The biggest risk facing investors right now is the unsustainable stock market valuations that will eventually mean revert, said Ted Oakley, founder and partner of Oxbow Advisors.
We're talking everything an investor needs to understand before actually getting involved in the markets with Ted Oakley. He is a founder and partner of Oxbow advisors. Ted. Welcome back to. Thank you, David. Glad to be here. 10. You're also an author and I learned this after our last a show together. And you send me your latest book, it's called your money mentality, how you feel about risk losses and gains.
And so, um, there's a lot of different, uh, different topics covered in your book, but I'd like to touch on a few of them with the audience today. Uh, the first being the major market risks today that investors should pay attention to, and also, um, We'll talk about, I don't want to call a self-help guy, but it is sort of in a way, um, a guide towards understanding yourself as an investor, understanding your own risk tolerances, understanding how to position yourself and understanding how to execute on your ideas.
Uh, very important and timely for today. So let's start with the major risks you highlighted. Um, the main reason. That would plague any market today. I'm just going to list a few, including credit risk market risk currency, risk inflation, risk, real estate, risk concentration risk among others. Ted, what is the highest in your, in your opinion, the highest rate of risk right now?
I think David, the highest risk right now is in actually the stock market. Now I think real estate is risky too at this level. Uh, I would say we're in a period where we call it everything speculative and that's true. Almost everything speculated, private businesses are selling perspective prices, but the markets are selling for prices that actually have never existed before.
And the problem with that is that when you get to this point and everybody keeps on speculating and it keeps on working, they just speculate. So that's where we feel like we are. And at this point, because I can take any measurement of that price to sales on the market or forward price earnings, I can price to book value and just look at all the specular guy activity.
And as well as the number of companies, I mean, there's so many companies that are at these exorbitant prices that are losing money are not making any money. And so I think people, uh, they just gotten completely. And I think the biggest risk right now is in that area and the tech bubble, we saw similar valuations in terms of bubbly, bubbly prices.
When you look at price to sales, price, to earnings, EBITDA, and so on. But back then we had a lot of companies that didn't do anything. They were just poor quality companies. Can you say the same today? I mean, it's one thing for the markets to be expensive because of monetary system. Or because of increased speculation, like you said, but maybe the quote, the companies themselves are actually, you know, in good shape.
What do you think? Well, I think, I think the, the problem with that, but comparing it to 99 is this, and I know, I remember it greatly because we sell some of our last tech stocks in, uh, in the fall of 99. And we actually lost some business. We had some people move accounts because they didn't like. Uh, it paid off well the next three years, but we were certainly against the grain today.
What you have is different. You have, uh, then you had a lot of value stocks and things like that that were okay. But today you have a tremendous amount of companies that really have no value. They're just trading and you look at the last two electric car companies that have come out here. If you look at Vivian and lucid, I mean your companies that have nothing and yet they have these billion dollar market gaps more.
And that's what we see today. We see this unbelievable amount of buying into things that don't have any value at this point. I'm not saying they wouldn't later on, but if you remember back in the back in the 99, early 2000 era, you had a lot of companies that were selling. If you look at AOL and Yahoo and those companies, I mean, those companies lost 80% of their value, 80, 85%.
Were they still around afterwards? Yeah. But things they really weren't worth the money. And that's what I'm saying. Uh, yes, there will probably be a number of these companies around, I think a number of them won't be around, but I think that's where we are today. I'm guessing. Tell you didn't buy Vivian. I did not.
You did not buy, you know, the thing about, I can't buy companies that don't have any revenue. I mean, you know, from a business standpoint and I do a lot of private investing too. I would never go out and buy a gun. That didn't have any revenue, you know, and speculate on maybe a junior miner, for example, or a startup tech company.
I will tell you this, the only way I would do that is if I knew the owner, the knew the founder really well, because when you invest in companies, you need to invest in the people. And since I don't know anybody in area or anything like that, obviously I wouldn't do that. Uh, when I do and look at private companies, I always look at the people, do I know the people doing what they're capable of, and that's a little different situation than the public sector, but now in the public sector, you can just come up with a great idea and come out with it and put a package it and come out.
And all of a sudden you're public. Well, somebody somebody's issuing a, you know, these IPO's, somebody is doing the fundraising, somebody buying these shares. Where's the money coming from Ted. Where's all this liquidity coming. Well, the liquidity to come in and they have the last year and a half, you know, when you keep pushing money in the system and you have the big keep buying the bonds like they have, it's made it, it's put a situation to where rates are so low, you can borrow for nothing.
And so not only is there a lot of cash, but there's a lot of easy borrowing going on. And I would say David, not to ever underestimate wall street, that they can sell anything I've been at. I started in New York. I know, I know what is like, and they can sell anything. There is, as long as they can make a buck, can you, can you send me this pen, Ted?
I'll tell you what if they got underwriters? They probably will. I want to talk about the stock market risks one more time, and then we'll get back to some of the other risks you noted. Now, stock markets, of course, valuations have been high for a while, but let me just, let me just pause it, this argument.
Okay. I've heard the, uh, the statement that stock market's overvalued. I've been hearing that since a while. I graduated from university in 2012. So 2012, um, back then after the, uh, after the financial crisis. Yeah. Uh, stocks went up and people were saying, well, look, it's it's peas. I've never been higher. And of course it continued just to just grind higher.
Even after that. Um, if you had sold back then on fears of a bubbly market, you would have missed out on 10 years of gains is a different this time. Well, I think it's different than this level. Now the big mantra has been David over the last 10 years, is that with interest rates where they are in markets are not overvalued.
My argument to that would be, let me take you back to 1982, when you had the earnings yield on the S and P at a level that was, and you had that, and you had to look at the 10 year bond. And by the way, at that point, that would have told you that the market was the most overvalued. But it actually was really, really cheap.
So the argument that interest rates should drive those multiples we don't buy into. We just look at, okay, we buy a company. How long is it going to take me to get my investment back? And on the other side, another strategy we use, how much cashflow am I going to receive annually? That's the way we look at it.
Then you can make an argument that people can that, Hey, I like to buy these things expensive because the rates are so. That it makes sense for me to get an earnings yield. It's better. Well, that may make sense if you're just comparing those two things, but it doesn't make any sense when you're looking at buying a business and that's what we're looking at.
So what's going to happen to the stock market. Then I'm here, I think at some point, and this has to do with the fed when they quit buying and you don't have. You don't have that holding up everything in the bonds on the whole thing. And they've, you can tell that they've been really tepid. I mean, they, they sort of, you know, tiptoed into the thing and they think they got it all under control.
They don't, but they think they do. And so what happens is when they, when that goes down to zero, or you go down a lot lower than we are, you don't have that underpinning the market anymore. So when, when the fixed income market start to be under pressure regarding. Then you'll probably see the equity market under pressure as well.
But, uh, you know, you, everything gets to a point where all of a sudden it just drops on its own light. And that's what you usually see at the top of a market. There's not a reason. It just starts off. Has that happened before, uh, in your career where, uh, the, the fed pulls the plug and the stock, market's just.
Well, uh, I'll give you an example. Uh, if you go back to Greenspan in the, uh, 1987 bright, okay. Um, he thought, well, we're, I'm going to be another Paul Volcker. And so I'm going to, I'm going to really hit this. We didn't really have that inflation was actually going down. It ticked up, but he thought, well, I'm going to really hit this inflation.
So he, so, so he got the bonds up to where, uh, the yield was 10%. And every portfolio manager said, why am I buying stocks? I'm selling the market. Cause I've got the, I've got the treasury it's 10 point. Yeah. And so that's what happened. That's what causes those things. It really wasn't the case. Uh, in 2000, I think in 2000, just the, the weight of the market itself, you know, you get to certain points and, and all of a sudden you roll over.
Uh, one of the problems now is that you have, you can't get a clean look at it until the fed backs out on the market. Then you get a clean look. Right. What about, um, what about credit risk? Are we seeing excessive leverage in our financial system? Are we seeing a buildup of potentially the next Lehman disaster?
Well, I don't know if y'all have another lien. I do think this though. I think that there's leveraged too much leverage everywhere and nobody's afraid of it. Last Thursday, I saw the announcements where the California pension funds CalPERS had decided that in addition to all their alternative investments, which they probably don't know where all of those are, they're going to leverage.
Now, if I'm a person and I've got a pension plan, that's decided to leverage, I think I'd retire and take the money. Yeah, I think go back part time or something. I wouldn't do that though. So everybody's getting leveraged there and they, you know, they, and you look at the leverage levels and nobody is afraid of it because rates are so low, they can say, well, I'll look at the cost cost of debt here is really low, but eventually, you know, it has to be paid back if you're a company or you go under.
But, um, yeah, I think there's just too much leverage everywhere. Real estate, private businesses, private equity, too much leverage. And every time. Okay. Um, inflation risk. I know it's not your top risk right now, but, uh, you did mention in the book, I'm just going to read this sentence. Most people, or many of today's investors have never witnessed inflation as a consequence when it does arrive.
And it will, we will have a lot of people who have, who will have no idea where the risks lie. Now you wrote this about this book a few months ago. Inflation is now at 6.2 billion. So I'm guessing when you wrote it, you had foreseen inflation to go higher. I think that's the underlying assumption. Um, this is the highest inflation level since the early nineties.
In fact, the last time we had this hive inflation level, I was still learning how to walk. So you're right. A lot of people, especially from my generation, I've never seen this. What should we do? You've outlined a few solutions in that chapter, buying hard assets, for example, but generally your, the, the, the, the message that you're trying to give is that most people don't know how to react.
Why is that a problem though? Why can't they just learn? Well, they can learn. The problem is, is, is that they'll lose, uh, buying, you know, the whole idea David behind investing is to maintain buying power over decades. If you can maintain buying power with your assets at the same level, through inflationary periods, that's the whole idea behind investing.
That means I've got as much money on an inflationary basis, 30 years from now that I have now. And what happens is a lot of people now, especially people in the business best business there they're buying long bonds, 20 to 25 30 year bonds. They're not getting much money on them, but when you know, I was in a period in investing in the bond market where you bought a bond.
And three months later, it was probably going to be lower in price because you kept on inflating all the time. And so you had to learn how to work around that. What happens now is everybody that is in the marketplace, especially investors, but also a lot of people investment business, you have not seen it in what happens during inflation is I'll just tell you it becomes more of a commoditized investment atmosphere.
You have to be able to trade a little bit. Like, we're not big traders or anything like that, but what happens is, and in c'mon enduring moves where inflation's moving higher all the time financial assets don't do as well, but they have these spurts they'll go up and they'll try it higher. And then they'll try it back because every time they get going and inflation keeps pushing up, it becomes a.
Now, I'm not saying we'll go through that. Like we did in the late seventies and early eighties again, I don't think we'll get that high at all, but if you get two, three or 4% inflation and just stick with it right there, there has to be some changes going on because everybody everybody's almost sudden in a negative, real right situation still.
So given that we might be persisting into a negative, real interest rate environment, given that inflation is a risk, given that the stock market. Aren't even bigger risk in your opinion, what should investors do? What should they buy? Well, I think they have to be balanced in this respect. I don't think they can just say, okay, I want to go all hard assets are all commodities.
I think they've got to have some of everything, but particularly I think the need to keep for a while, and maybe not later on, but for a while, they need to keep their bond maturity shorter than they normally would in back. Very short. I think the other side of it is they have to own. Some assets that are inflation sensitive brows.
For example, we own oil. We own natural gas. We own fertilizer. We own timber. Uh, you know, we, we own metals. And so we have, we have that, but it's not a hundred percent. It's, it's a balanced look so that we've got a chance to participate. If in fact, you keep this inflationary look going. One of the things that's up in the air is the ablations coming from internal.
Housing and food. That's where we're getting it. If that in fact changes and we slow that down, then that's going to change the atmosphere. But right now those three things are, are really driving the bus right now. Okay. Well, do you think that a stock market correction is eminent potentially in the next two years?
I do. I would guess that we'll have, um, some sort of a bear market within the next two years of you. If you asked me a yes or no question, I would say. Would it be as bad as 2008? That is last year? Well, usually from this level, if you get, if you look at your standard deviations of valuation, relative to where the market is, and you just go back to an average of where it should be, you know, that's, uh, that's probably right now, somewhere between, uh, uh, uh, 40 and 50% break.
I'm not predicting it's going to be 50%, but I have. It wouldn't surprise me only about guys. You'd go back. Everybody believes right now, they think you can't go back to the norms. Will you always go back to the norms? Eventually might not be this year or next year, but that's what happens in investing.
That's why it works the way it works. And so, uh, some point in time, you'll go back to some basic, those sorts of valuations. I'm not that doesn't necessarily bother me because I think, uh, people need to realize if you have liquidity in those. That's where you really make a lot of money. And I think, uh, we always look at it as an opportunity now, uh, most, uh, we're not most but many fund managers in the business today enter the business after 2008, which means that a lot of people haven't seen or witnessed a prolonged bear market.
What we saw last year was in precedented. The stock market's rebounded very quickly thereafter. Uh, I'm not saying it didn't wipe a lot of people out. I'm just saying it wasn't a prolonged bear market. So if we do have a bear market that persists for longer than two months, what's the consequence of having an industry where a lot of managers aren't experienced with that kind of environment?
I think the biggest thing, David is this. If you look at the people, who've come into this business over the last 12 to 14 years, They come into a situation where they all buy index funds, they all buy exchange, traded funds. They plug what I call, plug and play. They buy 10 assets and say, Hey, just no worry about it is great on the long run.
And everybody being will be fine. Well, in the last 10 years, that actually has been true. I can't argue with it. However, when you go into a bear market the last a year and a half or two years, it's crazy. It takes down the best stocks. It takes down the worst doc. It takes down everything you can have. You, ain't got to have the best docs in the board in bear markets, take them all down.
And the thing that they probably wouldn't understand, and that is that it wears people down over time. And the people that have been around the last 12 years or so haven't had a chance to be worn down yet. So what happens is. They get, they'll get that in my opinion. Now they'll get very frustrated and their investors will get them frustrated because they didn't have any liquidity.
So many of them that day, we see portfolios all the time, zero liquidity, you know, and there's none. There's no insurance policy whatsoever at something going wrong. I think that'll be the biggest problem for those people in that situation. One of the chapters in your book discusses, uh, understanding yourself as an investor, understanding your own risk tolerance, understanding your own control systems that you can utilize in that kind of situation.
How do you come about understanding yourself? This is not an easy thing to do for most people, like you mentioned right. Last year. One of your examples was in March last year when the stock markets. At the onset of COVID a lot of your clients sold off at the low because they couldn't stomach the volatility.
I'm just thinking about your example of a, what, what, what, what a, what an inexperienced fund manager might do. So how do you come to understand how to under well, how to basically hedge yourself in that kind of environment? Well, David, if, if, when you look at the book I write in the very beginning and I say, look, if you don't read the whole book, read these two things, and one of them is Alaska.
Which is basically, what is your choking point? Now, everybody, no matter how risky they are, are conservative, they are, has a point to where they want X amount of dollars not to go any further. Never. There, there is a point even the most risky people we know in get shaken up. If, if they lose enough, And so what happens is I tell everybody, look, whatever that whatever is in your psych, there's a dollar amount in there that says, okay, I want this amount of money to always be.
And we call it, we have to an idea. We have base capital and we have investment capital. And we always say on this base capital side, there's a certain amount of money that you need to keep out on the market. You need to keep it very, very simple. There's not, it's not volatile at all. That's the number that will allow you to go through the ups and downs of the market with your investment capital and not shake you out.
Yeah. If you have everything in the market, all of a sudden, you think, gosh, I never thought I I've had people tell me this before. I never thought my capital will go down to this level. Well, it's because they didn't have, you have to be able to live, to play another. And survive. Yeah. And I think that's the, that's the key point in investing is that you ha, if you get in a position where all of a sudden the market's controlling you, because you've got, you've hit that point, that where, you know what, I can't take it for young people.
Um, I think they always should have some money there. They can have more money in the market cause they put more money in all the. But, uh, that's what we look at. We, I think you have to get to that number and if you find, if you can realize what that number is, okay, that's a number I want, then everything else, awards.
Okay, well, let me, let me give you a hypothetical example. Uh, suppose I have $20,000 of capital and suppose initially I put in $10,000. So I've got 10,000 invested in the markets and the other 50% of cash. And then in this bull market that we've seen, I'm looking at all my friends getting rich, and I'm thinking to myself, what am I doing?
Being an idiot, staying off on the sidelines with 50% cash. So I'm going to go in 90%. I'm going to ride this bull out. What's your response to that? We'll do two responses. One. If, if you're a person that's going to be having money to put in every year, the next, you know, the rest of your life, that's that's, uh, you, you could, you could have more in the market and you can be.
Because you're going to be averaging out every year. If you're going to put more money in for so many investors, though, they have a lump sum of money. They can't do that. They, this is all, it's just what they have. They retired on it. They sold a company something's happened, but for somebody in the situation, you're speaking about, the only thing I would say is this.
And that is if that other 90% went to got cut in half, I'll use it. That example. Okay, then ask yourself how you would feel. And if you say why, that, that really wouldn't work for me, I wouldn't want to end up with that working like that. I like to have a, like them a little less than that. Okay. You give them an extreme example.
I'm not saying it's going to happen, but you always give them extreme. Cause it could happen in that way. They can get to where they want it. We liked stocks long-term but you have to know. When the put in more, I'm willing to put in less, I think. And that's where we, the logically it hurts more to miss out on gains than it is to actually lose money.
I've noticed that now it does. It does. But if you look at the studies that have been done over the years, uh, losses are twice as more painful than getting. In the long run right now, what happens is everybody, every time you go to a dinner party or you go see one of your friends and they're saying, well, I bought X and now it's 10 X.
You're like, you know, I'm missing out on the riches here. And I can't, you know, and, but that's what happens when markets are really frothy. Yeah. But if you look at the, if you look at, in any psychological book about gains and losses, they'll tell you that loss. Hurt generally twice as much as gains. And that's why people sell out at the low.
They can't take it, you know, uh, you rarely see anybody do anything crazy at the high, because I feel good, you know, but the emotion of that is to put more money in and that just keeps them working. But at the low it hurts. Right. Uh, one final point you do have another book, um, Rich kids, poor kids, kids, huh?
Brooke much kitchen broke kits. Um, my, my apologies. Okay. Well, I think the name speaks for itself, but, uh, w why don't you give us a bit of a synopsis here of what, what that is. And there is a very important message that ties back to investing. Well, you know, David, we've written a lot of books and on different topics, selling your business, different things, but one of the things we want to ride on a number of years ago, We found that, uh, people that have extraordinary wealth, particularly the first-generation, they sell a business, something goes on, they don't do a great job of getting that wealth correctly down to the second generation and particularly the third.
And it typically has to do with when we come into a second generation child, that's a sighted child, but on a. That inherited the money. Our third generation, many times we see the third generation, they'll say, well, my grandparents had a lot of money. They were mega wealthy, but the second generation spent most of it.
And then we spent the rest of it. And so we don't have a lot of money and it has to do with teaching the next generation, how to handle money. And the one main thing I use in there is I say this. No matter how much money you have, you need to make your children work. You need to make them get a job, learn how to work.
Okay. Learn how to appreciate the dollar that they make. Okay. And then they'll appreciate the dollar that you have. But if you just give them lump sums of money, they never have any appreciation for what it took to get there. And then the biggest thing about this is when you make them stand on their own two feet, it's hard on you because you could make it easy for them.
You really could. You could say. Here's a new car. Here's a new house. You and your wife, they don't have to do anything, but if you'll make them stand on their own two feet work, do their own work. It will help their own self-esteem so that when they're 45 years old and then they get some money, they'll think, you know, I'm going to really take care of this money because I know I know how hard it is to get it.
And I think that's one of the big mistakes that people make. But we talk a lot about that because people really don't have. The fortitude or the, the, the ability to say I'm not going to do that. I, I know in my own situation, I paid my friends who had businesses to work my kids from the time they were 11 or 12 years on until they could get injured by a company.
And then they had their own job. My children never knew it. I never knew it. I gave cash money and I said, you pay them a paycheck, just like they were working. And you know why it goes a long way. So tat then final question. Let's talk about wealth preservation. Let's talk about leaving an inheritance for, let's say your grandchildren.
If he had to leave an asset that you think would stand the test of time for more than one generation, let's say two generations. What could that be? Well, certainly, uh, David, any branded company and I'll use some examples. If you had a distributor ship that was only, uh, only for a territory. That you owned it and nobody else could be on that.
That's typically going be a kind of thing you don't want to sell. You can pass that down because nobody can ever enter that territory. The second part of it is, is that if you are able to, I particularly like real estate because real estate, uh, teaches a lot of things. It teaches how to finance. It teaches leasing teachers' interaction with people.
And all those sorts of things. So if I were leaving one thing, I would leave income producing real estate to my, to my second generation. Oh, fantastic. All right, Ted, thank you for your thoughts. Um, good luck with your new book and, uh, let me know when you have another one lined up, ready to go and, uh, available to the public.
Thank you for coming on kickoff today. All right, David. Thank you. Thank you for watching Keiko news. I'm David Linn. .