Unlocking Financial Mastery: Lessons from Munger and Buffett amid Global Economic Tides

February 26, 2024 

Discover the investment wisdom of Charlie Munger and Warren Buffett as we unwrap the secrets to patient, long-term success in the financial markets. Our episode takes a deep dive into Munger's life rules and how they apply to both personal finance and investment strategies, especially in the context of a tumultuous year shaped by political and geopolitical events. We talk about living within your means, the value of continuous learning, and the importance of being selective with investment opportunities – lessons that are further exemplified by Berkshire Hathaway's conservative approach amid a high-valuation market.

Navigate the intricate dance between deficits, inflation, and interest rates with us as we dissect the Federal Reserve's response to lingering post-COVID inflation and the effects of government spending. The conversation gets real as we explore how climbing interest rates are influencing government debt and the broader implications for global economies. We draw attention to the contrasting economic strategies, comparing China's curtailed foreign investment to the resilient U.S. stock markets and how these play into the larger financial picture.

Wrap up with the latest financial tidbits and predictions, spanning from Home Depot's revenue patterns to Nvidia's outstanding earnings. We celebrate Intuitive Machines' historic lunar landing and speculate on the potential outcomes of Amazon's addition to the Dow Jones Industrial Average. The episode also provides updates on the dynamic interplay between military actions, political shifts, and the stock market's hunt for direction, all while keeping tabs on the tech industry's groundbreaking innovations and legal challenges that could reshape the digital landscape. Join us for a comprehensive tour through the current financial and geopolitical climate, all while being equipped with expert insights and forward-looking analysis.

** For informational and educational purposes only, not intended as investment advice. Views and opinions are subject to change without notice.

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Transcript

Alan Eppers: 0:00

And now introducing Mr Keith Lanton.

Keith Lanton: 0:04

Hi, good morning. Hope everyone had a great weekend. Today is Monday, february 26th. Even though this is a leap year, we get an extra day. This is the last Monday of February, so almost already 1-6th.

Keith Lanton: 0:19

Through the year, it's been quite the year already, both in the equity markets and, of course, with everything that's taken place in the political world as well as the geopolitical world, which makes trying to decipher what's taken place in financial markets that much more interesting and complicated. Of course, if you sift through the noise and remain a long-term investor, history as so far been on your side that patience is a virtue. And then, in the long run, if you are appropriately allocated and invested, whether it's in equities or combination of equities and fixed income, historically you've done well as long as you have not been an emotional investor. So, speaking of an unemotional investor, charlie Munger, we're going to talk about rules for life in his words, and then we're going to talk about one of the bugaboos that's been plaguing investors, which is the prospects for inflation and higher interest rates. Berkshire Hathaway had earnings over the weekend, so we'll talk about some of what Warren Buffett had to say at the annual earnings report with respect to Berkshire and their earnings annual report, where he had some interesting comments, and then we'll talk about the financial markets, which last week had another good week in video head earnings and they were even better than expected and expectations were very high. Then we'll talk a little bit about Barons and then we'll turn things over to Brad. Give us his thoughts on financial markets, specifically fixed income markets, which have been more muted as of recently.

Keith Lanton: 2:12

So Charlie Munger, one of the most successful investors of all time, died at age 99, we've talked about him before some of his philosophies on life Live within your means. One of the reasons Mr Munger became a billionaire was he understood the value of a dollar. He said live within your income and save that you can invest Now, once you've saved, so that you can invest, he said you've got to learn how to invest and learning requires reading, which is why Mr Munger was an evangelist of books. He said in my whole life I have known no wise people over a broad subject matter area who didn't read all the time. None, zero. Mr Munger said you'd be amazed at how much Warren reads and at how much I read. There is no better teacher than history in determining the future. There are answers worth billions of dollars in a $30 history book.

Keith Lanton: 3:06

Keep it simple and be patient. We just talked about patience. He said one of the main things that gets taught in modern university education is that vast diversification is absolutely mandatory in investing in common stocks. He said that is an insane idea. It's not that easy to have a vast plethora of good opportunities that are easily identified and if you've got only three, I'd rather it be my best ideas instead of my worst.

Keith Lanton: 3:33

And, interestingly, in this rip-roaring market that we are currently experiencing, if you read through the Berkshire report, you'll have noticed that Berkshire's cash has piled up, adding 30% in the last year to $168 billion, the clearest indication that the legendary investor, warren Buffett, is waiting for an inflection point in the markets. He is being patient, he is keeping it simple to the companies that he knows and he understands and he is not getting caught up in the hoopla of the FOMO fear of missing out. Like many investors who are chasing stocks at the current moment, as they are approaching record highs and high valuations, he is waiting for his moment and history will determine whether or not he is correct or not, but the probabilities, based on history, are that he is right a lot more than he is wrong, but nobody's perfect. Mr Munger went on to say, unlike many stock gurus, that he says that money, the big money, is not in the buying or selling but in the waiting which we just talked about with Warren Buffett is currently doing. And then he said understand the importance of incentives.

Keith Lanton: 4:43

Perhaps Mr Munger's most famous quote is related to a key concept in economics, which is incentives. Show me the incentive and I'll show you the outcome. He once quipped the iron rule of nature is you get what you reward, for If you want ants to come, you put sugar on the floor. This is one reason Mr Munger, who is a staunch defender of capitalism, ridiculed government efforts to rescue companies that were deemed quote unquote too big to fail. He said capitalism without failure is like religion without hell. And then he said manage your character closely and reject envy. The world is not driven by greed, it's driven by envy. Envy is a really stupid sin, because it's the only sin you could never possibly have any fun at. There's a lot of pain and no fun. Why would you want to get on that trolley? And then, with respect to reputation, he says remember that reputation and integrity are your most valuable assets and they can be lost in a heartbeat.

Keith Lanton: 5:42

So, with that is our backdrop in terms of thinking about how to approach financial markets, let's take a look and see where we're at at the moment. We are at a moment where, just a short time ago, we were very, very focused on interest rates and what the Federal Reserve was going to do. The expectation, coming into 2024, was that interest rates were going to decline. Fed had said three times, markets were very determined and very adamant that the Fed was going to cut rates six times and that's why we saw a strong rally at the end of 2023 and we saw that rally begin in the beginning of 2024 on the thesis of rate cuts. But what has happened is that inflation has proven to be stickier than anticipated and I think when we look back at the let's call it the COVID and post-COVID era, I think that there's going to be a lot of economic textbooks written about the monetary policies that took place during the COVID era and a lot of studies that will be done when we take a look at the fiscal spending that has taken place in the COVID era and therefore the lift off in interest rates. So I think, like Charlie Munger said, keeping it simple it's really not that complicated to see, perhaps, why inflation is higher and why it is staying higher.

Keith Lanton: 7:04

And it all comes back to take a look at what the amount of money that the government is spending in excess of what the government is receiving, in other words, what is the annual budget deficit. And if you go back to 2015, which was last year of the Obama presidency, you were looking at about $438 billion as a US budget deficit. First year of the Trump presidency went up to $587 billion and then by 2019, we were knocking on the door of about a trillion-dollar budget deficit. Then COVID hit. In 2020, we ran a $3 trillion deficit, $21.8 trillion. And after 2021, after COVID receded a little bit further into the background, we are still running very large deficits $1.4 trillion in 2022. Last year was $1.7 trillion and this year is expected to be $1.6 trillion.

Keith Lanton: 7:55

And if you think about the size of these deficits relative to the size of the economy, it becomes kind of intuitive that we are spending a lot more money than we are creating as a nation. So in 2023, last year, we ran $1.7 trillion deficit and the $27 trillion economy is measured by GDP, so we ran a deficit of 7.4%. So if you are borrowing 7.4% more than you are creating, you are certainly going to create meaningful excess demand. And if you look at that 7.4% relative to where we were pre-COVID let's say 2017, when we ran a $665 billion deficit, at that time we had a $20 trillion economy, so the deficit was only 3.32% of the economy versus 7.4% today, meaning we are spending 4% more than we were before relative to the size of our economy. At some point you're going to hit a point where that's going to trigger inflation. You may remember going into 2020, even during COVID.

Keith Lanton: 8:59

There are a lot of Congress folks talking about this thing, which we never hear about anymore, called modern monetary theory, mmp, which was basically this theory that the US government with the reserve currency and we could spend as much money as we want. But like all good things, everything has a limit and you know what? There was probably some truth to the fact that we could have spent more than we were currently spending and not trigger inflation, and interest rates were hovering near zero. But when you ratchet things up enough and you spend enough, you're probably going to get inflation, and that is, in fact, what we have gotten. And now we are running these large deficits relative it's all relative to the size of our economy.

Keith Lanton: 9:39

Now, part of the reason that we are running these large deficits and this is where things become a self-fulfilling prophecy, a little bit of a hamster wheel is because of the fact that once we sort of reached this escape velocity and we started to create inflation, suddenly the government had to start paying interest on its debt and this added to the deficit. So now we have the fact that previously, the average interest rate on the debt was, let's say, one and a half to 2%, what we were paying, and now we're paying, let's say, four and a half percent. These are rough approximate numbers, but the bottom line is we were spending about $300 billion a year on interest and now we're approaching $1 trillion a year on interest. And this fact that we are paying interest on our debt is also contributing to inflation, because before, who's receiving these interest payments? Well, these interest payments are going to savers. Many of the savers are American citizens, some of them are foreign citizens, and what happens is when they get this interest that they previously weren't getting before they were getting $300 billion, now they're getting $1 trillion they feel wealthier, they spend more and this also contributes to the fact that we're seeing stickier inflation. So getting this inflation down significantly from this three plus elevated level that we're currently experiencing may come down to the simple fact that we are running big deficits. Higher interest rates in a sense beget bigger deficits, which also beget higher inflation, and the fact that more investors have more money in their pocket because they are earning this interest. All fees on itself and perhaps will create an environment where, outside of an exogenous or outside shock, it will be difficult perhaps for the Fed to get this interest rate lower, because inflation may prove stickier than previously thought and for the aforementioned reasons. Time will tell, but something to think about, with these big deficits and with the fact that we are paying all this interest that we weren't paying.

Keith Lanton: 11:43

Before Looking backwards, what happened last week? Well, last week we had the Chinese Lunar New Year begin and in the Chinese market foreign direct investment fell down to 1990 levels and officials there made a record cut in mortgage interest rates. So the Chinese economy currently sputtering. But here in the US stocks were able to dust themselves off, greatly helped by the earnings from Nvidia, which helped turn the indexes positive. Last week, during the short week because it was President's Day, the Dow was up 1.3%, the S&P 1.4 and the Nasdaq also up 1.4.

Keith Lanton: 12:25

Also, we had a record high set in Japan. 34 years since Japan set a record high, but last week it finally made its way back to levels seen almost 35 years ago. Also last week, jetblue said it would accept two Carl Icahn representatives to its board. Home Depot reported a fifth consecutive quarterly drop in revenue. Hsbc took a $3 billion charge on its Chinese bank and bad commercial real estate loans. Walmart beat earnings but was cautious about 2020. Warner Brothers Discovery they did not have a good quarter. They whipped on their cable and studio revenue that the streaming company. And Nvidia, as alluded to earlier, released blowout earnings, quarterly revenue tripling from a year earlier. S&p market cap up nearly $300 billion, breaching $2 trillion. On Friday fell back slightly, so it's just under that $2 trillion mark. And also last week, intuitive Machines, the publicly traded company, landed the first US spacecraft on the moon in 50 years.

Keith Lanton: 13:33

Amazon is going to join the Dow Jones industrial average today, replacing Walgreens Boots Alliance. Tomorrow we get the S&P Core Logic releasing the Case Shilla home price index. That's expected to show home prices of jump 6.3% year over year and acceleration from November is 5.4%. Wednesday we get earnings from Salesforce and Snowflake. Those will be carefully watched. And then Thursday we have the Bureau of Economic Analysis releasing the Personal Consumption Expenditure Index for January. Consensus estimates show the PCE rising 2.4% year over year versus 2.6 in December. The core measure, stripping output in energy, is expected to gain 2.8% versus 2.9% in December. This is a widely measured inflation index by the Federal Reserve and Fed officials. They say they want to see this index on a path to 2%, which would mean significantly lower than current levels before they start cutting interest rates.

Keith Lanton: 14:35

So we talked about the tremendous performance last week of NVIDIA and just to put some of these large cap US tech stocks into perspective, the combined market cap of the magnificent 7 stocks here in the US would make those 7 stocks the second largest stock exchange in the world. They are double the size of the Japanese stock market. Individually, microsoft and Apple each have similar market capitalizations to all the listed companies. In each of these companies France, saudi Arabia and the United Kingdom. Last week, joe Biden announced another round of cancellations for student debt. He has now cancelled about 138 billion student debt. Put in perspective the size of the total debt that is outstanding to students about 1.7 trillion and of that he has cancelled about 138 billion of that 1.7 trillion. What's going on? This morning, futures have just turned slightly positive, relatively quiet start to the week. Now, futures are up 6. S&p futures up 2.5. Nasdaq futures are up 25.5. Market is looking for some direction after the big move last week, as well as some of the earnings reports that we will get, that we discussed, and the economic data we will get at 10 o'clock today, january, new home sales coming out at 10 am. Treasury yields little change from Friday two year notes down a couple of basis points, yielding about 4.68. 10 years down just about two basis points, yielding 4.24.

Keith Lanton: 16:14

Us and the UK carried out large scale military strikes against sites in Yemen over the weekend. Also over the weekend, donald Trump defeated Nikki Haley by 20 points in the South Carolina primary. Nikki Haley hinted her campaign may soon come to an end, only committing to stay in the race through Super Tuesday, which is March 5th. She also lost the Koch brothers as financial beneficiaries to her campaign, saying they won't be funding it any further. Cnn saying that negotiators have an understanding of a potential deal to release hostages held by Hamas in exchange for a temporary ceasefire in Gaza.

Keith Lanton: 16:51

Nbc News talking about the budget again here in the United States. The House is expected to vote this week on four appropriations bills to once again a verdict of government shutdown, but might need a short one week continuing resolution to have enough time to complete the process. According to NBC News Reports that Apple is considering producing a fitness ring and smart glasses. Samsung just came out with a fitness ring. Today. Us Supreme Court to weigh Florida and Texas laws constraining social media companies. Supreme Court is set to hear arguments on the legality of Republican-backed laws in Florida and Texas that restrict the ability of social media platforms to curb content that these companies deem objectionable in a pair of cases that could reshape free speech rights in the digital age.

Keith Lanton: 17:42

And speaking again about Berkshire Hathaway Berkshire Hathaway's valuation is approaching the $1 trillion after a record profit in the most recent quarter. Operating profit rose 28% to about $5,884 per class A share. Total net income, including investments, more than double to $37.57 billion, or $26,000 a class A share, while the 96 billion annual profit in this quarter topped the old record, which was set in 2021. Barons over the weekend talked the course about NVIDIA and what effect NVIDIA had on the markets, saying this rally is bigger than NVIDIA and tech, and they also said what could end the rally. It's tempting to think that the scorching rally that sent stocks to an all-time high this past week was based entirely on hype about artificial intelligence. Barons says don't believe it. The rally may have been sparked by NVIDIA's blowout earnings on Wednesday, but it's spread beyond the AI behemoth. Three sectors hit new highs last week tech, healthcare and industrials. Financials and materials are less than 5% away from their peaks. Stocks like Costco, which sells more corn chips than microchips, is also at a record as well.

Keith Lanton: 19:03

What's remarkable is the stock market rally has persisted. The fact that its original justification has fallen apart. Most of the markets 25% gained since October were premised on the idea that the federal reserve would cut interest rates Starting in March or May. The latest recent comments from members of the Fed, along with persistent inflation, which we certainly just talked about, suggested the first cut could come in June or even later, while most of the incremental cuts are now priced out. The stock market did not correct at all. Economic indicators have held up well. Home sales, for example, are rebounding despite persistently high rates. Corporate earnings are holding up. Of companies that have reported earnings, 78% are beating estimates, a rate that is better than the historical average. On the contrarian side, somewhat concerning that retail investors are becoming exceedingly bullish, charles Schwab's quarterly survey of active traders, which was released last week, found that the highest bullish sentiment since they launched this indicator in 2021, and a very quick turnaround from a bearish reading in the fourth quarter of last year.

Keith Lanton: 20:12

We talked about Amazon joining the Dow Club. Barron's talking about what happens to stocks when they join the Dow Amazon joining the Dow today, replacing Walgreens, which was just added to the Dow in 2018. Since Walgreens was added to the Dow, it's lost about two-thirds of its value, which is an extreme example of what has happened to new members of the Dow in the last several years. Barron's compiled a study of recent stocks that have been added to the Dow, and what it shows is that the most recent 15 stocks that have been added to the Dow have lagged in their first year of being added to the Dow. They have lagged the S&P by almost 14% in the year that they've been added to the index. So we'll see if Amazon can buck history in those averages and see if it can perform better.

Keith Lanton: 21:10

A couple of well, actually, specifically one individual stock mentioned in Barron's and that is Bloomin' Brand symbol BLMN. You may know it better as the owner of Outback Steakhouses. They also own Caraba Grills, bonefish Grill, fleming Prime Steakhouse and Wine Bar and Aussie Steakhouse. The company gets its name that Bloomin' Brands, from Outback's Bloomin' Onion, the fried appetizer that served there. Barron's talking positively about the Bloomin' Brands, despite the fact that traffic dropped 4.3% year over year for the fourth quarter and for the full year in 2023. Although revenue last year, despite the drop in traffic, did increase 5.7% given that they raised their prices. Earnings per share in the latest quarter were 75 cents to share, which beat estimates of 69 cents per share, driven by a lower operating cost.

Keith Lanton: 22:12

Management is taking steps, barons, as to spur growth and achieve higher profitability. They are investing in digital sales as well as new marketing efforts in order to retake market share. In fact, in the fourth quarter, 24% of sales came from off-premise digital sales think Uber, eats, doordash. In addition, they are investing in advanced grills and ovens and handheld technology for servers. Other companies that have done this have been able to turn tables over more quickly and improve their margins. So analysts optimistic that this technology and this investment will pay for itself and that the stock will start to move higher.

Keith Lanton: 22:55

Such improvements are what starboard value, an activist investor that owns almost 10% of the stock, wants to see. They are hoping that earnings per share could grow by double digits, helped by continued stock buybacks, companies producing a few hundred million dollars of annual free cash flow. They have been buying back their stock and on Friday's call they said that they plan on buying back 350 million of shares going forward. Double digit growth in 2025. Earnings could move per share earnings up to about $2.83 a share. Shares now traded about 10 times expected earnings for the coming 12 months, a hair into other restaurant stocks and about half of the S&P 500s. 20 times forward earnings. In the past, the Blumen Brands has traded in line with the S&P 500, so if they were to start reaching towards that level, you'd be able to see a meaningful move up in the stock, balancing with an inexpensive stock and a start on planned improvements. Investors may do well for an appetite for Blumen.

Keith Lanton: 24:02

Finally, before I turn things over to Brad, interesting story in the fixed income markets, one of the darlings of the market, super micro computer. This is an AI darling symbol SMCI, sam, mike, charlie, ida Barron's talking about the fact that super micro last week did a convertible bond deal and they raised money basically for free, which is something that's concerning about interest rates. When you have public companies in an environment where you have 5 plus percent fed funds rate, able to access the capital markets and borrow money for zero, how does the company do this? Well, last week super micro, in a convertible note deal, raised $1.5 billion and the notes carry a 0% interest rates and are exchangeable into the company's common stock at a 37.5% premium over what the share is fetched at the time of the pricing. So super micro's convertible deal was a classic instance of using high flying shares to raise money at virtually no cost. This is something about a decade ago that Tesla did when they raised $1.6 billion, by effectively selling high price call options on a high price stock attached to its high priced bonds, and this is, in fact, what the super micro just did. They used the same playbook to sell notes convertible at a big premium over its shares, which are currently trading around 38.6 times 2024 estimates.

Keith Lanton: 25:39

So in this example, if super micro were to simply take the 1.5 billion that they raised, currently paying no interest on obviously they have to issue more stock if the stock appreciates more than 37.5% but they could take this 1.5 billion and they could simply invest it into treasuries and buy one-year treasury bills and they could make about $75 million a year because their interest cost is zero. And they raised a billion and a half times 5%. You get that $75 million. The ability to ring this sort of free money out of the capital market fairly screams easy financial conditions. So here we have an example.

Keith Lanton: 26:20

Despite interest rates being elevated, typically corporations have to issue money at a rate greater than the Treasury because they are of greater risk. Here's a company using financial engineering in an environment where interest rates are higher, hopefully creating tighter market conditions. Here they're able to raise money basically at zero interest in an environment that's supposed to look like tighter monetary conditions. Perhaps there's another reason why the Fed is having a challenge in slowing the economy with the higher rates, which is why higher for longer may be what our future looks like. But that I'm going to turn it over to Brad. Give us some more insights on the bond market and other factors taking place in the marketplace. Good morning, brad.

Brad Harris: 27:09

Good morning Keith. Good morning everyone. I hope everyone had a great weekend. I know you're all chomping at the bit to hear about the life at the bond trading casino, but last week was truly and surprisingly dull. Though the Treasury market had a big rally on Friday after weeks of lower to sideways prices, we still remain in Fed purgatory. The tenured dip below 4.25% this morning, down in yield, up in price from about 4.4% a few days ago, but it is still up in yield from a recent low close of around 3.75%.

Brad Harris: 27:46

Municipals have become richly priced first treasuries out to about 15 years. There's no other way to look at it. If you are a municipal bond buyer you're still doing better than treasuries out to 15 years, but they're certainly not as attractive as they have been a few weeks ago. Once you go out about 20 years in municipal, the percentage of first treasuries become better again. They're more normalized out there. It's still not the gift that you were getting back even a couple of weeks ago. There is a lot of supply coming in the next few weeks of municipal and this may put a cap on price appreciation. Not that many of you are concerned with price appreciation for municipal. But if you are looking to buy bonds with new money for municipal deep discount bonds with short calls that are subject to the minimum tax but are still out of favor from most institutions, and that's where the opportunity and value is for a buy and hold investor. The investment-grade corporate market seems to be fairly priced for the appropriate buyer, but it really is driven on a company-to-company basis and it's very difficult to make a blanket statement about how corporates are relative to treasuries and all other investments unless you analyze the corporate on a case-by-case scenario In a dull period.

Brad Harris: 29:10

I would not suggest chasing anything here, but sometimes dull periods are good opportunities to evaluate portfolios. For those lucky enough to have maybe owned it, maybe take some of that NVIDIA stock off the table, buy some nice shoes and maybe put a little into some bonds that still are offering some decent rates of return. There's sleep at night rates. You probably are not going to get hurt at this point, and it's just always a good opportunity to make sure that your portfolios are properly balanced to what your goals are for the portfolios. With that, I hope everyone has a great week and I'll pass it back to Keith. Thanks.

Alan Eppers: 29:55

Thank you for listening to Mr Keith Lanton. This podcast is available on most platforms, including Apple Podcasts, Spotify and Pandora. For more information, please visit our website at www. heraldlantern. com.

Sophie Cohen: 30:15

Opinions expressed herein are subject to change and not necessarily the opinion of the firm. Invest performance is no guarantee of future results. The information presented herein is for informational purposes only and is not intended to provide personal investment advice. It is important that you consider your tolerance for risk and investment goals when making investment decisions. Investing in securities does involve risk and the potential of losing money. The material does not constitute research, investment advice or trade recommendations.