THIS WEEK ON WEALTHTRACK, LEADING GLOBAL VALUE
MANAGER CHUCK DE LARDEMELLE SAYS IT’S TIME TO HEDGE STOCK PORTFOLIOS AND TO DO IT IN
SOMETHING OTHER THAN CASH. HE IS NEXT ON CONSUELO MACK WEALTHTRACK. HELLO AND WELCOME TO THIS EDITION OF WEALTHTRACK,
I’M CONSUELO MACK. WE WATCH BIG FINANCIAL TRENDS FOR YOU ON WEALTHTRACK
WHICH AFFECT THE INVESTMENT CLIMATE AND YOUR PORTFOLIO.
ONE WAS ANALYZED RECENTLY IN A SECOND QUARTER QUARTERLY LETTER TO CLIENTS FROM BEN INKER,
THE HEAD OF ASSET ALLOCATION AT GMO. INKER A PAST WEALTHTRACK GUEST HAS WORKED FOR YEARS
ALONGSIDE NOTED MARKET STRATEGIST JEREMY GRANTHAM. THE LETTER WAS TITLED “BIGGER’S BEEN BETTER.”
IN THIS CASE BIGGER REFERS TO THE 50 LARGEST U.S. BY STOCK MARKET VALUE CALLED MEGA CAPS.
THE BETTER REFERS TO THEIR RECORD MAKING EARNINGS AND STOCK PERFORMANCE.
AS INKER WROTE, “U.S. STOCKS HAVE PROFOUNDLY OUTPERFORMED STOCKS IN THE REST OF THE WORLD,
WHETHER OTHER DEVELOPED MARKETS OR EMERGING MARKETS…. AND THE LARGEST DRIVER OF THE
OUTPERFORMANCE HAS BEEN THE MASSIVE SUPERIORITY OF EARNINGS GROWTH IN THE U.S. RELATIVE TO
ANYWHERE ELSE… AND THE IMPROVEMENT IN PROFITABILITY HAS OCCURRED ONLY IN THE LARGEST COMPANIES.”
THE TOP 50 MEGA CAP COMPANIES TO BE EXACT, THE TECH NAMES THAT YOU ALL KNOW: MICROSOFT,
APPLE, AMAZON, ALPHABET, THE PARENT COMPANY OF GOOGLE, FACEBOOK, AND THE MORE TRADITIONAL
BUSINESS POWERHOUSES, BERKSHIRE HATHAWAY, VISA, J.P. MORGAN CHASE, JOHNSON AND JOHNSON,
WALMART ETC. GMO CALCULATED THAT THEIR “PROFIT/VALUE”
ADDED, MEANING THEIR GROSS PROFIT, (REVENUES LESS THE COST OF GOODS SOLD) HAS INCREASED
BY 62% SINCE THE LATE 1990S, WHEREAS THE PROFITABILITY OF THE NEXT 450 COMPANIES IMPROVED BY 37%,
AND THE NEXT 2500 ONLY 5%. THE OTHER BIG ISSUE IS THEIR STOCK MARKET
DOMINANCE. FOR THE FIRST TIME IN HISTORY ASSETS IN PASSIVE
EQUITY FUNDS AND ETFS BASED IN THE U.S. HAVE SURPASSED ASSETS IN ACTIVELY MANAGED MUTUAL
FUNDS. IT HAPPENED THIS SUMMER. THESE MEGA STOCKS DOMINATE INDEX FUNDS. HOW
THEY GO SO GOES THE MAJOR MARKET INDICES. THE LOGICAL QUESTION IS HOW RISKY DOES THEIR
CLOUT MAKE THE U.S. MARKET THIS WEEK’S GUEST IS KNOWN FOR ASSIDUOUSLY
AVOIDING MARKET RISK. HE IS GLOBAL VALUE MANAGER, CHARLES “CHUCK”
DE LARDEMELLE, A FOUNDING PARTNER OF INTERNATIONAL VALUE ADVISORS, KNOWN AS IVA, WHICH HE AND
HIS PARTNER LAUNCHED IN THE DEPTHS OF THE FINANCIAL CRISIS IN 2008.
DE LARDEMELLE IS CO-PORTFOLIO MANAGER OF THEIR TWO MUTUAL FUNDS IVA WORLDWIDE AND IVA INTERNATIONAL.
ALTHOUGH BOTH FUNDS LAG THEIR BENCHMARKS IN BULL MARKETS THEY PROTECT IN DECLINES AND
HAVE THUS EARNED MORNINGSTAR’S SILVER ANALYST RATING FOR THEIR “CAUTIOUS, PATIENT STRATEGY”
…MAKING THEM “A VALID LONG-TERM CHOICE FOR WARY INVESTORS.”
IVA DESCRIBES ITS STRATEGY AS WINNING BY NOT LOSING AND LOOKING TO ASSESS RISK AND TRY
TO AVOID IT WHEREVER POSSIBLE…” I ASKED DE LARDEMELLE WHERE HE IS SEEING RISK
IN THE WORLD THAT HE IS AVOIDING. I think usually a risk is associated with
too much credit growth, and there are a number of areas where we see a lot of credit growth.
One is corporate America, especially in the high-yield bond market driven by buybacks
and so on and so forth, and that usually leads to issues down the road.
There has been too much credit growth in China for a number of years now, and we are not
sure when that issue might come to fore, but eventually it will, and the third is more
difficult to assess, but I think in Europe you still have issues with banks and especially
the idea that government bonds are risk-free which we think is a lie anyhow because Italy
or Spain or France cannot print euros, and so we think there is a risk there. That is
substantial because it’s a risk that would bankrupt the banking system in Europe, and
that’s what moves a recession into a depression. CM: Would you ever get involved in a company
or a country that does have a fair amount of debt to …
CdL: Sometimes we do. CM: … GDP or in their balance sheet or … ?
CdL: Look. Value investing starts with price, and sometimes the price or the price is discounting
enough of the risk that you’re willing to get involved. You have to think when you invest
internationally as well. You have to think about the currency, and sometimes a crisis
ends up with currencies devaluing substantially, but you may have companies that are listed
in a country that do business in a different country.
So, for instance, we own Antofagasta which is a copper miner that’s listed in the U.K.
There’s no Brexit price there. Antofagasta is corporate. It’s a U.S.-driven business,
so that’s an example where you have a market is at risk with Brexit, but the security itself
is not. CM: Your sovereign debt exposure is zilch
(Laughs) in the Worldwide Fund. CdL: Well, we have cash but not really sovereign
debt. CM: All right.
CdL: Our cash is commercial paper. It’s not sovereign debt.
CM: Oh, so it’s not Treasuries. You’re not …
CdL: No, no, no, no. We pick our own commercial paper, so we get a bit more than Treasury
bills. CM: Well, how do you feel about the creditworthiness
of the United States government? CdL: Oh, on a relative basis, it’s very
strong. (Laughs) CM: Relative basis to any other country.
CdL: Exactly. (Laughs) Relative to Japan or relative to Europe, I think it’s very strong.
One of the reasons why it’s so strong is that you have had tremendous value creation
in California, in the U.S. in general with technology companies, whether with software
in the ’80s and ’90s or now with Internet-related companies, and that wealth allows the U.S.
government to tax, and that’s why the credit of the U.S. is well-supported by asset values
and wealth creation. In Europe, you have not had that same phenomenon.
So, you may have substantial amounts of debt, but on top of that they have not been able
to grow the economy as much as in the U.S., so there is more risk there we believe than
in the U.S. CM: So, your cash position when I looked at
it last – and of course it’s going to change, and I’m looking pretty much at the
IVA Worldwide Fund – is around 30 percent? Is that right? Cash equivalents?
CdL: Yes. It’s come down a little bit, and we’ve added to gold instead.
CM: Tell me about how you view cash because you said something interesting to me on the
phone where you didn’t think it was as effective a hedge as it once was?
CdL: Longer term we think that the central bankers are very keen on debasing the currency,
and therefore gold may be a more appropriate hedge today than cash in the long run. In
the short term, cash flow worked to obviously provide an optionality in terms of (Inaudible)
to be able to buy cheaper securities if they ever show up. But over the long term I’d
rather … you know how Buffett, oh, the perfect portfolio is 90 percent S&P 500 and ten percent
cash? I think I would argue with him that it may be 90 percent S&P and ten percent gold
rather than cash. CM: He would not agree with you (Laughs) yet
on that particular point. So, explain to me. I was reading the Morningstar report of course
about the Worldwide Fund, and one of the things that it said is that because you always want
to buy securities at a very deep discount and that the reason that the cash levels are
so high and that they vary is that you’re not finding the kind of values.
CdL: Correct. CM: As many values as you would and, therefore,
that would explain the higher cash positions. CdL: That is correct. Yes. You should know
that we’re trying to manage the Worldwide Fund as a family trust basically. We don’t
care about short term movements versus indices for instance, but over three, five, ten years
we’d like to compound nicely, and we want to avoid losses as much as possible, impairment
of capital as much as possible. In today’s environment where interest rates are so low,
that has pushed asset values very substantially. The expansion at least in the U.S. has been
tremendous and long, very long by historical standards.
CM: The longest. CdL: Yes, and so we are getting concerned
that we’re getting closer and closer to recession, and we believe that that risk has
gone up substantially over the last three months.
CM: Do you have a sense of when a recession? I mean you’re not forecasters.
CdL: Given where the data is my best guess would be six months to a year, and you need
to get prepared now, because markets tend to anticipate, and they fall before a recession
is even declared. CM: Looking at the U.S., so I’m looking
again at what your position is in the U.S. market, and as far as a percentage of your
portfolio… CdL: 30 percent, about 30 percent of our equity.
Yes. Thirty percent of our equity exposure is in the U.S.
CM: Thirty percent of equity. CdL: Yes. That is correct. Yes, and that’s
low by historical standards. We’re finding more value outside the U.S. than we are in
the U.S. at this point, and so … CM: For the last ten years actually since
you started the IVA, which you started it in October of 2008. Right?
CdL: That is correct. CM: The U.S. has been the place to invest
and especially the U.S. mega-caps it turns out.
CdL: Yes, driven by technology. Yes. CM: So, have you participated in that in the
last decade? CdL: We wish we had participated more.
CM: More. CdL: Yes. We still own Google. We own MasterCard.
CM: Apple at one point you owned. I don’t know if you still do.
CdL: We sold puts. It was a weird way to build an entry point, but yes, we got exposed to
Apple at some point. That is correct. We owned Microsoft at some point. We still own Oracle.
So we’ve been able as value investors, despite the fact that we’re value investors, we’ve
been able to understand the software models and some of the more stable, more mature technology,
but software is a fairly straightforward business model to understand, and we’ve been able
to participate over the years, but maybe not as much as we would have liked, but you know
hindsight’s 20/20. Now outside the U.S. there are plenty of companies.
There are global companies as well that may, given the composition of their revenues and
profitability, you wouldn’t be surprised to find them in the S&P 500, but because they’re
listed in France or other countries, they tend to start at some discount and sometimes
that’s not wanted. Nestlé is an example of (Overlap/Inaudible).
CM: So, what is an example? CdL: Nestlé.
CM: Oh, Nestlé. Sure. CdL: Nestlé is an example of such a company
we’ve owned for years and years and years. CM: But you told me I think that Nestlé is
kind of near the end of its run. CdL: So, we see today a very sharp contrast
between stable, large, non cyclical companies that are trading at higher and higher multiples.
CM: Because people consider them to be defensive, and they’ve got great dividends, and they
buy back their stock and all those things. CdL: And interest rates are very low.
CM: And interest rates. CdL: So, all of that has pushed them up, up
and up. Meanwhile, you’ve had cyclicals, and some cyclicals of high quality such as
BMW or Samsung that we own that have been pushed down, down and down, and in both cases,
Samsung and BMW, they actually sell on a price to book basis below where they were selling
in 2009. CM: Wow.
CdL: In the case of BMW for sure. In the case of Samsung, similar levels, and that shows
you the depth of the undervaluation we believe of these more cyclical companies, and the
contrast with the non-cyclical, high-quality companies is now not only sharp but at very
extremely levels, and we think that at some point that will snap back.
CM: So, as you said earlier, price matters. (Laughs)
CdL: It does. Yes. CM: A lot. So even though you’re talking
about a possible recession in the U.S., certainly things are not any better overseas. If anything,
economies are slowing earlier and faster. CdL: Correct.
CM: Then cyclicals you would say that’s a counter.
CdL: It’s very counterintuitive. CM: And very … right.
CdL: Yes. I think everybody anticipates a recession so much that nobody wants to touch
the cyclicals anymore, and they’re a few of quality that we think are overly discounted.
Now I think the proper hedge against that is to own some gold which historically goes
up in recessions. CM: So, the gold piece is very interesting
to me… CdL: Yes. We have ten percent of the Worldwide
Fund in gold bullion, and we have 13 percent, one three, in gold bullion in the International
Fund. The miners … CM: Is that a pretty high level for you historically?
CdL: Yes. That’s a high level for us historically. CM: Do you have a cap psychologically or financially
on that? CdL: We’re probably nearing the cap. The
reason why we have so much is that we also have more cyclicals than in the past. So,
you need more insurance basically against a sharper than expected recession or something
like that, and we believe that in a recession central bankers will manipulate interest rates
again, and usually when real interest rates go down, gold shoots up. Now the reason is
that gold is money. It’s a currency. You and I go to Iran, Japan, Russia. Gold will
be accepted. CM: Anywhere.
CdL: Anywhere to trade against the local currency and then buy shelter, food, whatever you need,
and so when real interest rates contract, gold goes up, and we think that the central
bankers again are bent on debasing currency to offset the load of debt that exists in
developed economies and that they continue to do so. Now historically it’s not easy
to value gold. Right? CM: No, no. I was going to say I’m just
trying to think of the … it’s illiquid. It’s expensive to hold.
CdL: It’s not that expensive to hold. I mean for instance …
CM: The ETFs. CdL: For insurance companies in Europe or
for banks now, they have to pay to park money at the central bank.
CM: Yes, that’s true in negative interest rates.
CdL: Or even in bonds. I think the ten-year bonds in Swiss francs is minus one percent.
So, you have to pay a large amount. So, the point being that the storing of gold
is a lot less expensive than the storing of cash or the negative rates you get on bonds
around the world today except for the U.S. CM: So, at IVA, how do you view this phenomenon
of negative interest rates? CdL: We think it’s likely to be creating
bubbles somewhere, and one is in government debt. One is in corporate debt, and the third
is in China we think, but we don’t know what the end game is. I don’t think anybody
does. We’ve been very surprised how long Japan has been able to continue on in an institution
like this. CM: And thrive really. I mean the economy’s
not collapsing. CdL: Correct, and the GDP per capita has gone
up substantially in Japan, partly because the population is shrinking now, but it’s
lasted for a long time, and we’re not sure when it ends, but we think it’s going to
be ugly. In the meantime, owning some gold as an offset against your equity position,
I think makes a lot of sense given how advanced the cycle is and what gold tends to do in
difficult markets. We think if you were to look at gold to GDP
which is a proxy for gold versus net worth – net worth is a multiple of GDP – if
you look at that, in September of 2011 gold ever mined marked-to-market versus GDP went
to 15 percent, one five. CM: This is of global GDP.
CdL: Yes, of global GDP. CM: The value of gold was 15 percent of global
GDP. CdL: If we were to go back to these levels
in a recession which we believe is likely in a recession, gold would be over $2,000
an ounce which is about $1,500 today. So that would help offset some of your losses in equities.
CM: This is absolutely fascinating, Chuck. It really is, but let’s go back to stocks.
(Laughs) That’s your stock and trade really. Where are you finding values in stocks, in
the stock market? CdL: We are trying to focus as we always do
on quality companies, and we’re trying more and more to find less cyclical companies that
are trading at reasonable multiples, and you have a few in the U.S. that are popping up
either because they are misunderstood, misclassified, but one of them, for instance, is LKQ, a computer
that provides parts to repair shops for auto collisions, and because it’s linked to the
car market, the stock trades at 11 times EBIT or so, but it’s absolutely not cyclical.
CM: No, because accidents happen, and people have to replace car parts.
CdL: That’s right. That’s right, and obviously, it’s a big procurement operation because
you can imagine the number of parts you need. Most insurance companies except State Farm
use LKQ because they provide cheaper parts either out of Taiwan or by salvaging cars
and getting spare parts from those cars that have been wrecked. So, you get your parts
for less money. You have to get them very quickly because insurance companies don’t
like to pay for that rental car that you’re using while the car is in the repair shop.
So, they have a dominant market share in the U.S., very steady business. The number of
collisions was slowly going down thanks to technology. It’s gone back up because of
texting and driving. We hope obviously that reverses (Overlap/Inaudible).
CM: But in the meantime … (Laughs). CdL: But in the meantime (Laughs) it’s been
helping. CM: You can take advantage of that.
CdL: It’s been helping LKQ a little bit. So, it’s a mature business, but it’s a
very nice cash cow, I think a Buffett type of business really, and it’s not huge. So,
is it part of ETFs or not? I’m not sure, but when I look at LKQ, would I put it in
a trust for my kids and forget about it for ten, 15 years? Absolutely at this price. Yes,
I would. CM: But you also own Berkshire obviously,
and we’ve talked about that on this show before, but your view of Berkshire. Again,
on another program, I had talked about the fact after one of the annual meetings that
basically I guess Charlie Munger said, “We’re not going to really be able to outperform
the S&P, or we might be able to outperform it a little bit better.” So, it’s kind
of like an index fund is the way that he was kind of downplaying it.
CdL: Absolutely. CM: What is your view of Berkshire?
CdL: My view is probably that assessment is probably accurate, but I look at two things.
One, where are we in the cycle? Do I want to own levered companies in this point in
the cycle, and the answer is no. CM: No.
CdL: So, they have 120 billion in cash. They have the insurance business that is not the
same cycle as the economic cycle and then, yes, they are exposed to manufacturing companies
through the cycle, but by and large within the S&P 500, this is, in my opinion, an extremely
defensive company. One. Second, we see a discount to intrinsic to
the order of 20, 25 percent which for a company of that magnitude, that large is actually
higher than what we see in other listed companies in the S&P 500 in general. So, there is a
nice discount. We know they are unlikely to make a major mistake in capital allocation.
The last point is if we do get into a bear market at some point, it’s one of these
rare companies where the intrinsic value can actually grow because they can put the money
to work into equities that may be discounted, buy a few businesses that maybe are on the
block for a cheap price. Last time he bought Burlington Northern which has been a homerun
for Berkshire Hathaway. So you have sort of that option that I really like of Berkshire
being able to grow its intrinsic because of a recession, and that’s very unique, and
so given where we are in the cycle, I think it makes a ton of sense, and so I would argue
over the next five years they are likely to outperform the S&P 500 because I think the
odds of a recession within the next five years are quite high.
CM: As far as technology is concerned, are you seeing any values that are intriguing
to you in the technology sector that have wealth-creating potential?
CdL: We own Oracle for instance, and it’s a sizable position for us, and we think it’s
one of those companies that is non-cyclical. So much of it is recurring fees on established
systems that you really can’t rip off, and when I look at the multiples of an Oracle
versus the multiples of a Nestlé, Oracle appears to be much cheaper.
CM: Oh, that’s interesting. CdL: Oracle you’re paying maybe about 13
times EBIT, and Nestlé is about 22 times today. So that’s one example of a company
that we believe is just very mildly cyclical and that may not have been recognized as such
by the market. CM: We ask every guest for one investment
for a long-term diversified portfolio. You mentioned one already that you would put (Laughs)
into your kids’ portfolio. But is there one that we should all own in a long-term
diversified portfolio? CdL: Oh, I think at this point in the cycle
and for the long term, Berkshire is the obvious answer at this point. Having five to ten percent
in gold as a percentage of your equities also is necessary, I believe at this point. CM: As a value investor when you look at we’ve
had this record-long economic recovery, we’ve had a record-long bull market, and most investors
in the U.S. are invested in U.S. stocks and they’ve done quite well because of that,
but how risky do you think the U.S. market is now? This is for American investors.
CdL: I think part of the answer is a political answer. Part of the last leg of the bull market
in the U.S. was driven by lower taxes for corporates, and we have a large budget deficit
today despite having very very low unemployment. So how markets and the Treasury market reacts
to very substantial budget deficits in a downturn remains to be seen, and I think there is a
large amount of risk there. It may be that the Fed decides to just print dollars or buy
Treasuries, and that would just devalue the dollar.
If the dollar devalues substantially, usually global markets or international markets do
better relative to the U.S. That’s usually when the dollar is very weak, and in a recession
usually the dollar is weak because interest rates get lowered. So, I think there is a
risk there that people tend to forget about because interest rates on Treasuries are so
low. We don’t know what is too much in terms of budget deficits, so there is a question
mark there. CM: Chuck de Lardemelle, thank you so much
for joining us on WealthTrack. CdL: Thank you, Consuelo.
CM: Our pleasure. CdL: I really appreciate it. Thank you. Thanks. AT THE CLOSE OF EVERY WEALTHTRACK WE TRY TO
GIVE YOU ONE SUGGESTION TO HELP YOU BUILD AND PROTECT YOUR WEALTH OVER THE LONG TERM.
THIS WEEK’S ACTION POINT IS ONE WE HAVE RECOMMENDED BEFORE BUT THERE IS EVEN MORE
COMPELLING EVIDENCE TO SUPPORT THE CASE FOR OWNING GOLD. THIS WEEK’S ACTION POINT IS:
OWN SOME GOLD AS A HEDGE AGAINST MARKET, ECONOMIC, AND CURRENCY DECLINES.
GOLD HAS PROTECTED INVESTORS DURING EVERY BEAR MARKET BUT ONE OVER THE LAST 50 YEARS
AND THAT WAS IN THE EARLY 1980’S WHEN THE FEDERAL RESERVE WAS RAISING INTEREST RATES
DRAMATICALLY AND SUCCESSFULLY TO FIGHT INFLATION. OTHERWISE, ANYTIME MARKETS WERE IN A BEAR
MARKET, GOLD PRICES WERE RISING. WORLD ECONOMIES ARE SLOWING,
CENTRAL BANKS ARE STIMULATING PUSHING INTEREST RATES AND THUS THEIR CURRENCIES EVEN LOWER
AND CORPORATE AND GOVERNMENT DEBT IS AT RECORD LEVELS.
WHAT WILL HOLD ITS STORE OF VALUE AND IS RECOGNIZED AND TRADED AROUND THE WORLD?
GOLD. DE LARDEMELLE IS HOLDING MORE THAN 10% OF
HIS PORTFOLIO IN GOLD. MOST INDIVIDUALS DON’T OWN ANY. THIS IS A GOOD TIME TO CONSIDER IT.
NEXT WEEK, THE CASE FOR SMALL COMPANY VALUE STOCKS WITH SMALL CAP PIONEER CHUCK ROYCE.
WHY THEY DESERVE YOUR ATTENTION NOW.. THIS WEEK IN OUR EXTRA FEATURE CHUCK DE LARDEMELLE
EXPLAINS THE IMPORTANCE OF BEING ABLE TO CHANGE YOUR MIND AS AN INVESTOR. HE’LL SHARE SOME
EXAMPLES ON OUR WEBSITE WEALTHTRACK.COM. WE WANT TO THANK YOU FOR YOUR FEEDBACK AND
HOPE YOU WILL REACH OUT TO US ON FACEBOOK AND TWITTER AND CHECK OUT OUR YOUTUBE CHANNEL.
THANK YOU FOR WATCHING. HAVE A GREAT WEEKEND AND MAKE THE WEEK AHEAD
A PROFITABLE AND A PRODUCTIVE ONE.