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- [00:00]
Drew
Foreign.
- [00:06]
Alex
Welcome to the Synopsis, a business and investing podcast. Today, I'm here joined by Drew, and we are talking about inflation. He dropped another video on Adobe that's doing well. For some reason, the people of YouTube love Adobe and software stocks and the AI revolution, but I'm here to talk about something a little more boring, a little more historical. And, and I'm happy about it.
- [00:31]
Drew
Great. I'm glad you're happy about it. It's all about making sure that Alex is getting what he needs in order to keep hosting.
- [00:38]
Alex
You're right. I, I really. We should be catering more to my interests at this point. So that's what we're going to be doing. And we're going to talk a little inflation, a little overall investing strategy. I think it's going to be a bit of a meander, but I think people don't handle the topic of inflation well. I think you did a really compelling YouTube video and I loved you starting off with the concept that cash is trash. And I think so many people will utilize that and they'll say, oh, I've got a hundred dollars. Again, this is hyperbole. Oh, I got $100 in my bank account. I need to put it in stocks right away because cash is trash and it's depreciating. And I feel like they learn a little surface level about inflation and investing. And again, it's kind of a sentence that is true, that is then taken to an extreme, that then makes it dangerous and unuseful. So why don't you push back on the concept that cash is trash?
- [01:28]
Drew
Yeah. So, you know, and Ray Dalio was someone who's kind of famous for saying this, and then when interest rates went up and financial assets went down in price, he wish he had more cash. Because the concept of inflation really should be split up between the consumption side when you spend money and on the financial side when you save money. And so when you are spending money and the prices of the items you're buying are, are going up, that is certainly inflation. However, within your savings, you don't necessarily experience inflation the same way. And that is because what tends to happen initially when we do get inflation is that interest rates tend to rise. Now, this isn't always the case, but it is by and large the case. Especially what we can expect to happen in the US if inflation does increase or continue to stay strong, we should expect to see rate cuts, in which case what happens to financial assets is they fall in value. And that is the overwhelming impact to financial pricing. Much more so than any sort of purchasing power degradation from inflation. And so this idea that cash is the worst thing you should own in inflation is true only on a longer time horizon. Because if, for instance, we see inflation kick back up right now in the US what we're going to see is rate hikes. And when you see rate hikes, what you can expect to happen. Generally speaking, stocks fall in value and, and bonds fall in value. In fact, basically all assets that are liquid or just generally too fall in value. The illiquid assets don't fall because they don't price them as such. Usually for a while they don't update those pricings and then play games with that. That is a different video. That is kind of the big take though, that I want to push right now.
- [03:11]
Alex
Yeah, no, I think it's a, again, it's kind of a time horizon situation, which is, yes, if you were in 1980 and you had $100 in savings and you held your $100 for 50 years, that will have a negative outcome. But I do think this notion that, oh, I can't have any cash ever again, it's kind of the other extreme. And it is interesting in these hyperinflationary environments, presumably when cash is, quote, unquote, the least value, because every time each day you have a dollar, if you think about hyperinflation is 30% a year, then technically by the end of the year, your hundred dollars has $70 of purchasing power. So again, you're not staying constant in what we call real terms. Right, which is inflation adjusted dollars. But as Drew pointed, and I think that this was such a interesting atmosphere to live through because a lot of investors didn't see rate hikes like that since, you know, obviously the hyperinflationary period to the 70s, but to see the re rating of everything dramatically, which is essentially, if you look at how DCFS work and everything, they're all based on the discount rate and the discount rate is tied to interest rates. So when interest rates goes up, the discount rates go up. And then, you know, if you want to say your terminal value goes way or your multiples go down. And so as an investor, it's kind of interesting to see, oh, well, I could be completely right in my business thesis, but the business is just worth like 4 or 5 turns less now on an exit multiple or DC, however you want to do it. But essentially your business just contracted because rates are higher, discount rates are higher, opportunity cost is higher, everything you own just went down dramatically. And I always think about it as and this is a compelling way to think about and some people call this duration, but duration is kind of the. How would you describe duration? Do you get where I'm going here? Like long duration, short duration?
- [04:55]
Drew
Sure. When, when you're talking about interest rates, the biggest impact is going to be to assets that have their cash flows very far out. And there is this concept of duration when it's usually brought up when you are bond investing, which is something to the effect of the weighted average time it takes for an investor to, to receive the present value of all cash flows from a bond. And so the idea, just generally speaking, more layman terms is the higher the duration, the longer it takes for you to get in present value, all of your cash flows back. And so when you are investing in companies with cash flows very far out in the future, there is very high duration because it's going to take many, many, many years in order to get that present value back. Now what ends up happening when interest rates go up is the cost of capital goes up and so of waiting goes up even more too. And so effectively these become worse investments. Anything that has very, very long duration. And you see this too in the bond market, if you're Invested in a 30 year bond, you could see, you know, a 20%, a 30% drawdown on the mark to mark value of that bond just because of interest rates moving. And so sometimes people think bonds are kind of a safer investment, but that's not necessarily the case if you are taking duration on that. Now, if you hold it down to maturity, sure. You know, if it's a government bond, not a huge risk of default there and you'll get your money back, but you are still taking that interest rate risk and reinvestment risk there too.
- [06:28]
Alex
Right. And another thing you could say is duration is measures to a degree, how sensitive an asset is to changes in interest rates. And if you think about again, specifically in that 2022 environment, why did all of the high flying software companies and SPACs get hit the hardest? Was it because they were, you know, people lost faith in their business models and things of that nature? Kind of like what's happening in the AI world? I think that's more of a business model risk that people are seeing there. It was really just a financial rerating, which is if all the cash flows from these software companies are going to happen way in the future, like my payment for this podcast is going to happen way in the future. Again, those cash flows become less and less valuable as interest rates go up. And so equities in general are quote unquote, long duration. Right. Or duration sensitive. And so whether you're going to be in a software company, that's kind of an extreme of that because again, a lot of the cash flows in the future. But even if you're in a four or five turn multiple company, which again, it's kind of, you know, you got a five year payback quote unquote from earnings, that's also going to get hit to a lesser degree because the cash flows aren't as far in the future. But the point here that we're making is that, you know, being invested in the market is not necessarily an inflation hedge. If you kind of put all your money out and again think about buying a bond, if you buy a 30 year bond at 2%, then you're taking on interest rate risk, you're taking on duration. And that is a similar, kind of a similar concept to an equity. Right. You are taking on duration and equity and I would say interest rate risk to a degree. Right. Every time you kind of purchase an equity, you add a current rate and a current multiple. You're assuming interest rates were more or less be normalized.
- [08:03]
Drew
Yeah, I just remember this conversation with someone who I guess at one point a number floating around of real inflation was like 7%. And so he kept thinking about how his purchasing power was going to go down by 7% if he stayed in cash, basically. And instead what ended up happening was he put his money in stocks and then the stock market fell some 20 plus percent, something like that. And so it just goes to show how counterintuitive this could be at some points where you think you're really escaping, you know, inflation by putting your money in stocks. And then instead stocks fall a lot more and you have less money. And so that's the big point though. The big takeaway I wanted to make is that to some extent, if you're concerned about inflation actually picking up, one of the best things you could do is you could hold some cash, short term Treasuries, basically. And so if you do expect rate increases to come through, financial assets will fall and then you'll have the opportunity to reinvest the money. Now that's not how I generally invest. And I don't suggest people try to time the market by selling out of their equities and all of that. It's just that if you are concerned about inflation, and that is a fear that then it could make sense to stockpile some cash as you continue to earn more money.
- [09:12]
Alex
Yeah. And one thing and I'm going to comment on that, but I just think it was really funny during this rate hike period where you and I were looking and obviously you do a lot of diligence on individual businesses and competition and all this work goes into it and it just feels like, wow, was that all just slapped down by the mighty hand of interest rates? Just nothing was relevant other than the fact that interest rates increased fivefold without so relevant. No amount of business, individual business analysis was going to get that right. And again, it had a major impact. Having said that, in the totality of time, I think you'd be okay, right?
- [09:49]
Drew
But well, there is an aphorism which is don't fight the Fed. And it's for exactly this reason. When you have a lot of flows are being dictated by just the rate of interest. And that by the way, is the exact reason why they manipulate the interest rate. You, it's very hard to perform very differently than those asset classes. Of course you can. But in the short run, it really is an overweighting factor in performance. Which is why during, you know, 2021 we had these boom in, in the stock market. It's all sorts of equities, all sorts of things, you know, cryptocurrencies, NFTs, all of this stuff was getting a lot of money thrown at it. And then as soon as we hit a tighter money environment, all of that reversed and went away.
- [10:33]
Alex
Right. And you know, you talk about how over the grand scheme of things, you know, how inflation takes a bite. If you did have $100 and you sat idly, but again, in the short term, how that's a little more challenging of a calculation. But the problem is, is as kind of if you are an absolute return investor, which is you say, okay, well listen, I don't know what the s and P500 is going to do over the next 10 years, but I think that X stock, you know, I can underrate a comfortable 10% return. Well, by you buying that company today, assuming your thesis works out, you're saying, okay, I'm happy with the 10% return in this environment. And again, if the risk free rate or something all the sudden went up to 10%, well then all of a sudden your investment looks pretty bad. Even if you're right, you're still taking on some type of equity risk and business risk. But if now the US government's paying you 10% and there's been a rewriting, now that money you put out doesn't look very attractive. And this is why if you look back to I think Berkshire Hathaway, in the 0 to 2% environment, they were really struggling, I think, to deploy capital because I think Warren Buffett and Charlie Munger knew that these were not normalized interest rates and it lasted a pretty long time. This zero interest rate environment.
- [11:43]
Drew
I disagree.
- [11:44]
Alex
Were struggling to put out capital.
- [11:45]
Drew
I know the argument. Yeah. Because the argument you're trying to make is that they should have lowered their required return in order to.
- [11:51]
Alex
That's not the argument I make capital. I'm making the argument that they had the insight to say that this was not a normalized environment and they didn't want to put out capital at a zero rate environment because they felt, again, maybe I don't know if this was explicit, but I did feel like they said at these meetings that this was not a normal rate environment and they.
- [12:06]
Drew
And that. That's true. But then you could still look back and there's plenty of investments that you could say kind of were in their wheelhouse and still worked out. I think. I think it's a different situation really what's happened with Berkshire over the last several years. I just think he, frankly, he's, you know, pretty old and there's a lot of companies and new things that he just doesn't quite understand as well as some older businesses and cut the guy a break. He's 90 plus years. And if you never got around to like really getting comfortable with a lot of technology stocks and you're looking for businesses that you know are in the s and P500, there's not that many that really did that well. Right. So his universe he was looking at was relatively small, which I think was kind of one of the bigger issues there in terms of actually deploying.
- [12:55]
Alex
So I'm giving them too much credit is what you're saying.
- [12:59]
Drew
I don't think you could ever give Buffett too much credit. He is absolutely the goat. But I don't think that that was necessarily them saying that rates are low so we're not going to invest. He doesn't think that way. And he's explicitly talked about how he wouldn't change his investment philosophy knowing what the interest rates are. If you go back though, there is a very interesting discussion Buffett and Munger had, or Munger and specifically was talking about what is the right cost of equity. And there's no real answer to that. And you know, he poo poo's the answers that the finance academics will give to that with Beta and wac. Instead, he's, he's just asking what is the cost of equity. And Berkshire's basically over time always use this, you know, 10% pre tax hurdle rate. And then the question is whether or not that's too high, if it should ever be lowered, if it is a lower rate environment, which is where I thought you were going with this. And the answer they gave was, yeah, I mean, over time, if we stay in a very low rate environment, then we should technically lower our hurdle rate to match that if we're not finding the right opportunities. And so you could say them not finding opportunities is the byproduct of two things. This could be your hypothesis. One, you could say their hurdle rate is too high and they're using too conservative assumptions. Two, though, you could say their universe is too small. And I think it's mostly the second rather than the first. And I think the byproduct of it being the second is just that we. One, they got really big, so fewer businesses they could look at. And then two, a lot of kind of the best businesses and the highest returning of businesses were in areas they just never built a competence in. And so that's kind of how I would explain their returns.
- [14:39]
Alex
Right. And again, I don't want to get into the whole hurdle rate situation, but of course, you know, you look at Constellation Software or something of that nature and when prices go up, the desire is, whether it's because of rate driven or competition, the desire is to lower the hurdle rate. And of course I think stalwart investors like Mark Leonard, like Warren Buffett, they're not going to lower their hurdle rate. And again, that could lead to a lot of missed opportunities. And again, I think there's a lot of value investors in that 0 to 2% rate environment that sat on their hands and said, oh my God, the S and P is trading at 20 times. This is unprecedented. I can't, it's coming crashing down. So Jeremy Grantham 2019 probably said same thing, but the notion is, is that not everything can lead to a steadfast rule, which is, oh, we're a zero percent environment, rates must come up and therefore I'm going to not invest because I think that I'm going to get to be able to get a better, a better deal down the line. And so that's where I think that in the practical sense that if you have a absolute rate that is set and call it what's a normal interest rate environment, I think we have pretty good data around where interest rates land in the US and the developed world. And you can understand that, hey there Might be these periods of very low inflation. There might be periods of very high inflation. And yes, in a world where if we could pick when rates are going to be at their highest and invest all our money then and then sell when rates are at our lowest, yes, that's the best way to make the most amount of money. Of course not feasible or easily done. And so you just have to have a strategy that's going to work for you in the most amount of environments. And I think having a little cash on the side is the way to survive in most environments. Whether that be a severe downturn and there's a lot of the deflation leading to asset prices, whether severe inflation that's going to lead to, you know, interest rates hiking up, re rating of asset prices. Again, the ability to play in that a little bit. And I think Morgan Housel has a great kind of quote about this which is he has cash not because again, if you're invested in 30 years, it does make the most sense to have all the money you can in the S and P or something similar for the most amount of time. Would you agree with that Drew, if you had a 30 year horizon put in the S and B as soon as you can?
- [16:51]
Drew
Yeah, no, the, I mean the data around whether or not you do lump investing or you cost average over time it shows that lump investing that is putting in all your money at once, it does better in like 2/3 of scenarios. So that's generally why people think that that's the best. Now I would prefer and I've never seen this analysis so if someone's seen it, that could be helpful. But if someone actually sensitized that for what the overall valuation levels are looking forward because if it's a very high valuation, I know there's anecdotal data or it's not even anecdotal, there's some data, it's just not a full picture across time of like a rolling investment that's being monitored. But if it is a higher valuation, we know there's lower prospective returns and there's certain 10 year periods. I know there's some JP Morgan report where it kind of looked at whenever the multiple was more than two standard deviations above the average, something like that, maybe it was a 22, 24 times multiples somewhere in there. It's a zero to negative prospective return for the next 10 years. But that's like the problem I have with that is I don't know enough about where that data is coming from, enough about that entire time period. And I also don't know if that forward return, when they're Talking about that 24 times multiple, if that ended up being an incorrect estimate or not. So those are basically, I have some open questions around how they're calculating that. But generally speaking, I think it's fine advice. If you have a long time horizon to you just drop the whole lump sum in the S and P and you don't muck around. I don't think most people want to do that. I think it's an uncomfortable thing to do psychologically. And so it makes sense to me, especially if valuations are a little bit high, which they're not terribly high, but they are a little bit high, around 21 times forward earning. I think the NASDAQ's around 24 times, something like that. So you could, you know, do 60% lump sum and then 40% cost average. But it's a different equation too. If you continue to make money and you could continue to add, versus if this is all the money you're ever going to have.
- [18:51]
Alex
Well, I mean, the traditional asset allocation, which is why I got into this notion of, hey, do you put everything in or have a little cash? Because a traditional bond, stock, bond portfolio, it works very simply, which is you're supposed to reallocate based on where things are in the market. So again, if stocks are down, presumably that's a lower interest rate environment. And if rates are trending down and you currently have a bond portfolio, then your bond portfolio should be rising. Stocks are presumably in a recessionary environment. You can sell bonds, buy stocks. And again, that's the traditional situation that works in kind of a deflationary environment. The problem in an inflationary environment is your bond portfolio is getting slammed because interest rates are going higher. Your stocks are getting slammed because interest rates are going higher. Gold is getting wrecked too. That was supposed to be the safe haven. As you dictated, Bitcoin's getting wrecked. So it's kind of like where, where do you hide in an inflationary environment? You know, if you have again, a lot of commercial real estate got hit because you either rerate the environment or floating rate debt. So the only place really to hide in an inflationary environment is cash. And what's funny about the inflationary environment, not to pick on Ray Dalio again, but he was all about we need to own gold because gold is going to be the only thing that does well. And inflation and hyperinflation is coming. And he kind of got, I mean, he was off by a few years, was always hard but he kind of got the inflation part right. I wouldn't say it was hyperinflation, but he got that there was an inflationary environment coming. But he got gold was not the asset to play that in. Right. Didn't do exceptionally well, although it has kind of come back and did have that big.
- [20:15]
Drew
But not when inflation was going up, but not when it was kind of a weird situation.
- [20:19]
Alex
Right.
- [20:20]
Drew
Yeah. So that's the thing that's also, you know, an argument against these kind of macro calls, right. Where you position your portfolio based off of your beliefs of how money flows are going to impact different asset classes. Because we just don't see, you know, it really work reliably. And if Bridgewater is a fund that collects more data across more markets across a longer history than everyone, and they're boofing that, then I just don't think that that's a very successful way for most investors to actually invest. I think the big thing to keep in mind is, and we've already hit this a lot, it's the interest rates is really what is dictating kind of the price level of all these different financial assets in your portfolio. And then if it is an inflationary environment, you're basically probably going to be worse off no matter what. And so that's kind of the unfortunate fact of this. You know, Warren Buffett had this article he wrote, I think it was in Fortune called How Inflation Swindles the Equity Investors. And the crux of it is basically return on invested capital doesn't go up to compensate when there's high inflation, it stays the same. There might be short term distortions, but if you were earning, you know, 10% on your capital and inflation goes up, you don't all of a sudden earn, you know, 17%. If inflation is, you know, 7%, it stays the same. And so you just do worse off. And you could read that article to see exactly how he walks through that argument. The kind of, again, the gist of it is, you know, there's like a margin that you could adjust, so that's taking pricing, but then your cost goes up. So you know, your margins aren't going to improve in an inflationary environment. Right. And you're not going to sell more goods in an inflationary environment either. Maybe you sell less or more, but it's not really related to inflation itself. And so if your margin's not going up and your turnover is the same, and the capital you're investing in the business, maybe you could sweat it a little bit more. But when you have to replace that. That also is going to be at a higher price. You can't get a higher return on invested capital. And so everyone is just worse off in an inflation. So that's kind of something to really keep in mind because I think a lot of times people try to position themselves for these different macro environments, but everything is just bad. And it's also a mistake, by the way, if you try to have a rolling, like put position in your portfolio because that's shown to just be a negative drag over time and not actually add outperformance. And so maybe it could stabilize your portfolio a little bit, but your overall returns would be less. And so this is just the truth, I think in life is that there's certain things that can happen in the world in the economy where we're all just worse off and there's not a lot we can do about it now if you're very concerned about it. Not the worst thing to have a little bit of cash.
- [23:00]
Alex
Yeah, I mean, not, not the worst thing. And you know, one, one thing about cash where people might say, oh, well, you know, what if I'm concerned about the US Currency or a basket of currencies or things of that nature, I think that in a world where I know the US currency is depreciating significantly and now you're holding cash, I mean, that's a difficult world to be in. But I would say that, I don't know, what do you say about that? I mean, that's a hard position. If the US Currency somehow, I guess that would be a hyperinflationary environment is what we're talking about. So if you're in a hyperinflationary environment, I guess I would lean back on the companies you own and say, hey, listen, if Google's going to find a way to make extract value in real terms, I mean, whatever the currency of the day may be. Right.
- [23:40]
Drew
Yeah. You're not going to be better off. It's all a relative decision. So what's the worst thing you could do and the best thing you could do? You know, people might say, oh, I want to own gold in that circumstance and it's, it's real money. But it could also be the case that, you know, economies are suffering and a lot of the central banks that are purchasing a lot of gold, which is, by the way, the real reason why gold has gone up in the past couple years kind of the US financial system proved that it can't be the most reliable and we can freeze assets. And so a Lot of central banks would prefer to own gold, at least on margin, rather than US Treasuries. And so that was kind of the big factor. But if you were in an inflationary environment, you could have central banks saying, we're going to sell gold and we're going to try to stimulate the economy because it's a mess.
- [24:27]
Alex
Drew, you hear Michael Saylor in the background right now advocating for Bitcoin as the true. But again, obviously bitcoin hasn't. It hasn't acted in a way that gold or a commodity or safe haven asset would. Right. Because that's the argument that gold and bitcoin, when everything's going to hell, you want to buy gold. That's kind of the argument. But again, when everything's going to hell, Bitcoin's down 80%. Right. So it hasn't acted as advertised.
- [24:53]
Drew
Yeah, I mean, look, if it's really like an end of the world scenario, very scary scenario, I could see gold doing well. I don't personally own any or advise people to because there's more than one scenario you want to manage a portfolio for. But if it makes you feel better, that's fine. I think if you do want to own it, it probably makes more sense to own it physically because then if you actually need it in a scenario, you could use it versus, you know, having some iShares ETF or something like that. But the bitcoin question is very different to me because it's never really traded correlated to much of anything other than just general liquidity. Right. So whenever there's a lot of liquidity in the market, it tends to go up. When liquidity is pulled from the market, it's tended to go down. It seems to be generally correlated to a lot of other, you know, financial markets. It certainly hasn't been a safe haven when other asset classes like equities were down. And so it just, it kind of seems like a random thing that you just, you got to kind of be very in touch with kind of the tailwinds in that market, you know, whether or not it's regulation driving it, whether or not it's, you know, ETF buying, there's all sorts of different things that could be driving the price of it. And people, you know, could potentially be kind of moving the price on it at margin too, because it's not quite as regulated of a market.
- [26:13]
Alex
Yeah, I think it's, you know, people start getting in when we start talking about these super safe haven assets. And I know people try to guard against these doomsday scenarios, which is, oh my God, there's been a nuclear war. We're in a Weimar Republic, hyperinflationary. The US dollar, it's 100% every month. And it's kind of. I don't mean to laugh at those scenarios or not guard against those scenarios, but I just kind of, when people give me those situations, I go, that would be really bad. That would be really bad. I don't think there's a good place to be in that situation. The world is falling apart, I think. And again, if you constantly think like that and people do think like that, and that's fine, you can allocate your resources that. But that's kind of like, get your doomsday bunker, survive with your canned foods, like, make sure you have some diamonds hidden under the floorboards. I don't know how to guard against those scenarios. And I also know if that scenario comes, I just, I'm not going to be. I'm not going to be a survivor in that post nuclear war apocalypse. I'm just. It's not me. I'm not making it, Drew. I'm not cut out for that. They don't need accountants. They don't need investing God in that scenario. You and I are useless. We're out of a job.
- [27:18]
Drew
I hope those are floor and decor floors, though, that you hide your diamonds under.
- [27:22]
Alex
Yeah, there you go. I mean, that's really, that's the scenario. I mean, you know, so those such draconian outcomes, they're difficult to guard against. How much energy and resources do you want to put into them? That's for everyone to decide. I think personally, if, you know, if you have some money in jewelry, a wedding ring, whatever, something, I guess that's kind of your escape hatch in a way. But I wouldn't have gold bars under my bed that I'm ready to pack up in a sack, personally.
- [27:48]
Drew
Well, so when Charlie Munger was asked this, like, when would you hold gold or something? He's like, look, like if you were a Jew in Vienna in 1930s, like, it probably made sense for you to have your wealth in gold and try to smuggle it out and get out. And I get that those circumstances could exist. I get that Bitcoin is theoretically like a better way to kind of move money in and out and it's decentralized and you don't have to carry all that gold with you. And so for that exact scenario, sure, like, makes sense. But again, I'm not really trying to optimize my life for that because my Life's already not going according to plan at that point.
- [28:26]
Alex
Yeah, exactly. You got a lot of problems. And again, I think in that situation, I don't know, how am I going to get my wallet out? Is the Internet down? Have the C cables been severed? I mean, is there electricity? I don't know. Right.
- [28:39]
Drew
And then as soon as you move to Bitcoin because it's trackable, they try to find you.
- [28:43]
Alex
Right. And now I've got the armed militia at my house trying to torture me for my Bitcoin password, my key. Again, I don't know. These are scenarios that I don't think we would do well in, but I think you need to guard against what is reasonably possible and again, what could be reasonably improbable? You know, I don't think it's crazy to think about, okay, how would a portfolio do in a Great Depression like scenario for an extended period of time? And that's why I think, you know, in your kind of investment video or wealth management video, you said, hey, it's good to have this amount of expenses in a cash buffer. So if a scenario like that, that did come, that was very draconian, you're not again, reasonably, I mean a nuclear war, I don't, I think extended recession where you could survive and you're not stressed with your family, that's a different, reasonable situation to guard against.
- [29:31]
Drew
Yeah, I'm not planning for nuclear war, but I think it's totally advisable to have a larger emergency savings than what most people typically say. I often hear people talk about maybe a three months to a six months emergency savings and I don't think that's enough. I think if, you know, you lose your job, it could take more than six months to get back on your feet. I think having a year is a, is a better number. I think that there's a lot of circumstances where that's, that's going to be great and maybe you're going to want even more than a year. I that's a level of conservatism in a conversation I more comfortable having than where we should buy our bullets in case the apocalypse comes.
- [30:10]
Alex
Right. And again, I think that's a reasonable approach to. Again, if I was someone who was deeply concerned about really adverse scenarios that again, aren't apocalyptic, I think that would be the way to save a guard against that, a year of expenses and cash savings. Again, assuming you wouldn't cut down expenses, presumably you're in a deflationary environment or something of that nature. And this is where we Kind of keep talking about this, but the stagflation is just a scary economic situation because you're in a recession and there are no jobs and everything's getting more expensive. That is a, that's a scary place to be. That's not great.
- [30:44]
Drew
Not great, not great.
- [30:45]
Alex
And nothing really to do about it other than survive and hope Volcker comes in and raises interest rates to 25% and gets it.
- [30:52]
Drew
I don't know.
- [30:52]
Alex
I mean, it's not a good place to be. And that is why. And we're getting a little off topic here, but I think that what's been a little scary about what's happening with the Fed right now. And again, I think I have a lot of respect for Jerome Powell previously. Kevin Warsh is coming in and he seems to not be doing what, what the President wants him to do by talking about rate increases and not immediately cutting rates down. But that is where I had a lot of respect for Jerome Powell and probably the markets because I think any student of markets is much more afraid of hyperinflation in that doom loop than overshooting on high rates and leading to a possible recession or, you know, something of that nature. I think that's a much scarier outcome to 100%.
- [31:36]
Drew
I think you almost shoot for the recession because of how bad hyperinflation or stagflation can be. And a recession is, relatively speaking, not the end of the world. Whereas if you hit hyperinflation stagflation and our currency loses its credibility, then it's very, very hard to get that back. And it took them basically a decade of economic pain to do it. So, you know, we both read this really good book, Secrets of the Temple, which is thoroughly dispelled us of any notion that it can be acceptable to risk such a scenario again.
- [32:13]
Alex
And the US it's funny. I'm reading. I just want the viewers to know you have flexed on them. We read Secrets of the Temple. I'm going to flex that. I'm reading the history of Singapore and Lee Kuan Yew's biography who's the founding father of modern Singapore. But it was really funny, him as a developing country speaking about how well, how are we going to pay for things. We actually have to generate tax revenue and run a surplus and buy reserve currencies and actually be, be intelligent with government money. I don't think the US has an appetite to do that. So if we don't have the ability to print treasuries without a hyperinflation loop and someone Buying those Treasuries, the US Is in a difficult position, so we really need to make sure the world does not lose confidence in the currency. That's a macro take, but I'm just saying, like, no, it's true.
- [32:57]
Drew
But then also it's, if you do get inflation because maybe you lower rates too soon, then you're going to have to go back and raise rates even more. And then we have so much debt and interest rates are going to increase. So to the extent that now a lot of our budget is just covering interest expense. And so it could really hit us in multiple bad areas, which is why it's just so asinine to me to just not want to come from a position of conservatism here.
- [33:23]
Alex
Yeah, no, I, I think that two great books to read, Secrets of the Temple, will scare you about hyperinflation. And then I'm forgetting the name of this book, but it's essentially diary entries from the Great Depression. Just a lawyer who is in, you know, living through the Great Depression, and he relatively interested in stocks, kind of like an average layperson reads the Wall Street Journal type situation. And just reading that day to day also made me terrified of the Depression. So again, where do you lean in all this? Just know, be prepared for all scenarios, be ready to survive in the long run. And you don't want to be a net seller of assets in those times. So have your cash buffer and make sure whatever's in the market can stay there for very long times.
- [34:06]
Drew
Well, when, when Buffett's asked about this, he just basically says, you know, make sure you have a skill that's valuable and you'll be able to, you know, charge for it and be valued in this other society. So if we do go to a doom apocalypse, you know, make sure you got a skill that's valuable there. Alex is going to figure something else out besides accounting.
- [34:24]
Alex
I just hope they take out all the data centers because then Claude can't do the cpa, accounting and or investing work, you know, so. That'll be good.
- [34:33]
Drew
That'll be good. Yeah.
- [34:36]
Alex
And again, I don't know, you know, we're going to be, I better learn some carpentry. I better learn some hard skills soon. You know, this, this service, the service industry might take quite a hit. You know, one thing we didn't touch on, which is kind of land hard assets. Right. We touched on gold. A lot of people will say, okay, land, real estate is another good place to be in this inflationary environment. What was your take on that?
- [34:58]
Drew
So it can be and it depends, but you're not necessarily in a better off position owning real assets in an inflationary environment versus a non inflationary environment. So said differently, it could relatively be a good place to park money, but your real estate could suffer too. Because if you own a residential property and people are economically struggling, get more vacancies. You own a commercial property, you could get more vacancies. And then the cost to do upkeep and all that, that's still going to be more expensive. And then, you know, depending on how you're financing it, that's going to really be sticking point. So if you had floating rate debt, very problematic. If you have long term fixed debt, okay, that could actually be a pretty interesting thing to do. Now I do not suggest people do this, but there is a thing in finance where sometimes they say you should be kind of hedged with very long term fixed rate debt against a sort of scenario like this. So if you had a 10 year, you know, loan out there with 3% interest that you're paying and then you just take that cash and you park it in Treasuries, that is there to kind of offset a scenario where you do get inflation. Now your debt is getting paid back in weaker dollars, interest rates go up. Since it's fixed, you're not paying there, but then your cash interest income is going up. So I don't recommend people do it. That kind of sounds like a recipe for making a mistake and just taking out debt that you don't end up paying back. But that's kind of effectively what ends up happening when you own some real estate property. So has been a lot of wealth that was made when you do own real estate with long term fixed debt and then you're able to pay it back basically with cheaper dollars. So it's not the worst thing in the world. But keep in mind, when you buy real estate, you're basically getting into a business for yourself. And there's also a lot of upkeep cost involved in that that people don't usually keep into account.
- [36:51]
Alex
And you know, I think one thing that sometimes I got this take when rates were very low, people would say, oh, you know, I have equity again, maybe someone who's paid their house off or they had very low debt balance on their house and like, oh, I'm getting all these banks asking me to take out a second line or maybe again, I paid off my house and put, you know, debt back onto my house and get it locked in at these 1 to 2% rates. You know, should I do that? And of course in hindsight that looks like a, a stellar move because theoretically, oh my God, I'm going to lock in this debt at 1 to 2% and then rates are going to spike up and now I have all these companies to invest in and the risk free rate is so much higher. Of course, to me that is the equating of if I timed everything perfectly because again, these 0 to 2% rate environments existed for a long period of time. You could have taken out these 0 to 2% loans and then had, you know, invested them elsewhere. And were you going to make a bunch of money? I don't know what your thoughts on that. Right. I think you could have a very negative scenario. It would have worked out this time in most environments, even if you had done it at the height of 2021, obviously the markets marched forward to that. But in, in my opinion, you're kind of taking the risk of, hey, I'm trying to take out this debt now in the event that I'm going to make a much better return in those environments, odds are that it's not obvious that that's going to happen. You know, especially given this.
- [38:06]
Drew
I'm a little more mixed on that one because I think if you have a home mortgage and you have to have one and you're going to have one, you're going to obviously refinance it if rates get lower. Right. Because you're going to want the lowest interest rate. And if you have that rate, to me it makes sense to hang on to the mortgage if it's, you know, 2 or 3% mortgage, maybe even for something pretty low, and just have that flexibility with the capital rather than, you know, pay it down basically. And so if you do have this low interest rate mortgage and then there's a question, what do I do with this extra cash? Maybe if I could have theoretically paid it down, then it makes sense to invest it in my opinion. And I hear you, you know, that's a little bit. Are you going to time it perfectly? What if you had it, you know, this mortgage in 2021 when the rates were low, then you had the money and you put, put the money in the market, then market fell. Well, it still just goes back to, if you have, you know, a timeline, five years to 10 years, then I think it's fine to still be invested in equities and try to play that arbitrage. I think that it doesn't happen on a large enough amount of money that it matters to most people and most People, when they have a home mortgage, it's not like they have all that excess cash just like sitting around or something.
- [39:10]
Alex
Well, I think you're right. I mean, if I were to say, hey, I have a mortgage and it's at two and a half percent and I have $500 in my account and I can either pay off this mortgage or do something else with it, I think that's a slightly different calculation than If I have $500 of home equity and I'm going to take out 250 incremental dollars of debt with my 2%, because I think I'm going to go play that differential. I think that again, I guess you have a margin line at a much lower rate in the totality of time. Will that go? Well, odds are in your favor, but it just still doesn't, it doesn't sit well with me. That move all the time.
- [39:44]
Drew
Yeah. I mean, it ultimately comes back to your kind of ability to repay that debt. Because if it is the case that it's a five year loan or something like that and it's a bullet payment at the end of year five, then yeah, that's a much riskier thing than a loan that amortizes over 30 years. So it just depends on the particularities there. But I don't have as much of a problem with that as you.
- [40:07]
Alex
Yeah, honestly, as I'm saying it out loud, it's hard for me to say that that's a losing bet. Honestly, it's a little difficult.
- [40:13]
Drew
If it was like a refinance home loan and it was a very short time horizon or if it was floating rate or if it was like an ARM that readjust, then those are different scenarios.
- [40:23]
Alex
I mean, especially if we're talking about, you know, a 750,000 tax deductible. Now my 2%, depending on my tax bracket is really 2%, you know, times a 40% tax shield or times 60%. So now I'm at a, you know, a 1.2% after tax rate. It's pretty. Now I'm getting pretty interested in that. So. I think you just sold me, Drew.
- [40:43]
Drew
I just, I think you sold yourself.
- [40:46]
Alex
I can't wait if that environment happens again in our lifetime. It might not. You never know.
- [40:51]
Drew
Yeah. This time's different, right?
- [40:53]
Alex
This time's different. We might not see the 0% rates again for a while. I think that this was kind of a meandering discussion about inflation and asset classes. And we throw in some asset allocation advice and some wealth management advice. It was kind of all over. But I thought this was an interesting discussion about, I would say the myths of inflation and what asset class actually performs decently in these inflationary environments. I think we've kind of seen that. Not, not really any of them. Not really any of them. Not really any kind of the answer there.
- [41:22]
Drew
Yeah. And if you go out and buy land, then you might end up in a situation like Alex is in now where he has all these plots of land he has to sell.
- [41:31]
Alex
I've got a lot of plots of land, you know, I actually watched one too many episodes of Yellowstone. Now I have plots of land. You know how that goes. But it's okay. Listen, if the world goes down, then I'll have to YouTube how to be a farmer and I can raise some cattle out there, I guess.
- [41:45]
Drew
And if the, the, the world deteriorates, I'm sure people will respect your property boundaries.
- [41:50]
Alex
You're right, they'll respect my property. Yeah, they will. And listen, that's why.
- [41:54]
Drew
Yeah.
- [41:54]
Alex
I don't know. We're again, not an environment I'm going to do well in and nor, nor will I pretend I would. But I think the next video or in the next series of videos what I do wanted to get into is you did a really great wealth management kind of asset allocation video. Just kind of the myths of financial planning, investment management, wealth management, how do all these things tie together and again and also into the individual stocks videos that you do. So I think maybe we'll touch on that video or parts of that video as it goes. But I'm just grateful I didn't have to talk about AI software, SpaceX today. I'm really sick of all three of those. I can't, I can't talk about it again.
- [42:28]
Drew
But you know what's our most popular episodes? I know.
- [42:32]
Alex
What are you going to do? Listen, give the people what they want, but I'm going to give myself what I want, you know.
- [42:37]
Drew
Okay, well, there you go. That's his motto. But until next time, I do the endings.
- [42:43]
Alex
Until next time.
- [42:45]
Drew
All right, until next time.