We Study Billionaires - The Investor’s Podcast Network - TIP314: Thoughts from Ray Dalio, Eric Schmidt, Peter Thiel, & Sam Zell on the Current Economy (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we've collected some important audio clips from some of the most prominent investors in the world. We'll be highlighting clips from billionaire Sam Zell, Ray Dalio, Peter Thiel, and Eric Schmidt. The clips cover topics like the hospitality and real estate market, education, social media monopolies, and the forced sales from Chinese governments to U.S.-based businesses, and much more. So without further delay, let's get rolling. You are listening to The Investors Podcast, where we're listening to the investors podcast, where we study the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:00:38 We keep you informed and prepared for the unexpected. Hey, everyone, welcome to the investors' podcast. I'm your host, Preston Pish. As always, I'm accompanied by my co-host, Stig Broderson. And we just want to welcome everybody to today's show. And as we said in the intro, we've got a bunch of really interesting clips from various self-made billionaires on the current state of the global economy. First up in the queue is billionaire Sam Zell. his net worth is almost $5 billion, and it's a fortune he has made as the founder and chairman of the private investment firm, equity group investments, which really specializes in real estate. That's how he really kind of made all of his money was in real estate. So we found this audio clip from about a month ago where Sam is talking about the hospitality business, the hotel business.

Starting point is 00:01:30 And so give this a listen and then we'll provide some comments afterwards. To go from 70% occupancy to zero, kind of gets your attention. And the answer is the hotels are going to slowly open. Occupancy is slowly going to increase. You know, one of the big issues that I have been focused on since the pandemic began and the shutdowns began. And that is everybody's talking about the costs of having your building closed down. Nobody is talking about the cost. of reopening. And those are very significant. And even in the best hotels across the United States,

Starting point is 00:02:11 they're going to open at 5 percent, and then they're going to go to 10, and they're going to go to 12. And so I think it's going to be a tough environment. I don't believe that this is going to end the quote-unquote convention business or the use of hotels to make deals. I think it'll start with, I've heard a lot of people say, God, with the experience we're having right now, I don't know why we ever put anybody on the road. I would expect that as it starts, there will be reticence of people to go on the road, and they'll say, we'll just zoom it out. And that's what will happen until some young, aggressive guy gets on a plane, goes and gets the deal done while you're sitting on Zoom selling an idea. So I don't think we have a

Starting point is 00:03:01 any significant change. We had, again, just like office space, we had an oversupply in the hotel business already in place before the pandemic. And the result is there's going to be a significant number of hotels that are not going to reopen. I would bet that they would have not reopened except maybe a year or two later than what's going to happen now. So I think the hospitality business is not going anywhere. I think people like me, Marriott and Hyatt and Hilton are going to get only more dominant and stronger as the world reopens. I wanted to play this clip because I found a very telling of the importance of understanding the competitive situation in any industry that you would enter.

Starting point is 00:03:48 As an investor, the lack of competition is really what you're after because less competition means higher margins and more pricing power. It's hard to find the industry with as much competition as the hospitality industry. Partly, this is because the service they provide is highly commoditized because you as a hotel guest has too many similar options and your switching costs are just so low going from one hotel to another. Now, what Samsell is really saying here is that the big hotel change will start to consolidate coming out of the pandemic.

Starting point is 00:04:21 One could just mention the recent rumor between a core hotels and IHG as one example. And what could happen is what we've seen in similar. away in the airline industry, at least before the pandemic. That too was a commoditized sector on-time regulations allowed for them to be restructured, then to consolidate with in effect meant gaining more monopoly power, and then indirectly allow for higher profit margin and higher prices for the consumers. In reality, that is a little harder to do for the hospitality sector, because you can add new capacity much easier than in the airline sector. Just take Airbnb be as an example. In the past, and you might even argue today, even though it's very challenging

Starting point is 00:05:02 during the pandemic, but they've been a major disruption because anyone with an extra bed could now add more capacity to the market. And even as a small-time investor or small group investors, you could much easier open a new hotel than, say, start an airline. And we very often see this after crisis, different sectors becoming more and more consolidated, simply because it's survival of the fittest. A lot of the weaker companies, those with less access to credit, for instance, they just go bankrupt. And then you see the bigger change, which was also what Samsell is getting at here, getting more and more dominant, which again means that they can push up prices. The only comment that I would add into that stig is just, it's going to be interesting

Starting point is 00:05:49 to see what happens here in the coming quarter, the fourth quarter of the calendar year, just to kind of see how much the travel picks back up. of anticipate that you are going to see some of the travel pick back up. You're going to see some of the hotels have more traffic than what we've seen in the last two quarters, mostly because things appear to be getting a little bit more back to normal. I know that the schools are starting to start up in a lot of states here, at least in the United States. And I kind of suspect that some businesses are going to probably send more employees out there to travel. So it's going to be interesting to see. And the way I would be tracking this is really kind of

Starting point is 00:06:26 watching the top line for all these companies, looking at the revenue for the quarter that we're currently in whenever it closes out. I'm really kind of curious to see how that top line revenue compares to the previous quarter. So that'll be something to watch closely. I don't know how much more pain these types of businesses can endure. And you can hear some of the numbers that Sam is thrown around, which are really kind of crazy. But let's go to one more clip from Sam. This is him talking about commercial mortgage-backed securities, and he has some thoughts on this. So we're going to play this clip, and then we'll have some more comments. If you look at where the real focus of CMBS has been, it's been in retail.

Starting point is 00:07:09 There's much more retail in CMBS than there is residential or anything else. But it's primarily retail, which, by the way, as far as I'm concerned, is still very much of a falling knife. And when you package things together, as CMBS does, you end up with, you know, you might have a good mall and four beds. And that just drags down the whole scenario and sends capital fleeing. And that's basically what's happened. And I wouldn't be very confident that those people who have stepped up and taken advantage of the CMBS market are likely to end up with very. you high positive results. You know, in this clip, he's talking about the malls and just that type of real estate.

Starting point is 00:08:00 And I can just tell you, my buying habits have just changed drastically from what they were five years ago. It's almost like they're in just a completely different universe, the way I consume and the way I buy things. And I think most people are similar to myself in that if I want to buy, something, I just pretty much go on Amazon and order it. I don't need to, I think the thing that has surprised so many people is just, you just don't need something right now. You can typically wait two days or even a week for something to arrive, way more than what I think I would

Starting point is 00:08:39 have suspected before this craze, this Amazon online shopping type craze. I honestly cannot even tell you the last time I went to a mall and walked around the mall, to go find something. I don't even know when it, it's years ago. Now, maybe I'm a more extreme example of, of that scenario, but whatever it is, I think that the main thing here is that buying habits, COVID has warped buying habits in a major way. And I think that this is probably one of the biggest victim areas of COVID is just the malls are not a place. I don't want to go inside and walk around and look for things. I just want to be able to, heck, just go on my phone and place the order while I'm sitting there on my couch, let alone getting up to a desktop

Starting point is 00:09:30 computer to place the order. It's that easy. So I'm with him on this. This was interesting to hear how much of a falling knife he sees this area. And I suspect this is going to continue to play out in a very abrupt way here in the coming two to four-core. orders. All right, so the next clip we're going to play is from billionaire Peter Thiel. Peter Thiel became famous for being the co-founder of PayPal. Later, he made a fortune as Facebook's first outside investor whenever he bought 10.2% stake for only $500,000 back in August 2004. And he later started Palantir and many other companies. So here's a clip with Peter Thiel about technology investment and formal education.

Starting point is 00:10:21 But there's obviously a lot that one can do online in all of these forms. When I take my venture capital list hat and look at these things as things to invest in, I always think it's very important to sort of break down a little bit the abstractions and to remember that education itself is always an abstraction. And if we make it a little bit less abstract, let me suggest there are four different things that education means in practice in our society. One thing is certainly the official meaning is that it's all about learning. It's about information.

Starting point is 00:10:52 It's a positive sum game. It's about learning. But four sort of variations of it is it's an investment in your future. So you go to college. It's sort of an investment into a better future. Second, it's a consumption decision. So it's like a four-year party. And I used to think that it was sort of this bad quantum superposition of investment and

Starting point is 00:11:13 consumption. It was sort of like people in the housing bubble bought a large house with a swimming pool. And it showed how frugal they were and how much they were saving for retirement. And it was sort of conflating investment consumption, which is always a mistake. But I now think it's the third and fourth one that are the more important. The third one is that it's an insurance product and that it's something you buy to avoid falling through the ever bigger cracks in our society. And they can charge more and more for you because people are getting more scared about

Starting point is 00:11:39 some of the things that have gone wrong in this country. And the fourth one is it's a zero-sum tournament where you have to think of Harvard and Stanford and Caltech and the other elite universities as a sort of Studio 54 nightclub. It's actually the value comes from excluding people. And so there's like a Harvard or a Stanford version of putting Harvard or Stanford classes online and letting people take them. And these universities have done it and people can take those classes in many cases, but they don't get credit at Harvard or Stanford and taking those classes does not lead to a Harvard or Stanford degree. And that tells you that a lot of the value of this very strange good that is called education comes not from the actual

Starting point is 00:12:23 learning, but more from things like status, selection, exclusion, things of that sort. And I think that when we look at these different approaches, we have to try to disentangle what they're doing. So online education is great for learning, but unfortunately learning has almost nothing to do with the so-called educational system. Okay, guys, so I really wanted to play this clip because Peter Thiel is voiced a concern that has troubled me for years, both as a student at Howard University, but later as a college professor at a local college. Till is talking about the elephant in the room, that formal education has fundamentally changed for the worse, and education is increasingly decoubled

Starting point is 00:13:05 from learning. For example, I don't think the quality of education I got at Harvard was significantly different than formal education elsewhere. But in reality, it really wasn't that different. it has opened a lot of doors that otherwise would have been closed, but I didn't really learn more. For business relationships and employers, at the face of it, there is so much asymmetric information that we use as signaling whenever we enter a new working relationship. And formal education is just one, but a very important example of that. And it's used as a very often irrelevant filter to exclude people.

Starting point is 00:13:42 So again, there's a decoupling between learning and education today where most of us are losers or at best we are no better off. And it's not just a signally issue from Ivy League schools. You see the same problem on the labor market giving the oversupply of PhDs. And what you've seen is that PhDs are taking jobs that have previously been held by those with a master's degree. And you've seen too many people with master degrees and then in turn have pushed down those with a bachelor degrees.

Starting point is 00:14:11 And on it goes. And so when education and qualifications do not go hand in hand, education creates debt-weight laws in society. We all rake up more student debt and just as bad we spend years on education that we don't need instead of joining the labor market, creating value for society. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:18:33 That's Shopify.com slash WSB. All right. Back to the show. So I'm sure I sound like a broken record when I say some of these things, but this is the result, in my humble opinion, of printing. This is the result of an incentive structure that's based on spending and increasing spending and increasing spending some more. People go out, they have to compete at an even higher level by spending more money at obscene you know, no way you're ever going to get that money back, uh,

Starting point is 00:19:09 rates of return for the, for the cost to get the next degree to just remain competitive. To do the job that the person's doing, they don't even require the degree that they often have at a master's or a PhD level. It's learned on the job. Um, I, I don't know. I, I really wanted to play this clip to Stig because I just find the whole education

Starting point is 00:19:33 model to be, insanely frustrating. And recently there was some news that Google was coming out with some courses that you can take their courses. And if you take those and you don't have a college degree or anything else, Google is going to wait that as far as being just as valuable in their hiring process. That's what they say. And I don't know if that's necessarily how it'll play out an application. But I think it's a step in the right direction. Now, when I talked about this on Twitter, I was kind of surprised at the amount of people that just started kicking and screaming and saying, well, they're training you on how to program things the Google way that then creates a network

Starting point is 00:20:18 effect that further amplifies their strength as a company and builds further dominance for them. And I just don't know what the right answer is. But I do think that Peter Till's comments about the exclusivity of this just separate people and not everybody having a fair shake is completely accurate on the money and needs to be said and needs to be talked about more. I just, I completely agree with him. And I think it's a big problem. And I think that technology is definitely coming for the education sector here in the coming five years. I also think it's coming for the finance sector in the coming five years. And it's going to be really interesting to see how this plays out. I really hope that it transitions and allow.

Starting point is 00:21:05 more people opportunities at a much lower and substantially reduced cost, and that employers will honor that and look at that as being the same in the eyes of performance in the way that they hire. But we'll see how things progress here in the coming five years. Okay, so next up, we're playing one of our favorite economist investors, Ray Dalio. This is Ray's comments on the limitations that exist for policymakers and central bankers, dealing with this current situation that we all know we're in as far as the printing

Starting point is 00:21:44 and the universal basic income, all of those factors. Ray goes on a long discussion of this, and this was recently recorded. This is something that he had talked about just within the last month. So this is a really important clip as far as I'm concerned, and I hope you guys enjoy listening. The limiting factor.

Starting point is 00:22:04 has to do with the demand for that money and debt. In other words, what debt is, a bond, is a promise to receive a lot of currency. And so when it gives no good return or bad return, and there's a printing of a lot of currency, clearly it's not desirable relative to other things for private investors. However, the central bank can buy it too. And so the limit has to do with the limit of demand. And that limit of demand has to do with the central bank's purchases of that because they could buy it and hence there's no problem. So you look at periods of time of where in history, where was the most of it that has

Starting point is 00:22:51 ever taken place and to try to define the limits. And the war years was an example. I think the most analogous period we're in now was 1930 to 1945. I'll explain the various ways it was analogous, but more importantly, I'd like to deal with the question of the limits. And so you first had the depression. And in that depression, and when you hit zero interest rates, you had the printing of money and the buying of financial assets. And then you had a lot of fiscal policy. So programs that produce large deficits, which then were monetized by more of that. And then you went into the war years. And the war years, there's, there's a

Starting point is 00:23:33 Very similar to now in terms of the need for a lot of money and credit, produced an enormous amount of money and credit, but it was managed by the central bank in a way where they were de facto taking that on. It was a good example of testing the limits of that. Now, we went into periods where, you know, what is an alternative source of wealth? And as I say, it could be stocks, gold, it can be other assets. But those became the boundaries. What would happen in terms of this limit is if something transpired where the dollar as a reserve currency, the holders outside, made another market that was a better market. It could be gold.

Starting point is 00:24:18 It could be stocks or it could be an alternative currency. In the earlier session, which I listened into, China as a reserve currency, there will need to be an alternative process. when that happens, and I think it will happen, then it looks like a currency defense. What I mean by currency defense is if money leaves that asset, if those who are holding bonds, don't want to hold the bonds because they have lousy returns and they're printing a lot of money and they want to go to something else. And that starts to accelerate should that happen. Then what that does is, as money leaves, it puts the central bank in the position of having to decide whether it

Starting point is 00:25:02 buys more bonds in order to fill in that gap or it lets interest rates rise. Well, they can't let interest rates rise. There's too much debt. And then also, interest rates rising means that the asset prices all go down. And it's too vulnerable. So like all currency defenses, what it means is that they then have to accommodate that, and the act of accommodating that in and of itself is a big problem. Should that happen, that would be terrible for the United States. Earlier I heard about the discussion of the privilege. That's right. The United States dollar is a tremendous privilege, and we are certainly pushing the limits of that. And if we were to think that the was to be any other currency because of us pushing the limits. If that were to happen,

Starting point is 00:25:56 it would be probably the biggest disruptor not only to the markets, but to the whole world geopolitical system. So we're in a fiat monetary system. What I mean is throughout most history, there was gold. Let's say 1994, we create the Brentwood system linked to gold. The United States printed a lot money and more claims on gold than there was gold. And in 1971, which wasn't very long ago, we couldn't meet those claims on gold because we had too many IOUs. So we had devaluation. And the dollar as a world's monetary system or currency is critical. But it very much depends on the United States competitiveness and so on. So it's a longer term risk. One of the things that's been a prop for the dollar is the fact that there's a lot of dollar denominated debt. So what that means,

Starting point is 00:26:49 it creates a demand for dollars. That debt will either be satisfied in some fashion or another because there'll be the dollars to produce it or that dollar debt will be defaulted on in one way or another. That's a whole other discussion we can get into if you want. But at that point, it'll reduce the desire, the short squeeze for dollars which will serve to weaken the dollar at the same time. And also, as we look longer term, the squeeze, the politicalization of it, changes the nature of the capital flows because we are in a situation where you can be squeezed. And so when you start to think about, yes, if you're China, you're holding a trillion dollars of treasuries, would you want to do that, particularly, I mean, given the returns, given all that,

Starting point is 00:27:38 and given the conflict. So this China piece is a part and piece. Let's say there's three things. We're spending a lot of time discussing the monetary and debt cycle. The second is the what I'll call the wealth gap and the values gap cycle. And then the third is China. So if we look at those things in combination, I think that's the best way to look at the whole picture. So there's a lot going on in this conversation.

Starting point is 00:28:05 and Ray is covering a lot of territory, but if a person's listening to this and it sounds kind of confusing, this would be the best way that I could simplify it for you. We're at a point where interest rates have been pushed down to nothing. If the demand for newly issued debt in the United States goes down, central bankers are just going to step in and continue to keep the yields at 0%. They're going to continue to be a buyer of pretty much anything. that's issued. And like Ray said, they can't allow for interest rates to go up. The main reason they cannot allow interest rates to go up is because the value of everything on the planet is based on

Starting point is 00:28:47 those interest rates. When interest rates go up, the value of everything goes down. And so if they allow the fixed income market to allow to allow it to have rates that start going up, it's going to have an enormous impact on the stock market, not in a good way, in a very bad way. And that's going to have just a rippling implications for the value in everyone's buying power across the globe. So you can see how we're at a situation or an end game. And that's why you see some really great macro thinkers, some of them like Grant Williams out there doing shows called The End game. This is what they're really getting at. And although Ray's comments are really valuable to kind of hear him put him in perspective, he doesn't really offer, in my humble opinion, in this exchange, he doesn't offer an example of

Starting point is 00:29:41 what's going to happen. Like, how does this play out moving forward? What's the most likely scenario of this playing out? Now, he does say that there has to be weakness in the dollar, but he doesn't necessarily get into how much buying of the bond market. He's not. He doesn't necessarily get into how much buying of the bond market, the central bankers are going to have to do, how much liquidity and fiscal spending they're going to have to do. He talked a little bit about how much they did back in World War II. But I suspect this is way more profound and way bigger of a deal than your typical market participants might realize. Way bigger deal. So really fascinating to always hear Ray's thoughts, a recent clip. So we wanted to play that for you guys and let you interpret it whatever way you

Starting point is 00:30:25 want, but that's the way we were hearing it. Okay, so the next clip that we have is billionaire Eric Schmidt. He's known for being the CEO of Google from 2001 to 2011, executive chairman of Google from 2011 to 2015. And he's holding a significant stake in Alphabet, the parent company of Google. And together with his other investments, he has an estimated net worth of $14 billion. In this clip, he's talking about things like TikTok, talking about the consolidation of technology, this piece with China. It's a really interesting clip. So we're going to go ahead and play this one for you. 20 years ago, the one really big player was Microsoft. Microsoft has now been joined by four other very, very large companies, each of which is run cleverly, but in a different way. They have different ways in which they win and they lose. We benefit from that brutal competition. Look at what you have in a mobile phone, the competition between Android and iOS and Apple phones and the Android ecosystem has brought a supercomputer into your pocket. That's going to continue.

Starting point is 00:31:26 The reason it'll be different in 20 years is because artificial intelligence will create a whole bunch of new platform winners. And remember that the way this works is the U.S. establishes global platforms that everyone else uses. We are forgetting that it is U.S. leadership at the platform level, whether it's Google or Apple or what have you, it has brought us to this point where we have multi-trillion dollar corporations that are leading the market. So I don't know enough about the dispute.

Starting point is 00:31:51 I left the board a decade ago. The important thing about the app stores is that they provide some level of security branding and protection for the user. In China, for example, Google does not have a single app store because of regulatory issues, and there's always been issues of is the app that you're using certified and so forth. I would be careful about breaking up the app store model as it does provide some security and protection. We can quibble about how they're managed, but the important thing is when you use an app store,

Starting point is 00:32:20 you can rely that what's on it is represented to be what. it really is. Just think of all those viruses that you are not getting as a result of the App Store. I don't know what the confidential security concerns are about TikTok. The claimed reason for this action is data sovereignty. In other words, people would like to have data for TikTok to be held in the United States. If that is the goal, there is a much simpler way to do it, which is to require TikTok and other companies like it to work with a cloud provider, Amazon, Google, or Microsoft as an example, who have the necessary security protections and are covered by U.S. law. What I worry about is that the U.S. taking a data sovereignty position, which is what this

Starting point is 00:32:59 effectively is, sets the precedent that this will now be done against American firms that have global presence. Essentially, every American tech firm has data that's stored in the U.S. that's subject to U.S. law that's used by Europeans, for example, and they bristle at that. So now you're setting the precedent that they can insist on this, too. Be very careful about the multi-move scenario, the back and forth in these things. It seems appealing, but then it sets in motion a whole bunch of things that can affect American dominance. We have benefited enormously by American values and American technology being used globally. I worry again, sorry, we have all these worries, that what we're doing is we're splintering

Starting point is 00:33:41 the Internet, as you said, because it's so easy for a country to say we don't like these other people. We are safer as a world because we're using each other's applications that we're getting to understand each other better. You have to make accommodations for national security. In Huawei's case, there was some evidence that Huawei was busy doing things that are inappropriate. There are a number of ways of stopping that and detecting it, but the best solution to Huawei is to have a strong competitor in the United States. And that strong competitor, right, should be able to wipe them out competitively. So again, we're playing with TikTok and Huawei from a behind position. I'd rather have strategies where I'm quite sure the U.S. will win.

Starting point is 00:34:18 We can win these battles with focus, create innovation, all the things that we do so well, and open borders and lots of people using it outside the country. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform.

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Starting point is 00:37:50 Back to the show. As you can tell, he is addressing a concern that all of the three major business regions, the U.S., Europe, and China are facing right now how to compete globally and the role of regulation. Now, Eric Smith is very smooth whenever he presents his arguments. What he's really saying there between the lines is that the, the The big tech companies are competing, which is good for consumers, but they shouldn't compete too much domestically, and the US government should protect them as much as possible for the

Starting point is 00:38:22 benefit of the country. And of course, keep in mind that Eric Smith is speaking as a private citizen and not as a representative of big tech here, like Google. Now, we know what the big tech companies want, but what do we want as private citizens? Well, we want for our national companies, of course, to be able to compete globally, that is tax revenues, at least to some extent, you might say, it's jobs. A lot of good things comes from our company's being able to compete. We also want privacy of our information, and we want low prices for our goods and services. So the good news is that we can get at least

Starting point is 00:38:58 one, and perhaps we can even get two, but you cannot have all three. So you cannot compete globally. You cannot have privacy of your information. And if you at the same time also want low prices for goods and services. Because the thought of having companies like Google, and I'm just using here as an example of your experience background, but you can just as well have said, Apple, to protect the national interest of the US is just not realistic if you ask me. Just to give you one argument, both companies have more international revenue than domestic revenue. So you have a management and a board that is hired to optimize shareholders' profit. They are not hired or incentivized to do anything for the greater good of America.

Starting point is 00:39:40 which is likely also why both companies have been giving up IP and make considerate concessions to compete abroad, most noticeable in China. Also, they try to evade tax in the US. Now, Eric Smith is not using the curse word monopoly here. And he's also not saying that as private citizens, we should trust big tech companies without sensitive personal data. But that is the implications of what he's saying. You cannot have global dominance, privacy of citizen information and low prices in the new era that we are facing today. And I don't fault him for saying that. Please do not get me wrong.

Starting point is 00:40:17 You hear the same arguments in all of the three major business regions. But here in the West, we as voters and consumers have to make a choice. All right. So next up, we have another Ray Dalio clip. And on this one, he's talking about some of his ideas on what's going to happen here in the near term once we get past this post-pandemic period. When we talk about investment, you have to start with who has what money to invest. That's where it starts. And that's why you have to look at incomes and balance sheets of all of the pieces.

Starting point is 00:40:51 Okay. And what's happened is it's damaged. So there are the holes. And so when we look at that, right now today, a lot will depend on who gets the support. So there's going to be an important redistribution of wealth that is happening today. when checks go out and get sent to people to fill in those particular holes. The economy will then readapt, but it'll adapt. I want to encourage you to think of it as follows.

Starting point is 00:41:20 There is a real economy that doesn't, just imagine there's no medium of exchange, that there's no money and credit, that it's just the real economy, the things you have around you and the ability to produce that. And then there's simultaneously this financial economy that has a, lot of IOUs, people who have accumulated this buying power, who have a claim on the goods and services purchases, as do the producers. So the amount of claims on these, the debt is a suck, a vacuum cleaner, essentially, that on network, it's a claim on net worth. And so how that's filled in by the governments and how well it is will be a defining characteristics. I would imagine

Starting point is 00:42:11 that what's going to happen is that savings rates are going to rise. That'll be individuals and companies because everybody wants to assure themselves of safety. It's redefined financially. I imagine that the priorities are going to shift. In other words, the priorities will be into health care and building the basics, I imagine. I imagine you're going to see, we'll learn things about social distancing and so on. And regards the last part point of the question, yes, we're going from a world that was interconnected and worked in a way where the most efficient producers on a global basis would compete with each other to sell things. And so it would be originated wherever it was best and it was a highly interconnected world and a more

Starting point is 00:43:04 efficient world because of that ability to specialize. That won't be anywhere near the same. We're now going to be moving to a self-sufficient world. Not only will individuals want to assure their self-sufficiency, but countries are going to want to have its self-sufficiency because they're also vulnerable. It's a different geopolitical world. So for political reasons and for various reasons, right now, merchandise is being shipped from China to the United States for masks, for ventilators, and so on. And that's a vulnerability. I imagine we're going to then want to build those things and build self-sufficiency. When that self-sufficiency is built, it'll make things more inefficient in the process. And so, yeah, the world will look different.

Starting point is 00:43:54 in that way. So even though Ray doesn't get into anything really too specifically in this clip, I find the clip interesting because it covers this idea that so much of the things it used to be purchased overseas, whatever those big chunk items are. So if you're somebody who's trying to analyze, where do I want to invest in the future? I would challenge a person to really look into what are the things that we have imported the most. And then of those things that we've imported the most, what strategically makes the most sense to keep organically or domestically inside the country? Those are the areas that I would probably take a really hard look at because what he's getting at is that things are going to become more compartmentalized than the future.

Starting point is 00:44:39 I agree with that. I don't think that trend is going to change post-COVID. At the first part of this clip, Ray was talking about the difference between money and credit and the idea that when the credit is becoming impaired or blows up, that has to be replenished by the government. That has to be put back into the system. And how it gets put back into the system is such a key point to try to understand because where it gets inserted is going to have a huge impact as to where those specific markets bloom up.

Starting point is 00:45:12 So I think it's going to be another area to investigate as we get this compartmentalization. also, as the government's replenished these promises and these agreements of credit that have become impaired, how they get replenished into the system. I suspect there's going to be a lot more UBI that's done in the future. So how does that play out if we're putting money into the hands of the population? How are they going to, Ray suggests there's going to be a higher savings rate, but for the part that isn't saved, where is that going to go? And those are some of the things to think about. All right, guys, so this point in time, this show, we'll play a question from your audience, and this question comes from Sack.

Starting point is 00:45:55 Hey, Preston, Stig. Zach here. First thing I want to say is thanks so much for the podcast. It's amazing and it's taught me so much, and I'm finally getting close to finishing all your episodes since I jumped on your guy's journey a bit late. My question has to do with portfolio diversification. I'm starting to understand how to value stocks and the accounting side of things, but I'm struggling with trying to figure out how to do.

Starting point is 00:46:17 diversify my portfolio to minimize risk. So my question to you guys is, how do you feel about the Markowitz or modern portfolio theory? And is that something that a newer investor such as myself could or should use to help me with diversifying my portfolio? Thanks for any help you can provide me with. So, Zach, that is a fantastic question and a very important question to ask. Before I do give you an answer, please allow me to introduce to the audience what the modern portfolio theory is, typically referred to as MPT. The general rule behind MPT is that you want to optimize your return with the least amount of risk, which is a very nice idea.

Starting point is 00:47:00 I also had to say that aside from the intention of the idea, the theory and the corresponding model is just so flawed that I would be doing you a great disservice not to tell you already, that before I start this recommendation, why the model and the theory is flawed, really keep in mind that the best advice I can give you is to completely ignore MBT. MPT is taught in business schools worldwide, and one of the many issues with the model is that it measures risk in terms of volatility, and it doesn't include any thinking in terms of intrinsic value or assessment of the underlying securities. And there is no such thing as intrinsic value in the model because it assumes that both

Starting point is 00:47:48 stocks and bonds are price corrected at all times and that all asset returns are distributed through a bell-shaped curve around a fictitious assumed rate for the stock market. Now, so if you're thinking, that just made no sense what you said there, stick. That's completely fine. I couldn't understand it either when my professor spent lecture after lecture in business school explaining why we shouldn't think for ourselves. And so just to give you an example of how absurd this theory is, when the S&P 500 tanked in March this year,

Starting point is 00:48:26 and the S&P 500 went from 3,300 to 2200, academics want you to believe that the price you bought in at would matter and that it was riskier to buy whenever the market quickly bottomed out of 2,200, than before it was trading in 3,300. And you might as a stock investor be thinking, well, if I can buy the same basket of stocks for $2,200, why would I buy them for $3,300? Wouldn't it just be a better deal just to get them cheaper?

Starting point is 00:48:57 And you would be right. And you might also be thinking, what is it really that you learn all these finance classes, whatever you're taught that it doesn't make any sense for you to think about what a stock is worth? Because the sum of all people who don't think rationally should make the stock market rational. But that is really a story for another day. I will stop my rant about eczemy for now. So what is risk?

Starting point is 00:49:25 Well, let me borrow Warren Buffett's definition. Buffett defines risk as the permanent loss of capital. That's one. And the second one would be risk of adequate return on capital. Now, keep in mind that both of those measures are at the time of disdainting. a qualitative assessment. It's not a fixed calculation. So to sum up, please do forget everything that has to do with the modern portfolio theory or MPT and use Buffett's definition instead if you want to be successful in investing. And to answer the second part of your question,

Starting point is 00:50:00 because you might be thinking, well, if I'm not going to use MPT, then what should I do to diversify? Well, if you want to diversify, you should identify and invest in uncorrelated assets. But really, and this, of course, comes from an investor who tends to be quite concentrated. More than diversification, for the sake of diversification, look for investments that have very little risk. The less risk you incur, the less you need to diversify in the first place. I'm curious to hear, what are your thoughts about this, Preston? So, Stig, the last point that you're talking about, which is the correlation, I think,

Starting point is 00:50:35 is how Ray Dalio would describe is the holy grail of investing is finding things that are uncorrelated. So let me just take Zach through a thought of experiment. A lot of the times you'll hear professional investors say, oh, you're too concentrated in that sector. I absolutely hate when people say that because it goes against just the logic of digging a little bit deeper. Okay. So let's say we're in the energy sector. Now, the chances are that most of the companies in the energy sector are correlated, but that doesn't mean that they are correlated.

Starting point is 00:51:13 So let's say you have company A and you have company B, and the correlation between these two companies is zero. Okay. Those two companies are completely uncorrelated. So if one has, and you're valuing these companies, which is a completely separate process, right? You're looking at how correlated they are. you're looking at what you think the value is. And let's say that for company A and B, you find both to be of substantial value.

Starting point is 00:51:40 Well, if they're completely uncorrelated, your volatility risk becomes reduced. Now, imagine doing that for four companies or five companies or ten companies. If the proportion of those 10 companies that you own are somewhat equally weighted and your correlation is at zero, you're drastically, drastically reducing that volatility, quote unquote, risk. And I think that I would really challenge people to think in terms of if you're concerned about volatility and you do buy into academia's definition that risk is equal to volatility, which I don't see it that way. I see the volatility as my opportunity to capture something of value because of the volatility

Starting point is 00:52:24 that the lower price offers me whenever it happens. You just got to make sure that your whole, if you're buying 15 different stocks and they're all correlated at 1.0, right? And there's a lot of volatility in those picks. Well, you better be prepared for a wild ride. But if there's no correlation between the picks or they sum out to a correlation of zero and you have a lot of volatility in those and you're weighting them appropriately based on that volatility, you can have all your picks in the same sector if the correlation on it is zero. So, I would just challenge that line of thinking. It's usually a good rule of thumb, but you got to dig deeper and you got to actually understand what the correlation is. So, Zach, I'm really excited to be able to give you our TIP finance tool because this is something that the tool does for you just automatically. We have a portfolio tab where you can enter all your different stock picks that you have, and then it pumps out a correlation table, and it shows you for each pick how correlated they are to each other. And your goal is to try to zero out your portfolio with respect to its correlation.

Starting point is 00:53:30 And I believe that's how you reduce the risk in your portfolio. And it's not just me. It's people like Warren Buffett, Ray Dalio. That's how they look at these kind of things. So I'm really excited to do that. If anybody else wants to get your question played on the show, just go to AsktheInvesters.com. Get your question played on the show. You'll get free access to our TIP finance tool.

Starting point is 00:53:49 And Zach, we're really excited to give that to you. and we really appreciate you asking such a fantastic question. All right, guys, Preston, I really hope you enjoyed this episode of The Investors Podcast. We will 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.

Starting point is 00:54:18 This show is copyrighted by the Investors Podcast Network. Written permissions must be great. before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP314: Thoughts from Ray Dalio, Eric Schmidt, Peter Thiel, & Sam Zell on the Current Economy (Business Podcast)

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