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Welcome to the Robert Hood financial market update. It's your host, Robert. I look at the week's financial news that can be a bit confusing, misleading, and take you off course and help to make it actionable, understandable, and clear. What a week and therefore what a show. We are going to be looking at a letter by Mr.
Howard Marx. He has one of these famous letters that all the folks will tell you to read. I actually agree with him. And this most recent letter from this famed investor. He's the co-founder and co-chairman of Oak Tree Capital Management, the largest investor in distress securities worldwide. and he's got a big old net worth of $2.2 billion, but excellent letter that he wrote because there was no Wi-Fi on the plane that day.
So maybe we should turn off our Wi-Fi on the plane. Maybe we'll do something productive. And then I talk a little bit about why it's actually tougher to stick with index investing than we think and why that is. Then we'll end with a little bit of commentary on why the world has always been going through difficulties.
It's never not been going through difficulties. And we can actually reference uh there was another Howard Mark's letter that's linked in this one from 2010. And in that letter, it says in 2010 it was just terrible to think about investing. Difficult, difficult, difficult. But let's start here. This is titled the calculus of value.
And it's tempting in personal finance spaces and particularly in the work I do to gloss over the why. What do I mean by that? Oftent times folks like me, financial advisors, friends will issue solutions that sound like this. Hey, you know what you should do? You should invest in index funds and there's a historic rate of return about 8% 9% and over a 30 40 year period that's really your best shot.
You should do that. And for most folks, that's enough. That's all the theory they want to go. That's all the only time in the classroom they want to spend is just give me the answer and let me go. What's the risk in simply giving the answer and going? You have what I would call an alien understanding of the concept.
You're you are trusting that whoever gave you that lesson is right. And because you don't potentially own that solution, when the storms come, you're not going to stick with it. So, Mr. Marks really puts our head into the books and ensures we understand it. So, I want us to listen to this because he's talking about value.
So, I want you to listen. Investment assets, stocks, bonds, companies, buildings, he says they have a value, which is referred to intrinsic value. It's a worth at any point in time. So whenever I say something like oh giz buy the index buy the index behind that there's actually a belief you have to have a belief that there is value and all those companies smooshed together in one exchange traded fund product.
He goes on and this is important. The totality of an asset's fundamentals constitute its earning power. Its ability to generate profits which in turn is the source of its value. Did you catch that? There's a bit of brilliance here. The totality of an asset's fundamentals consist constitute its earning power.
He's starting to sound a little bit like Warren Buffett, didn't he? So, he thinks of assets that don't produce operating cash flow or don't have the potential to do so in the future as not having earning power. And in his mind that makes them impossible to value objectively, analytically or intrinsically.
He then references his uh paper on gold. He has a 2010 paper that is also excellent called All That Glitters. But listen to that because this is actually why this will segue into our our why it's hard to own index funds. Listen, Markx is saying assets that don't produce operating cash flow, that means, hey, you have a business that's throwing off money, they have profits, or that doesn't have the potential to do so in the future.
So, of course, a lot of companies will run at a loss or break even for a long period of time, but in the future, Amazon.com's a great example. They ran at a loss for years and years and years and years. But there was this incredible growth in their revenues. So, there was this belief by investors that proved out to be very true.
very very true that they would have profits and now they do. So you could assign a value to amazon.com even in 1996 when they were not making money because there was a potential they could. However, and you you you probably hear the term coming if you don't have that visibility if you can't it's very very difficult to value that.
Which is why it's in my view very very very difficult to stick with investments assets whose value is contingent on someone else paying for it. So the old definition is and this is what Markx says he was taught at the University of Chicago Graduate School of Business. That's a strong program. It's a very strong program.
I'm not sure Texas&M had a program in the 1960s quite that robust. So we'll we'll excuse his absence from College Station Texas. He says this, "The right price for an asset is the discounted present value of its future cash flows of earnings." That's one of those basic definitions. I know we're in the classroom listener, but this is actually critical.
The right price for an asset. Now, what's the discount rate and how does that work? What discount rate do you assign? These are all good questions. That's how you come to a value today that you would pay. Now he goes in to talk about individual stocks and how he talks about General Motors. How oh this this investor will pay 52, this one will pay 46, this one will pay 58.
What's the market doing? It's finding that equilibrium price that folks are willing to transact. And that's happening all day, every day in the stock market. Now that valuation that's being arrived at bunch of participants a bunch of participants now I thought the real meat on this thing was where he says well what's happening now you know is the market overvalued today that's probably what the market update listener is interested in is it is it is it not I thought he had a humble approach to this question but I get it all the time and I asked myself that all the time.
By the way, I've always been wrong on this. I' I perpetually think the market's overvalued. I'd say from doesn't matter what year, 2012 to present, every year I thought I think people are paying too much for this stuff. Listen to this. He says the S&P 500 stock index is the most watched barometer of the US stock market.
Correct. towards the end of last year. It's forwardlooking PE ratio. That's uh price to earnings ratio. That's how much am I willing to pay per dollar of earnings was around 23. I paid 23 bucks per dollar of earnings. That's significantly above its historical average. Does that mean it's overvalued?
Now, check this data out. This makes this makes investors scared. JP Morgan published a graph showing that if you bought the S&P 500 index at 23 times the coming year's earnings per share in the period of 1987 to 2014, that's the only period where that data exists. The average annual return for the subsequent 10-year period was between plus two and minus2 every single time.
That's flat listener. That means when this 23, which is what we have now, the next decade flat. So that bodess poorly. If if that's if that's truly relevant data, it votes poorly. Well, what's happened? I think I mentioned this in yes in last week's podcast. Well, markets are actually up from the low point.
There was all the tariff stuff early in the year. From the low point on April 8th, the S&P 500's up 29%. Putting it up 9% for the year to date. Nine up 9%. H. So what's happening? Well, a bunch of variables in investing. So we have to be so careful when we read report. I remember and it still affects me as a young adult and as a child when I'd read a report by JP Morgan that showed the 1987 to 2014 period.
And if the S&P 500 was 23 times per, you know, oh that means it's a oh we're toast. I believed it every time. The older I get, the more I realize doesn't work. It doesn't work like that. I wish it was so easy that we just knew when to turn on and off the investing meter. H and he has all these reasons why, oh, the market did better and it's you, you know, the trade and trade deals were cut and therefore was priced in and you know, AI is still looking good, but we don't know.
He has other concerns. Markx does on value. I like this though. And this is where we'll end for Mark's letter because we Mark's letter probably deserves its own episode, but I'm going to link it. If you really want to if you would be perfect, go and read the entire letter. But listen to this. If you feel there's overvaluation, what can you do?
He has a great point. He says, "The existence of overvaluation can never be proved. And there's no reason to think the conditions discussed will mean there will be a correction any time. And he gives all these you can't. This is a guy that knows a lot about investing. You can't prove that it's overvalued.
You can't do it. So the question is investor, what should we do? He has six defcon levels. Defcon defcon five is not a big deal. And it he goes up to Defcon 1, which is like, oh, this is the worst. So, Defcon six, if you think the market's just just terribly overvalued, what do you do? You just stop buying, should cash.
Defcon five, reduce aggressive holdings and increase defensive holdings. Four, sell off the remaining aggressive holdings. Three, trim defensive holdings as well. Two, eliminate all holdings. One, go short. That's the belief that the market will go down. And I think he's exactly right. Listen to this.
In my view, it's essentially impossible to reasonably reach the degree of certainty needed to implement Invest Con 32 or one. That means going short the market, eliminate all your holdings or trimming your defensive holdings as well. What a relief. Now, he says he has no problem thinking it's invest five, which is just reduce aggressive holdings and increase defensive holdings, whatever.
He basically says you can buy bonds. Fair. Fair. But wouldn't that a relief listener to know that Mr. Howard Marx who knows a lot about value knows a lot about value. He's saying investor Robert not financial listener he doesn't know us yet but he will fight on pray on we're gaining ground over here at the market update.
Listen he says you can't do it like going short eliminating your holdings or trimming off the table. Off the table doesn't matter if the PE ratio is a jillion. and he talks about when he started in the 1960s how it was like 50 to 90 in these nifty50s whatever he says can't do it can't be done don't try it what a relief what a relief so go ahead and go back and look at this letter you'll enjoy it if you want to keep reading you can read his gold letter also excellent and now we talk about why it's hard to be an index fund investor and I want you to listen to this this is something I thought about this week.
I think I thought, you know, the more I'm a financial adviser and the more I have my hammer and nail, which it's not for everybody. For most people, it's just buy index funds, like you it's almost, as David Swson said, it's almost always the right thing to do all the time. That's the Yale endowment chief who's the late Yale endowment chief, his quote that I like.
It's just about the right thing to do all the time. I mean, just just do it. Why is it so hard to do? Because it is. the longer I do this, less hard to do. And one thing that's entered my brain is there's always something doing much better than the index in any given year. There there's always something doing much better than the index in any given year.
Let me tell you some a few. Did you know, listen, the last 12 months, gold's up 32.4% if you follow the GLD ticker. Bitcoin's up 81% if you follow the IBIT ticker. uh QQQ which is an index admittedly but I'm saying plain vanilla indexing it's up 16.7% over the past 12 months and your lite slow and steady boring VT which is the global index is up 13.31% in the last 12 months so for the investor who's looking around and is trying to tell himself you know maybe I should get exposure these other places because they're doing better.
And of course, that's always a possibility. And it's always permissible. I'll tell folks, I think it's totally permissible to take a 5% stake in gold, even a stake in in Bitcoin, if you treat it like an insurance policy, you know, and it could expire worthless. It could could be worth something, but it's just really tough.
One of the hardest things to do. And I found who are the people that can't that can and will just bare knuckle go with index funds. They're content not to follow their investments at all and they derive almost no enjoyment from investing. Happy to take the boring route. It's tough to stick with the index and yet it's ruthlessly effective.
ruthlessly effective. A quote I'll hear a lot and I think it deserves more teasing now. I'll hear people say, "Hey, I have enough money in stocks. I don't want more in stocks. I want I want to diversify." That you and that may be true for some people. I think it's a very rare group of people almost.
Yeah. Very very rare. And most of the time there's an unhealthy conception of what the stock market is that needs further education. Someone says, "I have too much money in stocks." They're saying, "I I have too much money in operating companies that are profitable profitable." That's essentially what they're saying.
I kind of say, "Huh. All right." Ironically, Warren Buffett, not an indexer, but a big fan of indexing. I believe a lot of his success is attributed to being willing to be second, third, fourth, and fifth place in any given year, but realizing over 50 years he'll be in first. That's tough. That's tough to do.
You got to be willing to live in Omaha, work out of your closet in your house, and just essentially be an unknown until you're 65, 60. Very few folks are signing up for that ride. Very few. And I'll also say everybody's different. There are some investors who I actually want 5, 10, 50. I want a percentage of their net worth to be in something they can engage in because I can I can certainly tell that is going to actually benefit them to have some capp exposure to some interesting asset class or something they enjoy engaging in better.
Absolutely. I can I can bless and affirm that all day long. And as we close an article, Faber Research says this, "Whatever the world is going through, it's probably been worse." And they look back, uh, this is an August 19th article, but they look back and they say 2020 was a terrible year, but you go back and you look at how many bad years there were.
third the year 1349 was the peak of the black death killed an estimated 75 to 200 million people in Europe Asia and North Africa 1520 was smallox in the US killed 90% of the indigenous population in the Americas 90% 25 to 55 million people perished 1918 influenza killed an estimated 50 million across the globe and on and on they say that 536 AD was the worst Volcano erupted in Iceland.
Dim the sun for 18 months. Global cooling. Coldest decade in 2000 years. Crop failures. Mass starvations. When I read this, I it it made me think, huh, maybe things aren't so bad. They then outline what it's like being born in 1900. You're born in 1900. When you're 14, World War I starts. It ends on your 18th birthday.
22 million people die. Later in the year, Spanish flu hits the planet and it runs until you're 20. 50 million people die. When you're 29, the Great Depression begins. Unemployment hits 25%. Global GDP dropped to 27%. That runs till you're 33. The country nearly collapses along with the world economy.
When you turn 39, World War II starts. When you're 41, the US is pulled into it. 75 75 million people perish in the war. Holocaust kills 6 million. 52 Korean War. 64 Vietnam War. Cuban missile crisis on your 62nd birthday. As you turn 75, the Vietnam War ends. That is a gauntlet. And of course, that affects our conception of the future and our level of optimism.
And so we've got to get back to what we can control because there are calamities always amongst us and always in the headlines. And you guessed it listener, what can you control? Keeping those cost low, that investing simple and that time horizon long because that is what's going to give us the best shot on our investing journey. Till next week.
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