We Study Billionaires - The Investor’s Podcast Network - TIP290: Current Market Conditions 4 April 2020 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. So there's a famous quote that there are decades where nothing happens and there are weeks where decades happen. And based on the current situation around the world that we're seeing, I think everyone can agree that that's exactly what we're seeing. First and foremost, our thoughts and prayers go out to all the families and people struggling around the world right now. Although our show is focused on great investing ideas and outperforming the markets,

Starting point is 00:00:23 please know that our sincerest interest is for everyone to have strength and courage to come out of this situation better than we came into it. it. So on today's show, Stig and I do another candid conversation about what's happening in the markets today and what we can expect moving forward. I hope you stay safe and enjoy the show. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone, welcome to The Investors podcast. I'm your host, Preston Pish, and as always, I'm a company by my co-host, Stig Broderson. And we're back with you here for another current market

Starting point is 00:01:14 conditions. We're trying to watch these things as best we can and provide the best feedback that we can. So we've got a list of things that we want to go through today. And I'm just going to throw it over to Stig to kind of kick things off. We'll just see where this takes us. The first thing we're going to talk about is what's happened to the stock market since we recorded last time. And it's two weeks ago since you heard from us last time about the current mind conditions. And today it's April 1st. And I have to say before the market opens, like these days, everything is so volatile that you almost have to say, not just the day, but like which time of day it is. It's absolutely amazing. Now, a few different things to the type of market environment that we're in right now, which is

Starting point is 00:01:55 quite unusual to say the least. First of all, I think it's important for the listeners to understand that you shouldn't believe the newspapers too much whenever they try to explain what's going on in the market. And that's because most newspapers treat it as sports, right? They want to put everything into one headline. That's just how the newspaper business works. It can be a little more confusing than helpful from time to time. So if the market goes up, it's always because of financial spending, or at least that's the way they phrase it. And if the market goes down, is always because the market is worried about something new with COVID-19. And I think that quickly becomes very simplistic. Not just the past two weeks, but for quite some time now, it has

Starting point is 00:02:38 been known to the market that the virus is very serious and it has also been very obvious that you would see major fiscal spending and we are likely not done. So as a stock investor, I think it's important that you zoom out and understand what's truly going on. What you see right now is that we get more and more data that the market is trying to factor in. And they're trying to do that with known unknowns and unknown unknowns. And that's just a very volatile process that takes some time to adjust for, which also takes me to the next point. Because in times like these, and I just mentioned before, that it is actually important to say which time of day we're recording. And by the way, we're recording this before the market opens. So what I've been doing some of these days,

Starting point is 00:03:23 as I've been putting out orders is that I'm looking at the futures market. And I usually never look at the futures market. And if I do, I don't do it for that day. So I just looked it up here and we are looking at something like the market opening in minus 3%. Now, the reason why I'm saying this is that we have often here on the show talked about using limit orders. And I still don't think there's anything wrong about doing limit orders. But we've seen days where the market has been like down 10% or up 10%. So it actually makes a lot of sense to look at futures if you are looking at the market on a day-to-day basis. So let me just give you an example. So for instance, say that you put out a limited order on the S&P 500 that right now

Starting point is 00:04:08 is trading at 2,500 and you put it out to say 2499. Usually under normal circumstances, if that was a bet you met a long time ago, you can say that's fine. But because it comes. But the markets are so volatile right now and because you see this major, major swings, it can actually make sense for you to pay attention to the futures and remove some of those orders, because the futures market, especially short term, are very, very efficient, and in that sense, you can go in and not take the worst beating right after you make that position. That goes for buy orders as well as sell orders. But other than that, I also just want to point out whenever I look at the past two weeks,

Starting point is 00:04:50 we've seen some crazy things happening 17% in just three days last week, which was the biggest relish since 1933. So if you're wondering, last time we talked about TEP finance, our new tool, we talked about the momentum of the market. And we talked about how a tool called the February 26th, that perhaps now was the time to go out of the market. that hasn't changed. And Stig, I just want to add that for people that maybe didn't experience 2008, 2009,

Starting point is 00:05:20 and they're looking at the volatility that we're seeing in the S&P 500 index and seeing these 10% swings or 5% swing in a day, and they're thinking, this is crazy, this is pretty normal for what it looks like when you're in a recession-type environment, a crash, this is how the market behaves. And so much of it goes back to some of the stuff that we mentioned two weeks ago with the derivatives market because I think the best way for people to think about why you're seeing such abrasive moves in the market is because you have everybody that has to come into cash. They have to come into Fiat money in order to make good on those derivatives.

Starting point is 00:06:02 And so when you have that playing out, and it's because you have people that are having margin calls because you had the biggest supplied demand shock the world has ever seen with this coronavirus. And so when you have that taking place, you have this force selling. You have these liquidations that are massive on scale. And so if you see it go down by 10 percent and then see the next day it's up 7 percent, that is your normal volatility, especially through the initial part of something that has such a ridiculous shock to the system. So the fact that the fact that we've seen a bounce, I'm not saying that it won't keep going higher, but I'm also not saying that the bottom's in. I think that what we're seeing right now is standard volatility for

Starting point is 00:06:46 the type of trend, the long-term trend that I expect to continue to see with the current market conditions. So it's easy for people to look at this and say, oh my God, it's up 20% from the bottom. I missed the bottom and now I got to buy. And then they step into the market. If you go to any large downturns that we've seen historically, and I'm not even just saying the 1929 one, because that's the most notorious one that literally went on clear out to 1933, every time you thought, all right, it's hit its bottom, let me step into this and buy something because it's up 40 or 50 percent. That was the next interim top for a mega downtrend. And I'm not saying that's what's happening here.

Starting point is 00:07:32 I kind of expect it to happen more, my personal opinion, but I think it's important for people to have that realization that if you see a 30% up, that that's not necessarily symbolizing that you've hit a bottom here. And I think something else to watch very closely is the volume that you see here. If you don't see a massive amount of volume, it's probably just within the momentum trend that we're seeing. And I think the long-term momentum trend here is in a downwind. direction. At least that's what our TIP momentum tool is recommending. It's still read on pretty

Starting point is 00:08:05 much every single company and ETF that we're viewing. So I think that's important for people to remember. I think you bring up a good point there, Preston. It's easy to have too much of a narrow focus. If you just look last week, it definitely looks like we're on the way up. But we talk about bull markets and bear markets as it's a linear process. Or at least that's the way it can be perceived, but that's not how it works. It's not like you have seven years and it just goes up, and then you have three years and it only goes down. If you do a case study on some of the crash is 29 or dot com for that matter in 2000, it didn't just go down. You have all types of interventions, financial stimulus package, monetary policy that's coming into the mex, and you see this spike

Starting point is 00:08:50 and a lot of people think, wow, now it's over. And now it just continues going down. So I think you're right. I can easily see this go down more. Then you're might see a spike again, you might see the market rally, and then you'll see it slide down again. I reference Ray Dalio a lot. I know I do, but he has some amazing points on helping people understand how the markets work. And when you start getting into some of these margin calls, especially very large shocks to the system, it has a self-reinforcing effect to it. And that's where I think people who especially have participated in the markets over the last 10 years and maybe didn't experience the 2007 to 2009 timeframe, just don't have that experience of seeing

Starting point is 00:09:34 how these actions and this selling that we're seeing has a compounding impact. And I would argue for how much upside we saw in the last 10 years, when you think of it like winding up something that's spring loaded, when you wind that up and wind it up, when you finally aren't able to push it any further because maybe with the source that you're using, the wind it is just not strong enough to wind it any tighter, when it starts to undo itself, it picks up steam and it picks up momentum as it starts spinning the other way. And so you're seeing that right now, the fact that you have all this capitalization. And when I say capitalization, you basically have central banks that have continued to supply more and more liquidity into the

Starting point is 00:10:18 market, which bids the prices of stocks, which bids the prices of all these different things as a capitalization above the earnings power. So if I'm a company and I made $10 last year, I might be capitalized in valuation at $100. If I make just one more dollar to $11, now my capitalization might jump to $110 or $115. And so the whole market is bid in a way that it's capitalized, meaning there's this multiple effect off of the earnings. So if those earnings start to contract, that capitalization, is moving in the opposite direction.

Starting point is 00:10:56 And so that has a compound impact to the valuations of how other things are priced. So like, let's say I went out and I was getting a loan on my house, but it was based on my net worth. And my net worth was based on a capitalization of 110. But now all of a sudden, because the earnings power that that underlying capitalization has moved down to, call it $7, and now the market cap moves from 110 down to call it 70 or 80 or whatever it might be. Now I can't afford to go out and get that loan that I used to be able to get because my net worth was capitalized at whatever. And I'm just giving a really,

Starting point is 00:11:31 really, really generic example to show how those forces compound upon themselves as things like this unravel. And so that's why you see these bursts and these drops and these bursts up and then further drops down because that wheel is spinning in the opposite direction. And that is a really important concept for people to understand that they're self-reinforcing on the way up, but then once that momentum shifts and you get into a long-term trend in the other direction, it's self-reinforcing in the opposite way as well. With that in mind, let's talk more about the Fed and what's going on these days. The Fed has been very busy. Previously, they announced that they would now start to buy up treasuries and mortgage-backed securities, traditional referred to as QE, quantitative easing.

Starting point is 00:12:18 Now they changed that to they would buy with no limits in the amount needed to support smooth market functioning, which to me sounds like very fancy language to let's print unlimited money more or less. And I sort of like enjoyed that phrasing, but just to sort of like set the scene, what is quantitative easing? And we talked a few times on this here on the show. But I think it's just important to preface the discussion, perhaps for those of you who wants a quick reminder about what is this all about. Really the process about the central bank

Starting point is 00:12:52 buying mortgage-backed securities and treasuries from its member banks. And with the money from that, it increases liquidity and the flow of money in capital markets. Practically, that means that the trade desk at the New York Fair Reserve Bank, they're handling all of this for the Fed. And even though it sounds like it's something that happens between banks, the banks really just the intermediate, the intention is to push out money in society and create growth, or in this situation, at least soften the blow from the economy contracting. So if we are looking at the balance sheet of the Fed, be ready for some big numbers here. The latest number I could pull up was $5.3 trillion, and that was up 12.4% over just the last week, and it continues

Starting point is 00:13:42 to grow. I mean, that's mind-boggling numbers. And the 12%. 12.4 increase, that was partly a function of the Fed adding 255 billion in treasuries and 19 billion in mortgage-backed securities. But what I think was really interesting was the currency swaps you see right now. And that rose from just two weeks ago from $25 billion to the $206 billion because there is a dollar shortage out there. The reason why the Fed has greatly expanded the currency swaps with all the central banks, this has both been the traditional partners, but actually also a bunch of new partners where treasuries are traded for USD. And because of the huge demand for dollar denominated assets, the Fed has greatly expanded the currency swaps. So basically

Starting point is 00:14:25 what's happening is they're trading U.S. treasuries with USD. And I would say that it's hard to know right now how big the balance sheet can grow. I've read estimates that some are saying it can reach 10 trillion by the end of the year. And keep in mind we're just above $5 trillion. I have another phrase here from the Fed. I just want to say in this regard. that they would aggressively and forthrightly continue its efforts and not run out of ammunition. So you do the math, how much you think the balance sheet would grow to. And just in comparison, again, in 2008 during the crash, we saw a 3.7 trillion growth in the balance sheet doing that.

Starting point is 00:15:05 I can easily imagine this would be a lot more. I think 10 trillion is low. I've seen some other things that were saying 20 plus. Now, whether you get there in 2020, I don't know, but this brings up a really interesting discussion that I want to talk about, which is really how are they going to decide in a fair and balanced way of who gets bailout money, who gets loan money? Because they're talking small businesses, we've got loans for you, but the large businesses will just, the Boeing's will just give you the $50 billion that you ask for with no strings attached. I just don't see that playing out

Starting point is 00:15:42 real well from a social unrest standpoint, especially all the elected officials in the various districts that they represent, that some of these large cap companies that are quote unquote too big to fail, just effectively getting a handout. I mean, what you're seeing with some of the existing policies and the direction that a lot of this looks like it's going towards, you effectively have socialism for the wealthy and the large cap companies, and you have capitalism for the small cap companies and the masses. And I know that that sounds crazy, but that's effectively what you're seeing with existing policies when a Boeing asks for $50 billion and they just get it.

Starting point is 00:16:27 And your small businesses are saying, hey, I know you're not working. And I know you don't have anybody there. You're not collecting any revenue. but we have a loan that we're willing to offer up to you. I just see that really causing issues in the manner and how all this money is being distributed. Now, where I think this only amplifies itself is when you start getting into state and municipality, the issues that each one of them are having with their solvency. Going into this, I would say that you didn't have the most credit worthy municipalities

Starting point is 00:17:00 and local governments going into this. Coming out of this, when you look at some of these smaller towns here in the United States, they are relying on those few small to mid-cap businesses in their regions for a significant portion of their tax revenues, whether it's the employees paying the taxes or it's the company itself paying the taxes. Well, if these businesses have been shut down for, let's just say they're shut down two months, everything comes completely back online with no issue. You've effectively had a 20% drop and what they would have received for the year. That is going to cause major, major issues, a 20% decrement and

Starting point is 00:17:43 tax revenues. And trust me, I don't think that it's going to be 20% in the grand scheme of things. Like when this all plays out, everything is not going to just come back online and everything's all hunky dory like it was before this happened. So that's my concern moving forward. is now you're going to have municipalities that are saying, we need a bailout. You've given all this money to all these companies, you've given this money to whoever. And so why don't we get the money? And so you're going to have this constant request for additional capital that I don't necessarily think everyone is accounting for at this point that's only going to amplify six months from now. Six months from now, a lot of this is going to start to be realized and you're going to see more

Starting point is 00:18:28 and more and more organizations, local governments, state governments that are then saying, we need some money. And it doesn't help that interest rates are pegged down into the zero or even negative if you're talking in real terms. How are people supposed to get yield in their portfolio? Especially if they can't tolerate volatility. How in the world are they possibly going to get yield? And so if they can't, they're going to have to do other things. And there's really no other options, in my personal opinion, for them to go, except for stepping into something that's very volatile. On a related note to talking about this monetary policy and what the Fed is doing,

Starting point is 00:19:10 I think it's very important to understand that we are in a very different situation than 2008. I know we keep on comparing to the last crisis because that is what most people remember, but it is very different many ways. We covered some of that in the last episode two. But the Fed only raised rates four times back in 2018. And if you do go back and listen, Press and I, we talked about the interest rate a lot. I voiced a lot of concerns about not hiding the interest rate more whenever the economy was going well for emergencies like these. Because what was the good situation during the last financial crisis, if you can even call the good situation? But that was we had a lot more interest

Starting point is 00:19:48 rate to work with. The interest rate was lowered from $5.25. to zero percent, like really, really fast, which helped pump out a lot of liquidity in the market. But we don't have that anymore. It was one and a half percent. Then 10 days later or whatnot, it was zero, right? So the Fed doesn't have as much in their toolkit anymore. Well, we do know that they have quantitative easing. That's one of the first thing that they go to right now, and that should be the last resort

Starting point is 00:20:12 kind of thing. And going to what you said before pressed in terms of who benefits. If you look at something like quantitative easing, it's not as broad of the measure as something like lowering the interest rate would be. If you go in and buy financial assets, there are definitely some grooves that call the halves that benefit a lot more than you have nots. And there's a lot to be said about this and it is an election year. That's the other thing. But it's very important to understand that element going into this, who benefits whenever we're doing this. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:24:51 All right, back to the show. Well, no, I just want to piggyback on that because now that you're seeing the Fed step in and buy the corporate bond market, which has never been done ever, you have just opened up a whole new can of worms of them making decisions on who's going to remain solvent, who can basically step into the market and ask for more money at a advantageous. yield because the yield isn't real. The yield has been propped up and artificially lowered by the government at that point because you're not letting markets be free and open when you have government stepping in and buying the corporate bond market. So you're in this fantasy land of reality. So like if I'm a business, and let's just say that the yields on my bonds are artificially kept low because the government has stepped in and is buying these ETFs, now I can issue more debt at a lower interest rate relative to the risk that my company actually poses to

Starting point is 00:25:56 its solvency. I don't care what anybody says. That does not end well. That is not something that in the end game, as long as that policy is going to be maintained, in the end, that will end in tears and tragedy because you're stepping in and doing and manipulating things at a mass scale. So where's the limit on that? If you turn something like that on, you have to have, you absolutely have to have a stop limit of this will only happen for one month and it can never be used again because of this dire situation. You have to put in place when you stand it up. You also have to put in place how it will be turned off forever and never used again. But we haven't seen anything like that. I mean, not even close have we seen anything like that. So if I'm a local government, just going back to that argument, and I'm asking for money or I'm asking for assistance with my debt to keep my yield low because I can't afford for my yield to go higher. I just don't know how they could possibly say, well, no, you don't get it, but this organization over here does in a year from now or six months from now.

Starting point is 00:27:08 It's kind of crazy to think that that's what's happening here in the United States where we supposedly have free and open markets. I think you bring up a good point there. Free and open markets, that's not how we can characterize what's playing out in the markets right now. There's just so many short-term gains, long-term pains involved into this, where I'm like, how are you going to solve that? And again, quoting Redallio, and we talked about Redali multiple times here, he mentioned

Starting point is 00:27:35 that one of the reasons why the financial crisis in 2008 was handled so well was that more or less everyone was rescued. And I understand that argument. And I think generally a good thing for all the economy to do that. But we just always also need to understand that if we set a precedent for, hey, no matter how much you mess up, as long as you're big enough, nothing bad will happen to you. And whenever I see some of the things that happening in corporations today, I might imagine that some have been looking back at what happened last time.

Starting point is 00:28:07 I'm not talking just about Boeing. Like, okay, we do a bad job. Oh, we can just get $50 billion with no strings attached. It creates a lot of long-term or incentive for management going forward. And then you really have to figure out for yourself. What's the goal here? Is the goal to punish management who aren't performed well? Is that our goal?

Starting point is 00:28:28 Is it to have a good capitalist system? Is it to save as many jobs, short-term? What's the goal? And depending on what the goal is, the policies that you want to carry out are just very, very different. You know, we should talk about Adam Smith a lot more on this show. And when I look back at how long we've been doing the show, I'm kind of disappointed in us for not talking about Adam Smith more. As everyone knows, Adam Smith's big points was the invisible hand. Well, right now, you've got two very visible hands that are controlling the living heck out of this market. So how are we calculating

Starting point is 00:29:04 inflation? Well, it's a basket of different commodities that make up that index. Let's just talk about oil for a second. So oil is pressing up on the $20 price point with what I would tell you is a trend that is going lower. And I don't expect that trend to change, at least not today here on the 1st of April. Maybe by the end of the month, you might start to see this thing bottoming out. I don't know. But it's completely dependent on how long people continue to not work here in the U.S. everyone's on quarantine. The flights aren't flying. And you're seeing it all around the globe. People are spending way less, extremely less than they normally do, especially when it comes to oil. So there's only so much of this that you can put in storage before the storage is hit max capacity.

Starting point is 00:29:56 I would argue you're kind of hitting those limits today. And as a result, now all the producers now have to start producing less, unless they want to start building capital infrastructure in order to store their oil as they're pulling it out of the ground, which does not happen quickly. So you're going to continue to see price pressure on oil. Now, my point is going back to inflation. Let's just say, for example, the price gets to $15 or $10 a barrel, which is insanely low. It's mind-boggling low. But let's say it goes to $10 a barrel. And everything comes back online. The first stuff that starts getting pulled out is all the stuff in the containers, everything that was in storage, it starts going, well, all your manufacturing has slowed down

Starting point is 00:30:43 significantly to account for what's happened. And you just can't turn it back on like a light switch. So there's this delay of ramping capability back online. So what does this do to the price? Well, of course, the price is going to go up when you're in that environment where demand is coming back online. Do I think you're going to see the same demand profile you saw before this happen? No, but it doesn't need to. It just needs to be more demand than what you were seeing. So if the price goes from $10, back up to $20, from an inflation standpoint, we just saw 100% inflation off the previous price, right? A hundred percent, just going to $20. What if it goes to $30?40. What does that look like from an inflation standpoint?

Starting point is 00:31:30 Those numbers are massive. They are huge. And so when we're thinking about what that impact is going to have on the market, on other securities, when we're seeing what I would describe as not big nominal moves, but massive, unprecedented percentage moves, that is going to cause some serious, serious issues for other securities. So let's just talk through. some of those. So if we see some of these moves in commodities, because I'm talking oil specifically, but think about how commodities perform almost like a scarce resource due to the flow that they come out. And so when you're measuring that compared to a fiat currency, call it the dollar, the euro, the yen, whatever, when you're comparing that to a fiat currency that's expanding

Starting point is 00:32:24 at a rate that we've never seen ever, you're going to see the price on a lot of these commodities pop. So when we talk about how does that impact the bond market? Well, bonds are measured on two main variables. Number one, the risk of the company to actually return your principle. That's first and foremost how bonds, at least corporate bonds, not necessarily government-issued bonds. But let's just say we're talking about corporate bonds. They're first measured off of the ability of the company to repay it. Second, they're based on a premium above the inflation rate. So if my expectation is that inflation is going to be 5%, there's no way in hack in a free and open market that you should find the interest on that corporate debt below 5%.

Starting point is 00:33:11 Right? That's your starting point. That's your base is the inflation rate. So if inflation is, and I'm using crazy numbers, especially for the time we're sitting in right now, but let's just say inflation is 7%. You should not be able to find a corporate bond below 7%, no matter what. Then you add the risk on top of that. So if the company's super risky, well, then maybe you add 10%.

Starting point is 00:33:30 above that. If the company is super solvent and doesn't have any risk to go in into default, well, then maybe it's a 2% premium above that inflation rate. My point is when those yields are going up due to the base layer of inflation, the first thing that you're accounting for going up, that means the price of the bonds are going down. And they're going down in a major way, especially if you have even a 3% adjustment to inflation. I can't even tell you how that impacts a $100 trillion fixed income bond market. It impacts it in a dramatic and insane way. So now let's pull the thread even one more notch.

Starting point is 00:34:14 So let's talk about the equity market. How is the equity market priced? Well, it uses a discount rate based off the free cash flows. So let's just say the free cash flows are completely the same. No change through any of this. The free cash flows are, if it was 100 yesterday, it's 100 tomorrow. If you change the discount rate so that the percent is higher, which is what will happen if you have any type of inflation, guess what? The valuation of that business goes down, just like a bond. If the yield goes up, the price for the bond or the price for the stock goes down. And so I think that you,

Starting point is 00:34:53 I think that these are some of the things that when you go back and you look at a chart from 1929, and I'm not specifically pointing that out because it's analogous to this period, which I think in some ways it is, but I'm not pointing it out for that reason. I'm pointing it out for the reason that back then you saw the market go up 50%, only to contract another 60% from there. I guess what I'm saying is there was all these fake outs where people started stepping back into the market only to find out that it wasn't over yet. So when I think about six months from now, and maybe the market's in a better condition

Starting point is 00:35:26 than where it was at its lowest point. And people are saying, okay, I think we're through this. And demand is going to start coming back online. And then you're going to see inflation start stepping in in a dramatic way just because you're looking at the delta of where the price was moving from before. Now all of a sudden, that's going to start getting priced into the bond market. It's going to start getting into the stock market. And then you're in this situation where what appeared to be a return to reality is only a wake-up call

Starting point is 00:35:55 to the reality that there's been some serious printing going on. And there's been some serious increase in market prices relative to where they were before. And that is going to be priced into the market, whether people want to believe it or not. I would like to continue talking about inflation and perhaps talk a bit more about, is inflation good, is it bad? Because I think that there is this common misperception that inflation is bad. Most people would say that deflation is also bad. So let's start there. Let's start talking about what is good, what is bad, and why.

Starting point is 00:36:31 In most of the developed world, we target something like a 2% inflation rate. So we're not targeting, not having inflation. Actually, we would like to have a bit of inflation. Now, why do we want that? Well, inflation makes consumers expect prices to continue rising. And whenever prices are going up, people will buy now rather than pay more later. And that's good because that increased demand in the short term. And as a result, stores sell more, factories produce more, and they're more likely to hire

Starting point is 00:37:04 new workers to meet demand. And that just creates a really good cycle because those workers get more money and they spend that and on it goes. Deflation, on the other hand, is the opposite of inflation, and we don't want that. So this is when prices go down across the board, we have deflation. Because think about what happened with inflation. That is that people consume now. But if you had deflation, people will wait to see if prices would drop even more before

Starting point is 00:37:33 buying. And it cuts back on demand. Businesses reduce their inventory. As for salt factories produce less. Perhaps they need to lay off workers. As you have unemployment going up, it also leads to wage deflation and now workers have less money to spend. So that means even less demand.

Starting point is 00:37:51 So this is one of those self-reinforcing cycles. So one was up and the other one was down. The Great Depression is perhaps the best example of this. In 1931 and 1932, we had a year-over-year deflation of more than 10% each year. We don't want that. And if you look at the International Monetary Fund, they predict a recession here in the time to come in Q2-Q3. The outlook for global growth in perhaps not just in 2020 is just very doom and gloom. I saw this report here recently from Goldman Sachs.

Starting point is 00:38:26 They predicted a 34% contraction in Q2 in US GDP. Now, what happened in 2008? Inflation was only 0.1% which was the lowest since 1954. because of those deflationary pressures that we're seeing right now. And of course, these pressures are known to the government, which is also why you see that governments worldwide continue printing money through the central banks, the lower interest rates if they can,

Starting point is 00:38:57 and they spend as much money as they can, and that is all to mitigate deflation. So before we talk more about the potential scenario with hyperinflation, that we talked about last time, and we got a ton of questions about those scenarios and how to persist themselves and what it means when there is inflation for us as investors. We'll talk about all of that. But I would like to preface some of that discussion by talking about global reserve currencies, because I think it's so important to understand that whenever you talk about inflation and deflation, you have to understand that some countries are in a different situation than others.

Starting point is 00:39:36 So, what is a global reserve currency? A reserve currency is a currency that is accepted around the world for transactions and savings. And the country that gets to print the world's primary reserve, that is the U.S., it's just in a very privileged and powerful position because debt is denominated in that currency, that's one thing, but also it's considered a stall of wealth. And it's very important to understand that the most important reserve currency, that's the US dollar, that's more than 60%, then it comes to the euro, more than 20%, and then you have the

Starting point is 00:40:09 yen. And those three regions are just in a very different scenario when it comes to mitigating those deflationary pressure, and the possibility of hyperinflation happening are just very, very different too. So perhaps the best way I can explain hyperinflation and explain the importance of having a global reserve currency is the textbook example of the Vibeenflation. Republic after the First World War. And as an economist, I just love this example because it's so educational and it's so

Starting point is 00:40:42 interesting whenever you hear those numbers here. So whenever I say, Vimer Republic, you can just think Germany after World War I. Between July 1922 and November 1923, price rose with 387 billion percent. In a little more than a year, we had more than 387 billion percent. increase in Germany. That was an inflationary crisis. So it was not the world's reserve currency. And now, what happened? So after the Versailles Treaty, after First World War, the Allies demanded war reparations, and it had to be paid in foreign currency and essentially had to be paid in gold too. And as a result, money was printed in Germany with no limits because they wanted

Starting point is 00:41:31 to pay off that debt. But as a result of the Germans, just printing, prints and printing, Mark was the name of the currency at the time, they currency depreciated as rapidly as inflation went up, and you saw hyperinflation. And what happened was that the Vimer Republic was no better off, and the crisis had basically just been a lot worse. Now, why did Germany do what they did? actually, if you go back, it sort of makes sense why they did what they did. At the end of the war, Germany couldn't borrow in their own currency. And that was due to the outlook of the war, creditors were just afraid that they won't be repaid. So they couldn't do that in the German mark. They were really faced by two options. They could not borrow money and be 100% sure

Starting point is 00:42:19 they would lose the war, or they could borrow money in another currency, typically in Sterling or in the US dollar. And if they won the war, they expected to be a global reserve currency, they could print money, and they could also enforce war reparations from the Allies. We know what happened, Germany lost the war, and now they were just this huge issue, like what were they supposed to do? There was a lot of negotiations going on, especially the French, didn't want to give the Germans any kind of debt relief, and they wanted to be paid in full, they wanted

Starting point is 00:42:46 to keep Germany really weak. Looking back, that was probably not the right thing to do, and you had the Nazis, the rights of that and everything that happened dealing up to the Second World War. But going back to what this means is that you have to look at, is this inflationary or is it the deflationary environment? I want to talk about this inflation versus deflation because I'll tell you, this is a really difficult concept for people because it's so relative to what you're referring to. So let me give you an example. When you have inflationary policy, which is what I would argue, The U.S. and pretty much every other country in the world has implemented since Bretton Woods,

Starting point is 00:43:29 where they've baked in 2% inflation or at least attempt to bake in 2% inflation of the currency. What you get with that is this incentive structure for people to spend and for people to invest their money in order to try to outpace that 2%. So when you look at the advancements that we've seen over that 80-year period of time, It all makes total sense on how that has compounded over time and how we're seeing such drastic growth in productivity and in basically all the different products and services that we've seen over the last 80 years progress at the rate that we've seen because we've had this rigid inflationary policy.

Starting point is 00:44:13 If you had the exact opposite policy, let's say we were trying to bake in deflation of the currency at 2% over an 80%. year period of time. I think what you would see at the end of that 80 year period of time would be something that looks like society really just does not try to produce anything new. You would see people that really don't invest in anything. And you'd see the polar opposite of what you've seen happen. Now, with that said, there is a person that I have started to follow very closely because I I think he has some amazing, amazing arguments and amazing points of view. And his name is Jeff Booth.

Starting point is 00:44:55 He has a real vision discussion that is available for free on YouTube. We'll put a link to that discussion in the show notes because I think some of the things that he's talking about are fascinating ideas. He has a book out. It's called The Price of Tomorrow. I'm currently reading this book and I've currently coordinated with Jeff to come on the show to have a discussion about some of these ideas. And Jeff, he is a extremely successful entrepreneur. He has founded and developed multi-billion dollar companies in the past and just a

Starting point is 00:45:31 wealth of knowledge. Now, one of the things that he's talking about, which I completely agree with, is that the policies that we're watching at the end of using an inflationary policy for this long, they end in what we're currently all experiencing. And as long as we continue to implement the same policies that we have in the past, you're going to get more of the same and you're going to accelerate more of the same from a social standpoint. What his opinion is, is that you actually have to allow deflation to start to happen in order to bring things back to normalcy. But you have to do it in a controlled way. Something else that I think is important. So when we're defining inflation versus deflation, when you have these inflationary policies

Starting point is 00:46:16 from a monetary policy standpoint in place, what they create is deflation of price. Let me explain that. Let's just talk about the internet and how fast you're able to shop and buy something. In the past, you'd have to get in your car. You'd have to spend gas money to go to the mall. You'd have to use your time in order to, and if you were going to put a value on that, you could put a value on your time in order to walk through the mall to find exactly what you're looking for, to then go there and purchase it and go to the person at the checkout counter.

Starting point is 00:46:48 You'd be paying for all the people that are stocking those items in the mall. You're paying for the transportation of those items to then go to the mall and then the transportation for them that go back to your house. All of these things, right? Those have a higher cost than me logging on to Amazon in less than 30 seconds and conducting a purchase and then having the shipping come directly to my house. The price of that item becomes deflationary relative to the price that it used to be. So when you look at everything that's happening in the world over the last 80 years, we can see how that deflationary pressure

Starting point is 00:47:24 has been in existence for a very, very long period of time. Many of these ideas that I'm talking about are in Jeff's book, The Price of Tomorrow. And he talks about how a lot of this price capture because of the deflation that's happened in the price of goods and services has not completely flown homogeneously to the end user. Instead, there's been some things that have gone down in price, call it a TV, whereas other things have gone significantly up in price, call it healthcare. And so he lays out an incredible argument in this book. We're going to have them on the show.

Starting point is 00:48:03 We're going to talk about all these ideas in much more detail. We're also going to have a link in the show notes to one of the interviews that he's already done so people can check that out. And I think it's important for people to understand that whenever we say, oh, there could be hyperinflation in the future, it's all relative to what you're measuring it in. So if I'm measuring the price of things going up and I'm using Fiat dollars in order to measure that, well, you might have inflation. If you're using something else to measure it, you might actually be able to say, oh, that's deflationary relative to X, Y, and. People need to think about that context of how they're using that terminology whenever they're having these discussions because it can get extremely confusing very fast. And those are just a couple examples of what I'm talking about.

Starting point is 00:48:50 And whenever we hear about the financial stimulus packets of $2.2 trillion that's being pumped out in society right now, it might sound like the U.S. is in the risk of something like hyperinflation. If not the Weimar Republic, then something going really bad because trillions of dollars, that's a lot of money right. The size of the US GDP in comparison is $22 trillion. And if Goldman Sachs is right that in Q2 will see a contraction of the economy of 34%. It's not as inflationary as it might sound like. So whenever you see all that money being pumped out, we always have to relate to how much money is being taken out of the economy and how much money do we want to have taken

Starting point is 00:49:29 out. And that's also why whenever we try to target different levels of inflation, it's not not an exact science. We don't exactly know before it has happened how much money is going in, how much money is going out. A lot of it's not controlled by the Fed. It's not controlled by the government. It's controlled by the banks and it's controlled by us as consumers. And I think that's so important to understand that scenario whenever you're talking about inflation. So the question really is, at least to me, when I'm looking at this, will we see a change in the current Fiat currency system we have, where the US dollar, euro, yen, for that matter, dominates. And with all the flaws that we're seeing, and we see a lot of mistakes in the system we have, I don't think we'll see

Starting point is 00:50:16 that. I think that it would take something like a major, major black swan before it could happen. Something like a World War could make it happen, something like a type of financial instability that led up to Britain which, that could change the system. Before that happens, I think don't see the system change. We can make a lot of arguments, and I definitely here on the podcast made a lot of arguments why the current system is wrong. I don't necessarily have the perfect solution myself. We talked about all the inherent mistakes you have in a fiat-based currency system, where you just have different incentives to doing what you're doing. But at least that's the way I see. I'm very curious to hear what Preston says, do you think we'll see a major shift in the current

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Starting point is 00:54:57 100% confidence. I have opinions on what I think that timeline is going to be. And I kind of think that it's probably in the next four years, my personal opinion. I think a lot of people would argue with that. I think that's a very aggressive and short time frame for a lot of people to hear. It's just my personal opinion, and I have reasons to believe that to be true. But without getting into all of those reasons, I think that it's important for people to develop their own opinion, for them to troubleshoot and try to understand other people's opinions in order to kind of arrive at your own truth and will you buy into that logic or not. But I think that this is really important. The more that we use the same tools from the past, but more aggressively use those tools,

Starting point is 00:55:42 which is what I see happening right now, I think it only accelerates that timeline. I think that it forces it to be pulled further to the left and for it to occur even sooner. If all the policies that we've been seeing over the last 10 years, if they were playing out at the rate that they had been playing out, I would say that this is going to go out way further before you're going to see a demand for a shift in currency and basically policy. But I think this coronavirus is accelerating that personally. I think that because you had the coronavirus, because you had this massive volatility shock. It has caused those policies to accelerate and pretty much unravel themselves is what I kind of expect to see in the coming four years. But I truly hope I'm wrong. I hope that

Starting point is 00:56:30 that's not what happens because I think there's going to be a lot of pain. Anytime there's massive change like this, there's going to be pain for a lot of people. And that's what I don't want to see is for your common person to have to deal with such pain of change at such a a large and massive scale. I don't want to see that. But I do think on the other side of all this is probably going to be better for the world to whatever that shift becomes. I think globally, that's probably be a better solution, but it's going to be a painful experience to go through. The only thing that we do know is that it will eventually happen. The future is a pretty long time. Redell you discussed this. You can have major shift within the reign of a country,

Starting point is 00:57:13 say it's the era of the U.S. It can't happen. know, Redwoods would be an example. And I would say a major shift happened geopolitical after the First World War. And up to that, like the UK, if not ruled the world, they definitely had a lot say in terms of monetary policy around the world. And there was a major shift after First World War and then you had Breton Woods and the US dollar was the main currency was pegged to gold and the oil currencies were pegged to the US dollar. So that was a huge change. And that can happen with having, I think Redellio referred to it as empire. And I just want to give you a fun fact We'll make sure to link to this piece.

Starting point is 00:57:47 He said that countries or empires typically last 250 years, give or take 150 years. I was like, that's an interesting stat. He briefly mentioned some of the quote-unquote empires you had. The U.S. took over from the UK. And before that, you know, we even had the Dutch being the reserve currency. Believe it or not, we had so many different systems. And it's so interesting hearing Redallio talk about these empires. And something like that, that's sort of like what I refer to whenever I say a gradual shift in power.

Starting point is 00:58:19 I don't see it anytime soon. And I'm not talking about whether or not China would take over as the biggest economy in the world. That's not necessarily what I mean by a geopolitical shift in that size. And we have a system right now where the U.S., Europe, Japan are quite happy or at least not as unhappy with the current system as they can be. And combined, it's just a very, very different size regardless of the next 10, 15, 30 years growth rate in China. So, Stig, I got a question for you.

Starting point is 00:58:48 You got UBI happening here, and there's a lot of people that are pushing back saying it's not UBI, it's just a single check that they're going to send out in the U.S. to everybody for, like, a household with two kids. You're going to get, I don't know, like $3,000 or something like that here in the U.S. So my question is, is it a single check? And I want to preface this with, we have an election coming up in November. Is this a single check or is this something that's going to turn into multiple checks or many checks? Because I have a very strong opinion.

Starting point is 00:59:25 I want to hear what your opinion is, though. I take door number three. And the reason why I said that was whenever you saw this bill passed in the Senate, the vote was 96 to 0. It is a deed in an election year. I want to take door number three. I just don't know how they're going to possibly turn this off before November. I mean, I think that you could potentially see it run clear out until November. I think it's going to be a very popular policy, especially for the countless of people that have lost their jobs

Starting point is 01:00:00 and that are going to have difficulty getting jobs back after all this comes back online. And then you look at how much money from a trillion dollar standpoint that encompasses for just a single check. let alone checks till November, and what kind of impact that's going to have long term on the amount of money supply that's in the system? I was playing out the inflation scenario, right? When demand comes back online, you're going to have inflation pick up, and then it's going to greatly impact the bond and equity market and not in a favorable way. So that impact is going to require more bailouts from companies and municipalities. And I think that when we're looking at this in six to nine months from now and you compound it with the fact that you're in an election year, I don't know.

Starting point is 01:00:46 From my vantage point, I see monetary policy and fiscal policy to be extremely loose and as wide open as you could turn it on, not just now, but clear out till the election at a minimum. My opinion is just looking at it from how does that play out in the markets based on those policies that I expect to occur based on incentive structures, that's how I'm looking at it, is how are they incentivized, what actions do I expect them to take, and then how does that impact the markets from an investing in portfolio standpoint? And I think that that's the only way that you can invest in the markets with a clear mind in order to be successful. You can't get polarized in one or the other. You have to look at it as objectively as possible based on the incentive

Starting point is 01:01:32 of structures. All right. So Stig, let's quickly talk about our list or the companies that we're looking at today for buys in the market, because we've talked about a lot of gloom and doom, but there's a lot of companies that are losing enormous market cap right now, which means the prices are getting in a position where you want to start building your list of things to buy when you feel that that opportunity comes up. So right now, for me personally, and I'm kind of curious how you're doing this, but I'm literally going to the TIP finance filter. I'm looking at the companies that have a very low enterprise value and a very high earnings capacity with respect to their free cash flows. And when I'm looking at that list, the companies that are coming up completely

Starting point is 01:02:21 at the top are all these finance-based industries. I'm also seeing some insurance companies. And when I'm looking at these companies and I'm looking at the earnings, like, let me just give you the first one here, Charles Schwab, okay? So when you look at the enterprise value on the company, it's at $1.8 billion. And when you look at the earnings before their interest and taxes, it's $4.8 billion, which is crazy. Like, that's just like you're getting literally four times the amount of earnings annually than the enterprise value of the business. Now, the concern is we talk about something with such a insanely juicy ratio.

Starting point is 01:03:04 When we talk about this, you also have to consider that do you expect that earnings power, which I'm looking at right now as a historical number, is that number going to be just as high moving forward? Of course not. it's going to be lower. But if we still go in and you do an intrinsic value estimate on this, it's still coming up very large. And I think that it's important for people to start building these lists of companies that are in these positions as we're just looking at these. And I'm not saying that Charles Schwab is a buy at this point. I'm absolutely not saying that. I am not buying any of these picks that are at the top of my list. But I'm looking at them and I'm paying close attention. I'm kind of curious how you're addressing it and how you're looking at maybe your

Starting point is 01:03:46 potential buy list when the opportunity strikes. The first thing that I notice is that all the companies that we're looking at, more or less all the companies, all the momentum is just red. They do talk about blots in the streets, and that's definitely true whenever you look at momentum of almost all stocks in the universe that we're looking at here. I see a lot of great companies, actually a lot of the companies that we've been talking about during the mastermind discussion, HP, Allstate, I think we even talked about micron, perhaps a potential compounder. So there's a lot of different interesting stocks trading at more interesting valuations than before. And keep in mind that even if you do

Starting point is 01:04:27 a discounted cash flow calculation, which you can do on TAP finance, even if we say with a 10% discount rate that they won't make any money in the next 12 months, that's just approximately 10% You have to cut off the intrinsic value if you do the math. So it's very interesting if you go into this with a mindset of what's a normalized earnings, not what's the past 12 months necessarily, definitely not what's the next 12 months. But if you come into this and say, what is your normalized earnings? I do think that why it's not super, super cheap, it's definitely not much 2009 cheap, but there are definitely more appealing stocks out there if you look at it in a filter perspective,

Starting point is 01:05:06 like sorting the cheapest ones. I guess that's how I'm seeing it these days. It's kind of interesting to see which companies have been sold off the most that still have a substantial amount of earnings if you were assuming that those earnings would come forward or even if you would say that it's a proportion of whatever, maybe it's 75% less or 50% less at the end of this. You'd have to apply that same logic to pretty much across the board for most of these companies. And it's interesting to see where they're already trading at. And my expectation is that

Starting point is 01:05:40 the prices are only going to get better. And I'm going to continue to watch the filtering tool here pretty closely because as those prices adjust and some companies become even more advantageous, they're going to pop into the top of the filter. So it's going to be interesting to see how some of these progress. And just for the audience, some of the ones at the top of the filter right now are finance companies. We're seeing some insurance companies. I see deltas there. And mix. Micron, there's Aflac, it's up in the mix, and these are just large cap companies that I'm talking about. It's getting fascinating. Don't try and time the button. I mean, it would be fantastic. You would have great conversation at the end of the parties. Oh, got the lowest price of

Starting point is 01:06:21 all investors on the planet, but that's just typically not how it works. You know, buying trances, you know, divided your money up in three, four, five different portions, whatever it is if you want to go into the market. Don't try and time it. I don't want to miss out on that 10-year bull run in March 2009, whenever everyone thought it would continue sliding because you thought we'd go even lower in April. No, that's not the way to do it. If you find stocks at a reasonable price now or a cheap price now, perhaps it's time to put some chips in. I don't think there's any reason to put all the excess cash into the market right now. All right, so this is the point in the show where we take a question from the audience, and this question comes from Mario.

Starting point is 01:06:58 Hi, Preston Stig. Thank you for the excellent podcast and keep up the great work. My question is around a conversation you had on your previous podcast on options, where you highlighted that it's worth understanding the cost of these options and whether it's worth, for example, putting in a normal stop on a stock position rather than actually buying a put, which could be very expensive in particular if it's very volatile. I wanted to understand how is it possible to price these options? Because I understand it is quite complex and there are a number of factors involved. And also, where can one find the resources and tools online in order to price these options so that you can ascertain whether it's worth buying an option if you wanted to have

Starting point is 01:07:40 exposure on the downside, but also on the upside when you want to do leaps, for example. Thank you. Mario, I absolutely love that question. I think that there is a strong misperception of how options work and how they're priced. So I really like to go through, like an example, it's going to be a few numbers. So please stay with me. Perhaps you need to go back and re-listen to the example, but I think it's very important for people to understand some of the math behind options. Let me give you an example with the price of Berksa Heatherway. And in this example, I just assume that the price of Berksa Heatherway is $180.

Starting point is 01:08:14 The first term we need to clarify is what is a premium. And a premium is just a fancy word for the price of an option. So what does it cost to buy? And now in this example, we're just talking about a call option, so we hope for the price of that underlying stock to go up. And now we also need to clarify what is a strike price. So a strike price is the right to buy something at a given price. So let's take the example of Berkshire Heatherway. And as mentioned before, you know, it's trading $180. If you had a call option that gives you the right to buy one share of Berksa Hellerway for $150, say, a year from now

Starting point is 01:08:51 or two years from now, that $150, that is your strike price. Now, we also need to have a a third term. I know it becomes a little complicated now, but as I mentioned before, this is just to give you some of the math, some of the intuition behind a call option. If the strike price is $150, if it gives you to write to buy that, it's what we call the intrinsic value of a stock. Now, please don't be confused. I know we talked a lot about intrinsic value, which we call like the true value of a stock, but when we talk about options, that basically just means that you can exercise that option now and you can get X dollars out of it. And so, in the same, In this situation, if one shares $180 and there's a strike price of $150, you have what's called

Starting point is 01:09:35 intrinsic value of the option to be $30. That's money you are more or less guaranteed with today's price. Now, the value of an option is also determined by what is referred to as extrinsic value. So the extrinsic value, that's your potential upside. Remember, you don't have to exercise the option today. That's the entire point. If you buy an option today, you have the option or the opportunity to exercise that later. And that's very, very important to understand. Then you have something like volatility that includes into pricing of an option. So if we think that Berksa Heatherway is very volatile, it's actually not. But if you think it's very volatile, that premium of Berksa Hellerway would go up, like the

Starting point is 01:10:20 price would go up because you don't care if you buy one share of Berksa Heatherway, if you just by the call option if the price goes down to $100 or $50. Because remember, you were guaranteed money as soon as it's worth more than $150 for one share of Berksa Heatherway. And the last thing, please stay with me, guys. The last thing that's also determined by is the time for expiration. Because the longer you have to wait for, say, the underlying value of Berkshire Heatherway to go up, longer you have, the more lucrative is that option, because you can just sit and wait

Starting point is 01:10:54 for good things to happen, for the market to go in your direction or whatnot. So let's just have a practical example of an option of Berksa Helloway today. If you bought that at a strike price of $150, an expiration date, 21st of January, 2022, the premium would be $50. So let's talk about why does that make sense? Well, the stock is trading $180, so we already know that you have $30 in intrinsic value. So the extra $20 in premium that comes from the optionality that Berkshire Hallaway appreciates in price for more than $180, and it would do that before the 21st of January 2020.

Starting point is 01:11:37 Now, they can give you another example. You could also have bought a call option out on the money with a strike price of $300. The premium for that would only be $0.65. sense. That's because it's highly unlikely that works a other way it would trade at more than $300 before January 2022. And even if it did, it would likely not trade a lot higher than $300. Say, for instance, that the stock would be trading at $310 at $310 at $3.10 at $10.00 So to make money in options, you have to have a different opinion than the market. So whenever Preston and I talk about, potentially all price could go to $50, $100, and for us to buy an option on that, you have to understand that the money it takes to make that bet is very, very different than the potential outcome. Now, it has to cover in Spawn, but it's not like, oh, I would much rather have an option with a strike price at $150 because that's more like than $300. That's obviously priced into the market one way or the other. Do I think that $0.65 is a good price?

Starting point is 01:12:46 I would say that they're good arguments, why it would be a fair price. But if it was trading at $10, there was no way I would touch it, but was it trading at one cent? You bet I would buy all the options I could get my hands on. I think the main thing people can take away from Stig's comment, especially if you've never dealt with options, is this is something that you typically have to get your hands dirty with in order to kind of understand how they work. If you're just reading about the theory of it and you've never actually stepped into the market and actually purchased a call option, it's not really going to sink in. You're not going to understand that when you're buying out of the money call options, that they're

Starting point is 01:13:25 very illiquid. And if you want to sell that position, you're going to pretty much take a shalacking as you offload it. Like those kind of things you don't understand until you've taken the shalacking. And so this is something that I want to tell people that I think is really important. Most of how I deal with options, I have taken straight out of Joel Greenblatt's book. You can be a stock market genius. That book, I think, lays out some really sound ground rules, especially for people that might

Starting point is 01:13:54 be doing this for the first time. One of the most important pieces of the ground rules that he talks about is whatever principle you have in your portfolio, it should not make up more than 10% at most of your portfolio if you're doing options. I think that's a very safe rule to have. And some in the industry would look at 10% as being extremely high. So I would preface that. I live by that rule.

Starting point is 01:14:18 The other thing that he talks about is he only does long call options in leaps. And so I've adopted the exact same rule. I only buy call options. I don't participate in the derivatives market. I'm sure a lot of people might be rolling their eyes and saying, oh, well, that's ridiculous. you're leaving a lot of opportunities on the table. But for me, it works. I know that whenever I buy that long call, two-year call, I have time for the position to be right. And I also am in a position where my downside is limited to the amount that I put into it. So if I put $1,000

Starting point is 01:14:55 into that position, I can lose that entire $1,000 position if I hold it to maturity and the price does not go above it, the strike price on the call. But I'm fine with that. That's just how I personally do it, and I know there's many arguments why I could do more with my options strategy, but that's just how I do it. One note on the premium part of it. So when an option is priced using Black Shoals model, that's the model that if you took a derivatives class in an MBA program or something like that, you're going to do these Black Shoals models. And you're going to come up with evaluation for these options. And it's going to come out to be whatever strike price for whatever security and for whatever duration.

Starting point is 01:15:34 One of the main factors in this is the expectation for future volatility. So if you're dealing with a security that doesn't have a lot of volatility, the price for that option is going to be greatly impacted by that volatility. If a volatility expectation or the past performance of the volatility has been very wide, that also is going to be based into the price because when you think about the potential for the price going to the upside or the downside with a lot of volatility, that has to be built into the equation. And so you're going to pay a lot more for something with a lot of volatility.

Starting point is 01:16:11 So when you talk about a premium for an option, the way I think about it is the market is the market is anticipating that underlying security going in a certain direction. And so they're paying a price above the Black Shoals amount that you're calculating. So like let's say if we did Black Shoals that the option should be priced at $2 per option, but the market is currently trading it at $3 per option. You could say that there's a $1 premium being placed on that option above the Black Shoals price because the market's anticipating that the trend of the underlying security is going to be going above the volatility range that is being calculated based on past performance. because when you're doing Black Shoals, you're basing that volatility on past performance. Black Shoals, you can read a ton of it. We can put some links in the show notes to provide you the equation for Black Shoals

Starting point is 01:17:06 and all the variables and how it's calculated if you want to learn some more. This stuff gets pretty complicated. Like, you know, if I was going to say one of the hardest classes I took whenever I was getting my MBA was a derivatives class, I found it quite challenging to do a lot of the math and to think through my long and my short, is it a put? Is it a call? All that kind of stuff gets pretty complicated. But I would tell you, if you really do want to do this stuff, definitely start out with

Starting point is 01:17:31 very small position sizes. If you get your hands dirty, it's going to help you out a ton to just kind of understand the nuances of it. Because when you lose money on a position, let me tell you, there's no greater education you can possibly receive than by taking a loss or a hard lesson by buying things that are way out in the money and you don't have liquidity when you want to change your mind and things like that. You learn all those hard lessons.

Starting point is 01:17:54 So anyway, Mario, for asking such a great question, we're going to give you a free subscription to our TIP finance tool, which we had talked about earlier on the show, where you can go in, you can filter some of the results for every single stock on the stock market. You have access to the momentum tool, which also gets into some of the long-term volatility of some of these picks. And we just really appreciate you asking such a great candid question that so many of us can learn more about. So thank you for doing that, and I hope you enjoy your subscription to TIP finance.

Starting point is 01:18:23 All right, guys, thank you so much tuning in. That was all that Presta and I had for this week's episode of The Investors Podcast. We see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network.

Starting point is 01:18:48 Written permissions must be granted before syndication or rebroadcasting. Thank you.

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