damn right so you know we have blank check companies again and the blank check companies which didn't work last time have a protection in them to make them better than the last slot and they're still not working this time right so there's all sorts of things like that that make me think it's the top and every now and again i think it's the top and i get a little bit more

aggressive with my shorts and i get thumped talk about the puzzle of middleby oh middleby this is just one of hundreds of puzzles in the stock market. Middleby is a maker of commercial kitchens. It makes the ovens in commercial restaurants, etc. And its customers this year should have had a very bad time. Now, you've got to think what very bad time here means. Food is a little bit cyclic. The food price goes up and down a little bit with economic cycles, but it's not enormous. If you buy a processed food company, it's barely cyclic at all.

Washing machines are more cyclic than food. And the reason is that when times are good, I'll refurbish my kitchen or i'll buy a new washing machine but even when times are bad i might buy a washing machine because the last one died right but you know washing machines are a bit more cyclic machine tools literally yes okay all right yeah top weirdly and this is to tell you just how extreme um investing can get we know a lot about the enzymes that go into detergents because we've invested in companies that make them occasionally and you can wind up learning a lot about the constituents of detergents and then you can

wind up learning about the difference of top loaders and front loaders and how they perform and now i now you realize just how dull my job is you know right i wind up reading washing machine performance statistics for work so yes although they're cyclic when we and there are differences when we caught up last year you were investigating bull masturbating. Oh, yeah. Always boring. Actually, I'll tell that story because it's good fun, which is there's a company in the UK called Genus.

And Genus is the biggest supplier of pig genetics in the world. And pig genetics have improved and improved. And what I mean by improved is they're more resistant to disease, but much more importantly than that, they have good grain conversion rates. The grain conversion's down to about 2.2, which means you need 2.2 kilograms of grain to get a kilo of pig. And that makes pigs cheap. Now, that's much better than beef, which is more like four and a half or five kilos of grain to get a kilo of beef. Now, the company that's driven more of that than any other company in the world is an English company called the Pig Improvement Company, which is a subsidiary of Genus.

And the Pig Improvement Company's had a very good year or so on replacing the pig stock in China after swine flu. And China is modernizing its piggeries on a grand scale. And there are all sorts of lines about this. The way that a modern piggery works is that they have breeding sows who have 24 in each litter and the breeding sows are basically caged so they don't roll onto their offspring and they're artificially inseminated and genus will sell you the breeding sow lines and it will also sell you the semen lines and there's they breed them separately so the breeding sow lines are bred for fertility and the male lines are bred for meat conversion and there are both males and females in the male lines and there are males and females in the female lines but most of the breeding is done with the males because males can have more offspring but when you're selling breeding sows

you've got to get them from england to china so the first question is do pigs fly and the answer is if they're good enough but in this case the pigs fly with 24 offspring in them. So they IVF fertilise a breeding sow with 24 more good breeding sows. And so now highly pregnant pigs fly. But genus also has another business in dairy genetics. And dairy genetics has been turned on its head in the last six years by sex sorting and the idea is that you're a dairy farmer and you have your potties your your your cows and you know which ones are good cows and which ones are bad cows because you've got a

um an rfID chip in every one of their udders and you actually measure the milk by cow so you know that this this cow's a really good cow and this cow's not and every cow's got to have a calf every year right no calf no milk but what is really bad news is if your your very good cow has a male calf, right, because a male dairy cow is useless, right? They're sold off for pet food and you don't get anything for them. In India, a male dairy cow is even worse than useless because it's a sacred cow, you have to feed it,

but you don't get any milk from it. So giving them sex- semen means that only your female dairy your best female cows all have females which improves the quality of your herd. Also if you have them from very fancy bulls right which might be say A2 A2 or some some genetic characteristic that you like, you can improve your breeding stock by buying semen from the very best bulls. Now, this led us to what I think is the classic piece of stock research, which is that we wound up telephoning just sort of randomly a business in Queensland called Bull Masturbators. And Bull Masturbators effectively confirmed the story for us.

They had six ST Genetics, which is a competitor's sex sorting machines at the back, and you could leave your fancy bull there and they would milk it. And then the guy who ran it just said... Not the sort of milk you want to drink. yeah with the guy who said to me well that ain't milk right but it is a sticky business right and yeah i mean this is very typical bronte stock which is highly technical it's a small thing that makes a big thing better. And semen is a small thing that makes your whole dairy herd better. And if it's a small thing that makes a big thing better, you can charge a lot of money for it. So they tend to be fairly good businesses. And I know that we can make jokes about, you know, selling semen and then it was kind of funny because all of this semen is distributed to dairy farms all around the world with a cryogenic cool chain it's distributed in straws in liquid

nitrogen and there's been all this talk about how hard it's going to be to distribute covid vaccines and having talked to people who distribute dairy seam, and I've come to the conclusion there's quite a large infrastructure there in place. So, you know, some of this talk seems to be rather overstated, even in rural areas. So, you know, it's kind of puzzling how things that you see in one part of the world wind up affecting things you see in others. I didn't mean to talk about sticky business. It's kind of fun. It is. I distracted you. I'm sorry. We were talking about Middleby. Yeah. Middleby makes ovens. And food is a little bit cyclic. Washing machines are very cyclic.

As a general rule of thumb, capital equipment is more cyclic than non-capital equipment. So if you own a capital equipment stock and there's a boom, you're going to make a crap load of money. And if you own a capital equipment stock and there's a bust, you generally lose a crap load of money. And it's particularly bad when the capital equipment has a good liquid second-hand market. So if you're Caterpillarillar you're making bulldozers small

bulldozers and they have a good liquid second hand market when the bad time comes nobody buys a new bulldozer because there are plenty of good cheap second hand ones around and so you know you would expect caterpillar or joy global or kamatsu to be a highly cyclical stock and not this cycle because it hasn't seemed to happen but in every other cycle in history they have and you know the Joy Global went bust on a cycle a few years back and you sort of expect that and the right price for a caterpillar dealer in or a John Deere dealer in Aubrey Wodonga at the bottom of an agricultural cycle is a dollar right the dealers the dealers take a disproportionate amount of the

pain now Middleby make ovens for commercial kitchens and you'd have thought that there was a very big cycle going on right there are an awful lot of restaurants that are closing right um one of my favorite Greek restaurants in Sydney is closing this week and they're blaming coronavirus as the story. Which one's that? 1826. Yeah. It's gone, so I can't recommend it anymore.

Lucio's is closing. I mean, these are disasters for Sydney fine dining. But as those restaurants close, their commercial kitchens should get resold. And it's good equipment. It's got long lifespans. So you would expect that this sort of thing is impacting the second-hand market very dramatically

and should impact the new sales. And I can't see it middle b is it's not middle b is back at its all-time highs the stock is not bleeding large amounts of cash you know psych capital equipment makers selling cyclic equipment should go bust in a bad time and it's going great guns and i i've got puzzle after puzzle after puzzle like that and sometimes the answer to the puzzle you'll discover is it's not really going great guns it's faking its accounts i don't think that's the case at middle b and i'm pretty good at spotting fake accounts and it might be but i don't think it is right another way is that you've just understood the market wrong they might be

selling entirely to sort of a takeaway industry doing greasy buffalo chicken wings delivered by doordash and it might actually be on the right side of the cycle but i'm thinking it's on the right wrong side of the cycle because it's making high-end commercial ovens as well and so i'm i have an illusion because I've just misunderstood it. If anyone actually knows the answer, please tell me. But I could also point you to 50 other puzzles like that. The auto industry is full of puzzles like that. It looked like it was going to slow down.

Miles driven is obviously way way down this year and yet the auto industry seems to be doing fine now part of that is that um ordinary cars are down and luxury cars are up and luxury cars have fatter margins and so the auto industry is being a bit bailed out by the fact that this is a drive towards fat margin luxury cars. But again, the whole world is seemingly full of these puzzles. I wish I knew the answers because I'm just being thumped every day at the moment. And I talked to competent suburban financial planners, which are a very rare but existent species. And they are having problems that their clients have started punting stocks during March when lockdown.

And the clients are up 70 or 80 percent and the fund that the client's in is up six. And so they're pulling money out and thinking that they can do it better. And this probably ends badly, but I can also see this happening to us if I'm not careful because our numbers are not great at the moment. And I'm pretty sure some of my clients think maybe correctly maybe incorrectly they can do it better when I see 40 million active retail accounts in the US I know that at least 39 million of them are done and the Dunning-Kruger effect is really positively there in 39 million of those cases if you're out there trading speculatively I hope you're in the last million Really positively there in 39 million of those cases. If you're out there trading speculatively,

I hope you're in the last million. But that is how this year is. It's full of things that surprised me, right? Whether it be the real behavioural model of coronavirus or whether it be politics surprising me in ways that I think it is and things I don't understand like why is Middleby not in the crapper and I'm fighting what looks to be a generational bubble but I don't know whether it's a generational bubble because it's 1998 on the way to a collapse two years later or whether it's a gen or whether we're already into july or august 2000

and the gate the gig is up and i i've got to try and make sure that I don't get thumped, but still be there when those 39 million bad retail accounts unwind at the end. We'll leave it at that. I've got to cook you dinner. Sounds good. Thanks so much, John. Bye for now. Thank you for listening.

Links and show notes are on my website, josephnoelwalker.com. If you want to get me a Christmas present, leave me a review and a five-star rating on iTunes. I promise I haven't been naughty this year. Until next time, thank you for listening. Ciao.