Paul Winkler: Welcome. This is “The Investor Coaching Show.” I am Paul Winkler.
Today, Dan Hill is actually in the house. Man. And Evan Barnard, of course.
Evan Barnard: Of course? What do you mean, “Of course?” I’m not always here.
PW: Dan will have the lower voice of the two of us. Go ahead, speak to us.
Dan Hill: Welcome. Welcome everyone.
PW: Yeah, nice. Well, it is good to be with you guys. I think we’ll have some fun today. I have a feeling — if we can dodge the thunderstorms for long enough.
I think that’s what’s coming on. I was going to ride my bike over here. I got a bike, Dan.
DH: A Harley? You got a Harley now?
PW: No, not that. One that you actually get exercise on.
DH: Not electric.
PW: It’s assist, because there are some hills between here and my house that I do not want to go up.
EB: It’s solar-powered.
PW: It is not solar-powered.
DH: I don’t know why he didn’t ride his horse over here.
PW: My horse? Oh, gosh. Yeah, that’s funny. Yeah.
So if you’re wondering what he’s talking about, so the other morning, Nick, my wife says, “Look outside!” And I’m like going, “What?” And I’m doing something else.
“What?” “Look outside!” “What? Hang on, I’ll be there in a second.”
“No, look outside!” I’m going, “Okay.”
DH: It’s Bigfoot.
PW: So I’m thinking, maybe there’s a deer out there, maybe there’s a turkey, because that’s typically what wanders through the yard is something like that. No, it’s a horse.
EB: Yeah, of course.
PW: No, yeah, of course. And it was not Mr. Ed. Yeah, it’s just like, “What? A horse in the backyard?”
And this thing is the most mischievous little horse. He’s biting my arm. Oh, yeah, he’s biting my arm.
EB: Did you give it peppermints?
PW: He’s nibbling on my wife. I’m like, “Stay away from my wife.”
EB: Stick to the carrots. Stick to the carrots.
PW: “We’re giving you some oats, we’re giving you some molasses, leave my wife alone.”
And then come to find out it belongs to one of the neighbors who happens to be none other than a Fox News guy. So I’m just like, “Okay, this is fun. All right, this is really interesting.”
EB: Yeah, if it was a liberal, you’d have called the police, but since it was Fox News, you’re like, “Okay, I’ll be a good neighbor.”
PW: So it was one way or another we were going to meet this guy, but he was off at the RNC, so he had to have somebody else pick it up.
DH: There you go.
PW: But yeah, it was just funny. So yeah, that’s the horse reference. Yeah, it’s been one of those weeks. Yeah.
Yeah. There you go.
Uncertainty Affecting Markets
PW: I don’t even know where to start today. There are lots of things to be talking about.
EB: It’s not like there was any news this week since the show ended.
PW: Last Saturday, right? That’s why I said I’m not even sure where to start; there was so much stuff that happened this week. I know Evan, Dan, you guys probably have comments, because last week the show was in our third hour and we ended up getting preempted for what was happening and it was absolutely shocking.
EB: For a worthwhile cause. Oh, yeah.
PW: When I got home, my wife was like, “Do you know what’s going on?” I was like, “Okay. Yeah.” And of course, you had texted me, “Are you watching?” I said, “Yeah.”
I was riveted to what was going on. And looking at the scene and just looking at the grounds where this was taking place, I was going, “This is pretty obvious, this building.”
And a lot of people have spoken about that. I don’t know that we need to go down that avenue, but I think for the markets, because we talk about stock markets, anything like that, you go, “What moves markets up or down?”
EB: Uncertainty.
PW: In the early part of the week, you’re looking at markets jumping up for whatever reason, maybe the possibility of that happening.
EB: About 900 points in the first couple of days. About 900 points, I think, between the two days.
PW: Yeah, pretty significantly. And then toward the end of the week, it goes down. And you go, “Well, why did the market go down?”
I think you can make the point that the market does not like uncertainty, and it’s not that profits had a chance to change whatsoever toward the end of the week, but simply the fact that we had uncertainty as to who was going to be in the election, who the candidate was going to be. Now we know who one candidate’s going to be so far. That was a close call last week.
EB: Which one is that, Paul?
PW: Yeah. Well, you know what I’m saying, close call last week. But the second candidate, we’re sitting there going, “Are we going to get an announcement?”
You don’t know when or what’s going to happen, but the market doesn’t like the uncertainty.
So what happens is the only thing you can change. You can’t change what the profits are going to be for the company right away. It’ll take a while for profits to change, but you can project what profits might be or what they might not be, so some events do change markets immediately based on expected profitability going down.
Expected Returns Going Up
PW: But if you’re looking at nothing necessarily changing profitability two months, three months, or however many months into the future, the only thing that you can actually change is the pricing. And when pricing goes down, when stock prices go down, basically what’s happening is if there is nothing that necessarily changes earnings taking place, then your expected return in the future is actually going up because investors who are willing to buy stocks in times of uncertainty pay lower prices.
So I gave an example, literally the night when Trump was first elected, when he was first in office on that night of election. I was on with, it was Michael DelGiorno, Dan Mandis was on there, Phil Valentine was still around at that point in time. And they were like, “Paul, get up on the stage.”
And the example I gave on the stage that night, because they were talking about the futures being down so much, was, “Okay, let’s say that stocks are selling for 20 times earnings.” Okay, let’s say that that is what’s going on. And you turn that number over, you’re getting one dollar of earnings for each 20 dollars you pay.
The earnings yield has gone to 5%. One divided by 20 is 5%. If all of a sudden, to use an extreme example, now there is more risk in the markets, and now we need a 10% return or a 10% earnings yield, just to keep the math simple, what will have to happen to price?
It will have to go to $10. It’ll have to go from 20.
DH: Drop 50%. Yeah.
PW: Yeah, it’ll have to go down to 10. So in essence, what will happen is now my new earnings yield is one over 10.
Would you as an investor say, “Oh, it’s great. It’s time to sell. The expected return has just gone up.” No, that doesn’t make any sense.
But people, when they get panicky about these types of things, they don’t think about that particular aspect of things. But it’s been a busy week.
Big Market Movements
EB: Yeah. One of the things that you mentioned in the first couple of paragraphs that I was thinking about Thursday and Friday was to the point that nothing materially changed. Trump was hit, went down, came back up, but he’s fine.
That didn’t change the amount of Pepsi that people were buying, it didn’t change the amount of gasoline people were buying, or phones, and trips weren’t canceled. Economically, nothing materially changed, but people’s expectations of what might happen because of news and new information changed.
They reevaluate the certainty of all of those things even though nothing actually changed.
PW: Right.
EB: It’s just pure speculation.
PW: Also think about the example that we sometimes use in our workshops with the Challenger taking off. Then you had those companies that were making the parts for the Challenger, all of them, their stock price went down slightly, but one of them went down significantly.
EB: And stayed down.
PW: And stayed down. It was the company that made the O-rings. So you look at that and go, “Well, all the stocks went down, but not much.” A couple percent right off the bat, with the three companies that made the other parts of the Challenger.
But why the one that made the O-rings went down so much is because of their profitability. It was pretty certain that the profitability of that company would be hurt by what just had happened because they might not be the company that made parts for the Challenger anymore, so therefore their profits went down. But that’s what the market is responding to.
Their profits didn’t have a chance to go down yet when the Challenger exploded. We didn’t have a chance to see the new earnings lower. But it was the expectation that they would be lower, and with good reason, the expectations were there.
EB: Yeah, they’d had prior problems was the deal. That’s why it dropped so quickly. There had been earlier reports before the Challenger even took off that there were some issues with the O-rings. And theoretically, they were resolved or whatever, and it took off, and all of a sudden people were like, “Oh, I guess there were issues with O-rings.”
PW: Right, it was confirmed.
EB: And bam.
PW: Yeah. Yeah, for example. Yeah. So, to me, that explains why you have these big market movements.
Switching to Gold-Backed Currency
PW: I was having a conversation with a friend of mine just before the show started, and we were just going back and forth about currencies. People out there are scared that, “Hey, if we go to a digital currency, we go to the gold-backed currency, then what’ll happen is our fixed income investments aren’t going to be holding value and everything’s going to be great there, but the stock markets will be necessarily decimated by that.” And I think so often what happens with fear, as we know this physiologically, what happens is the front part of our brains shuts down when we get into fear, and we stop thinking.
Because here’s my thinking regarding any of these things happening that we’re talking about here is if, let’s say we go to a digital currency, let’s say we go to something gold-backed, I don’t think that it’s terribly likely, but if it were to happen, it’s not something to worry about because I am going to switch to whatever that currency is as a company owner. I am going to accept that currency from now on.
I will be exposed to it, and I’ll be an owner of that currency, and my company will be valued in that currency as well.
It’s not an issue. I don’t worry about those types of things.
EB: Cheetos will be 32 Republic credits or something like that.
PW: Yeah, there you go.
DH: Well, it’s interesting because as we were talking about this pre-show, I had a client that brought in some money from, was it the Revolutionary War? I think it was Revolutionary, where the actual manufacturer printed their own currency.
PW: There you go.
DH: And so when you worked for them, you got paid by, this was Vermont, so Vermont Steel or whatever it was.
PW: The company store.
DH: And then yeah, you went to the bank and they said —
PW: What a great example, Danny.
DH: —”That’s a great company. We expect that place to be around, so we’ll accept that currency.” And Evan and I were kidding about how the currency used to be beaver pelts. “I’ll trade you my beaver pelts for a bottle of Jim Bean, Jack Daniels, I guess, here.”
PW: Right, right. But I would much rather own the company that’s going to decide whether they’re going to accept the beaver pelts or not. So I think that’s a really good example right there.
But we lose track of that. My company is going to be selling for 16 beaver pelts for every dollar of beaver pelt earnings. That’s just going to be what ends up happening.
EB: That’s the new marketing campaign, man.
PW: You like that? Should we go with it?
EB: Our planning fee is three beaver pelts.
DH: No. PETA won’t like that.
PW: There you go. I think that’s a plan.
The History of Gold
PW: So that leads to something that I was going to talk about here.
EB: I think you should.
PW: I think I should, I really think I should. Because we talk about the gold standards, and are we going to go to a gold standard? Are we going to go back to gold and should people be investing in gold? You hear that all the time.
And one of the things that I’ve been hearing all the time in commercials is that gold is a great inflation hedge. “It’s going to protect you. The dollar’s going to go down in value, you need to own this as an inflation hedge. It’s going to protect you and blah, blah, blah.”
And the reality of it is — Forbes had an article about this very topic a while back, and I thought it’d be probably good to revisit it — but basically if you look at the history of gold as a protector against inflation, it’s just not a good hedge; it’s not correlated in reality.
Let’s go back to the first half of 2022. You had the demand for gold increasing 12% year over year, and what happened was consumer prices went up 9.1% to that year-end in June of 2022. And if you look at the research from 1974 through 2008, there were eight years when inflation was considered high during that period of time.
But during those periods of time, gold prices rose an average of 14.9% per year. So literally, what happens is that people look at that and go, “Oh, that means that it is something that is a good hedge against inflation.”
But when you look back in history and really examine the data, it’s not quite that clear that it’s a great inflation hedge.
They pointed it out in Forbes. He says, “Lessons about gold track record as an investing hedge may be learned by going back to the 1970s. The U.S. experienced hype out of inflation, oil prices, shocks, and energy shortages that drove average annual U.S. inflation up around 8.8% between 1973 and 1979. Gold did fine during that period of time; it went up during that period of time. Then you look at 1980 to 1984, and inflation was 6.5%.”
That’s pretty high. Look at it compared to now, it’s as high, if not higher than, it is right now.
And the article says, “Gold prices, though, fell 10% on average each year.” 10% per year. You just do the math on that; that’s not so great.
Not only did it fall short of inflation, losing money, but it underperformed real estate, commodities, S&P 500, average inflation average from 1988 through 1991, 4.6%. But gold fell 7.6% per year on average.
Is Gold a Good Hedge Against Inflation?
PW: So if you look at it and say, “Well, what is a hedge?” A hedge means that it should rise in line with sharp increases in consumer prices. And the reality of it is we’re not seeing that.
During the most recent extreme movements in inflation, U.S. gold was very mixed; it was back and forth.
And so the reality of it is as a hedge against inflation, it’s just not a great hedge. It is marketed that way. And remember, never forget, when I talk to the other guys on the station, I talk to Matt and Dan and Chris, and we all talk about that. Chris is always the first one to bring it up.
He goes, “I’ll never forget, Paul, you said that. You made that point that why is it that they are willing to take your dollars for their gold if they really think that the dollar is going to be destroyed?”
EB: Exactly. Yep. Totally.
PW: Why do they do that?
EB: Well, and even from an academic standpoint, on principle, you don’t use something with extremely high volatility, gold, price volatility to hedge something with low volatility, which is the inflation rate. It may go up or down, but not in enormous swings. And yet you have gold that has a standard deviation of like 25 or something like that.
PW: It’s higher than the stocks, yes.
EB: And inflation fluctuates by three or four percent. It just doesn’t even make academic sense.
Now if you go back 200 years, not 10-year periods, sure, an ounce of gold has been a pretty good store of value long, long, long term. But not as some short-term play to quote-unquote hedge inflation.
PW: Yeah, Dan?
DH: No. So just going back to our currency thing, it used to be used as currency. You could go into the Long Branch Saloon and give Ms. Kitty some gold nuggets and she’d give you a cold beer.
PW: It wasn’t a very practical currency.
DH: No, but it was. And we talk about it nowadays. What?
PW: Ms. Kitty.
DH: Gold is good for jewelry, okay? You can’t go to McDonald’s and get a Happy Meal with some gold.
PW: And the dollar was backed by gold, so you actually had gold certificates.
EB: Right.
The Best Inflation Hedges
PW: But the thing that Forbes points out, and it’s something that I always point out — this is a little ways back, about a year ago that this article came out, but it’s dead on right — is what are the best inflation hedges? That’s the question that they asked in the article.
And it was this one person saying, “I’m always surprised how often investors forget that plain old stocks hedge against inflation over the long run. Of course, stock valuations may fluctuate with the day’s economic news, but across multiple business cycles, market indices have significantly outperformed inflation.”
Then you can also look at, for example, I bonds are another example of something that could protect against inflation. And you might have something like TIPS in a portfolio — Treasury Inflation-Protected Securities, which would be in a portfolio.
But the reality of it is you look at these things and go, “Okay, what do we do to protect against inflation?” Well, you’ve got to define inflation, as I always say.
What is it? It’s prices going up. Who’s raising prices? Companies.
That’s why we want to own companies. The short-term fluctuations in stock markets — and they will happen — they’re typically not that long.
Market downturns don’t last that long. But what do we do? We have fixed-income investments. But you look at regular savings accounts as well.
What happens with regular savings accounts when inflation goes up? Go back 10 years.
What was inflation? Nonexistent. What were interest rates at banks? Nonexistent.
EB: Nonexistent.
PW: Right. Now, what’s going on? Higher inflation. What’s happening? Higher interest rates at banks.
So we have treasuries themselves protecting. Now, the issue that you have with I bonds is you have a really, really tiny fixed rate on the bonds and then an inflation rate on top of that, and then you also have the penalties for pulling money out early because you lose interest.
And then you have the limitations on how much you can put in those bonds: $10,000. So that’s why more people don’t use that, it’s because it’s very limited.
And then think about this, I’ll leave this segment with this thought: Think about who is setting the interest rate on inflation that these bonds are going to pay as your interest. The government.
EB: The government.
PW: That’s right.
EB: And we trust everything they say.
PW: Yeah, exactly. And what they want to do, because it’s debt that they are incurring, and it’s more debt they are incurring if the interest rate is higher, their desire is to keep that interest rate as low as possible, and thereby the inflation rate may be a little bit lower.
So you look at some of these things that might be hedges, quote-unquote, and I would look at that with a little bit of a skeptical eye, but just call me a little bit cynical. But you got to be thinking about these things.
Banks Dumping Real Estate Loans
PW: “Fearing losses, banks are quietly dumping real estate loans.” It’s not quiet anymore. They went and put it in a newspaper.
What’s the idea behind that? Come on, guys.
EB: “Our secret two-for-one sale at such and such.” Yeah. Okay.
PW: I get a kick out of that kind of stuff. Wall Street’s banks are worried that landlords have vacant and struggling office buildings.
But this goes along with, as I’ve often said, how you see people that don’t diversify and they think that real estate is safer as a result of it.
And you go, “Well, they’re going to be dumping loans.” If they’re going to dump loans, they’re not going to lend. What are they going to do with interest rates if they’re worried about lending to people who are buying real estate?
That is an upward pressure on real estate loan interest rates. But they’re just basically talking about how it’s an early but telling sign of the broader distress brewing in the commercial and real estate market.
But how many times have we guys — I’m saying you guys and me — seen people walk into our office with investment portfolios, and they’ve got real estate funds in their real estate investment trust and limited partnerships and those types of things that have been sold to them by investment advisors, and you just go, Why are they doing that? Why are they concentrating in that?
Because it sounds good from an income standpoint that I own a piece of real estate. With real estate, you have to pay rent and then you have an income source and it’s stable.
And the reality of it is, this is why you diversify very, very broadly in lots of different asset categories because you don’t know what’s going to happen from year to year. You don’t know what’s going to happen, where things are going to be going well, where things could be doing poorly, and we talk about CDs or any fixed-income investments.
If I put $100,000 in a CD or I put a lot of money in a CD that pays a fixed interest rate, and all of a sudden these concerns that people keep talking about happen — that the dollar goes down, that it goes away, that inflation, or that you have a devaluation or you change currencies or whatever — then basically they only have to give you back the money that you gave them with the interest, which would be worthless because the interest was the same dollars.
EB: Insignificant, yeah.
PW: You’re paid in dollars still, so you don’t have that protection anytime you walk away from diversification in any way, shape, or form.
Real Estate Is Not a Guaranteed Investment
EB: Real estate, a lot of times, I think is spoken of in the abstract. Particularly, we’re talking about it in an investment portfolio. I’m not talking about someone that is a real estate person, but just an investor.
PW: Where it’s your job.
EB: Job that’s adding a REIT — real estate investment trust — or something to your mix, or your advisor has added that. It’s still not a fixed game. COVID, if nothing else, taught us occupancy rates could change.
Typically, I mean, back in the days when I was on the dark side, we would emphasize the strength of the tenant when we were selling these REITs. Oh, TGIFridays is one of the tenants. Tractor Supply is one of the tenants, and nursing homes. People aren’t going to quit going to nursing homes.
And well, that’s fine if all of those companies stay in business, if they can keep people on staff. But all of a sudden taxes may go up. We talked about costs going up to people just because of heat that the insurance companies don’t necessarily cover just heat damage or extra storm damage, and so they’re closed for a while. It’s not like a CD.
Real estate is not like a guaranteed investment. There are a lot of moving parts that can make it not be very favorable very quickly.
PW: And not the least of which could be tax law changes, could be fluctuations in, like you said, interest rates. It could be fluctuations in, let’s say, who lives in a certain area, demand for real estate for those reasons.
There are just a lot of things that can create problems. And anytime you own stocks, as I always say, you own lots of real estate already.
DH: Typically, well, these REITs could be apartment buildings, but typically I think of the skyscrapers I always talk about. But they’re affected by economic factors.
Distrusting Investment Advisors
DH: I know for instance, a very close friend of mine who was involved in that business was a partner in a building in Houston that was 90% rented by Conoco Phillips for 20 years. Okay. Oil company.
PW: I was just going to say, I think I see exactly where you’re going. Really good.
DH: Oil prices fluctuate just like every other asset class, real estate. And when those oil prices went down, they didn’t have the capital or the need for all that office space.
So the REIT was paying like 9% because it said Conoco Phillips, everybody needs oil. No, it didn’t pay 9% in those years of recession or when the oil prices went way down to $26 a barrel, if anybody remembers those days.
EB: And it doesn’t have to. I think that’s the other thing. If you buy it and they say, “Oh, it’s got this 7% yield.”
Today, it does. That doesn’t mean it has to stay seven. It’s not a guaranteed thing like a CD you were talking about or a bond rate.
Well, today it’s seven, but it could be three, it could be zero. We just hope to sell the building. And we see it all the time where all of a sudden now you can’t get rid of it because nobody wants something that just dropped in yield significantly, and you can only sell it to some third party that’s willing to come and pick it up for pennies on the dollar.
So we’ve seen that time and time again. And that’s why I think so often people don’t trust the investment advisors that I talk about when they’re commission-based and they get paid selling products because they’ve been burnt so many times before, and that’s why we constantly preach that. We always talk about that because it is something to be concerned about.
Quite often the conflicts of interest that are created create people that actually say things that I don’t know if they believe it or they don’t believe it, but that’s what they’re trained to go out and sell.
Quite often, they actually believe the message because their manager told them to believe it, and that’s where it’s unfortunate.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
