Ep 14: Budget vs Trade Deficit, Market Volatility & Private Equity in Retirement

In this episode of The Point, we kick off with “In the News,” where we unpack the latest on tariffs and trade policy—and what they could mean for your wallet. Then, we break down three big financial questions that are top of mind for investors. Our hosts clarify the differences between the budget deficit and trade deficit, explore smart ways to navigate market volatility, and discuss whether Private Equity has a place in a well-constructed retirement portfolio.

🔹 Topics Covered:
✅ Budget Deficit vs. Trade Deficit: What each one really means
✅ How to approach market volatility with a long-term mindset
✅ Pros and cons of Private Equity in retirement planning
✅ What current trade policy shifts could mean for investors

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Transcript

Episode 14: Budget vs. Trade Deficit, Market Volatility & Private Equity in Retirement

Key topics:

tariffs, trade policy, budget deficit, trade deficit, economic policy, globalization, market volatility, private equity, leverage, economic uncertainty, investment strategy, portfolio management, liquidity, economic impact, trade negotiations

Welcome to The Point Podcast. We have informed, intelligent conversations about today's financial topics submitted by viewers like you. Let's go ahead and get started. Here are your hosts, Landis Wiley and Allen Wallace.

Welcome to The Point. I'm your host. Landis Wiley, sitting here as always, with Chief Investment Officer, Allen Wallace, hello. Thanks again for joining us. We got a lot to talk about today. Yeah, kind of all over the map. Lots of headlines going on, lots of noise in the markets, lots of noise in the headlines. 

IT reminds me of that old saying that there are decades where nothing happens, and then there are weeks where decades happen, and seems like we're entering one of those periods of time. Kind of feels like we've been there for a couple of months here, so still kind of grinding along slowly, though. 

So again, we appreciate you taking your time to join us. I do want to put in a little plug for those who may be listening to us on your favorite podcast app. This is streaming on YouTube and available there. So, if you want to watch us in all of our glory and also be able to see some of the charts that accompany the topics that we talk about, be sure to check out our YouTube channel and enjoy all right, so with that, we'll go ahead and kind of kick this off. So let's start, you know, we kind of touched on there's a lot going on, a lot being talked about, so let's talk about what's going on in the news. There's a lot of ways we could go with that, sure. So where do you want to start?

I think the thing that people are talking most about right now is tariffs and trade policy, that kind of thing. That's what's sort of dominating my news feed, which may be different than the average news feed. I’m guessing that's probably most people Sure so. And there seems to be a lot of discussion around that. 

A lot of it, of course, is sort of, you know, getting muddied in with the politics of the issues  And people's views on that, you know, as we look though, and as we talk about tariff and trade policy, it sort of leads into a whole bunch of different ways that we could go down the conversation with it, I think, right? So maybe let's just summarize what's kind of happened. Can I be a good starting place? Sure, that sounds good. You want me to do that? I would love for you to do that. 

I'll start off by just quoting Henry Haslett, who wrote economics in one lesson. And he begins the book by talking about bad economists. And he defines a bad economist as someone who either only looks at the short-term implications of a policy or only considers how they impact one group. And I think right now, this entire discussion is tainted by a little bit of bad economics. We've got a lot of arguments about the short-run effects, and then we also have a lot of discussion about how individual groups are impacted. And whenever you make an economic decision, you have to think about, you know, what are the unintended consequences of this? You know, we know nothing in economics operates in isolation. Everything is interconnected. So I think there's been a lot of short-termism going on here, like, Hey, this is already failing. And then there's a lot of isolating individual groups that might be harmed, and then highlighting them. Right? I think there's this misconception that there's some sort of divine economic plan that's going to equally benefit everyone. And unfortunately, because economics is sort of, you know, how we deal with scarce resources, anytime you implement some sort of economic policy, you're going to have winners and losers. And we have to decide, you know, who are we going to support and who are we going to allow to suffer whenever we make any sort of economic change, and we've got that going on right now. I mean, you know, the stated goal of the tariff policy is to bring people to the bargaining table and to try to change the terms by which we trade with our world, global trading partners, and to say that, you know, that's a catastrophic failure before it's even started. I think that's a little disingenuous, but it doesn't mean that they're wrong. It just means that maybe they're not taking the time to let things play out right?

And as you talk about that, obviously, the changes that are being contemplated or proposed with current policy, you know there are winners and losers to that, but the reality is, there's been economic policy in play for decades that has sort of led us to this current point. And the fact is, there are winners and losers in that too. Yeah.

I mean, I think the current environment goes all the way back to World War Two, right? There's a lot of rebuilding happening. Happening after we sort of leveled Europe and Japan, and the United States sort of took this role as the global superpower, especially after the Soviet Union collapsed, and we're sort of on the tail end of that sort of dollar supremacy. You know, the United States is sort of the world's police. I guess I'm not willing to say that it's over, but it's definitely, you know, in a receding phase. So we are seeing forces of de globalization right now. And to say that that can be done without pain, I think, isn't an honest answer, and the question is, who is going to feel the pain, and is it worth it? And those are the things we need to ask ourselves. And mean, I don't know that right now, because we're still pretty early in the game, but I do know that we need to think longer term, instead of like, how is this going to impact me next week? Right, right? 

So kind of along those lines with the topic of tariff and trade policy. You know, usually we have our format set up so we get a single question and kind of dive into it. Today, we got a bunch of questions that hit on a variety of topics, but I think they all kind of tie back to this. And the first one, I think would be good as a transition here would be, what's the difference between the budget deficit and the trade deficit? Because really, the headlines that we're talking about around tariff and trade policy, a big component of that in the discussion has been the US current trade deficit with really most of the world, right? And to your point about the US role, post World War Two, and sort of rebuilding a large chunk of the world, the transition through globalization that's happened over the last 30 or 40 or 50 years, and sort of the down channel effects, or the perceived effects, real effects that that's had on manufacturing and production in the US, the impacts the middle class, the Rust Belt, right? All those types of things. Certainly, this notion of the US having a large trade deficit seems to a major driving impetus behind the focus on tariffs and trying to reset trade policy and kind of adjust that economic model that you talked about. So, let's start with maybe defining the difference between trade deficit and budget deficit, because I think they're both relevant. Certainly, discussion on those is key to kind of understanding what's going on in the headlines, they're also the things sort of driving some of the market impacts and volatility that we've seen, but in different ways, right? So, start with, let's just define what they are.

The biggest mistake I see is people confusing the debt with the deficit, right? The debt is the total that we owe. The deficit is the annual difference between tax revenues and what we spend. So that is the federal deficit. It's how much we've spent over what we've brought in in government revenue that could be from tariffs, that could be from income taxes, certain other government services that generate some sort of revenue. The trade deficit is how much more we import than we export, right? So, and this happens sort of at the micro scale, right? That's individual exporters bringing goods into the country, and then, you know, buying foreign currency in order to pay for those goods, the receiver, you know, may convert those into their own currency, or they may actually use dollars for trade. The dollars, the reserve currency, which means that most of the transactions are done in dollars. And it's sort of like having a credit card with no limit. You can choose to consume more than you produce. And that's really what a trade deficit is. We make something like $27 trillion worth of goods in this country, but we want to consume 28 trillion, and so we have to fund that somehow, and it's typically either funded through equity capital stakes in the US or through taking on debt from foreign banks. And so, if you go back to that credit card analogy, let's say your family has a perpetual unlimited credit card, and you're able to spend as much as you want on it, but you still have to make the payments, right? So you when we borrow money from foreign countries, we have to make those payments. We could exist on that credit card for a long time, but really, what we're doing is we're pulling future consumption to today. And so the system's been running for 40 or 50 years, and at a certain point, the payments become so much that we can't afford to make them based on how much income we have. And that may not be a problem for this year or next year, but at some point, the debt that we saddle our future generations with is going to become onerous. And I think we're actually to the point now with 36 trillion in debt that the interest payments are becoming a significant portion of the annual budget, right? So that's more federal deficit-related, but the trade deficit is like giving a stake of our economy to someone else. You know, we're selling little pieces of our economy in order to take on more consumption today. If you remember back to the late 80s, and maybe going into 1990, Japan was buying up all the buildings in the US, especially in New York, right? Well, the way that they were funding that was they were exporting more to us. And so they had excess dollars, and they were putting those dollars to work by buying up real property in the United States. So, every time we have a trade deficit, we give away a little bit of our future consumption.

And with Japan going through that in the late 80s and into the 90s, we've seen that with China as the primary counterparty over in recent years. 

Yeah, and more of theirs was held in US Treasuries. I do think that there's a lot of farmland in the US owned by Chinese sources. There's been legislation proposed to prevent foreign ownership of US farmland, and I think those are the kind of things where we go back to that short-run effect versus long-run effect right? In the short run, we get to spend a little bit more than we earn, and that feels good. But in the long run, we're either mortgaging or outright selling a big percentage of our real economy. 

And the two aren't unrelated, right? Because theoretically, if we're running a budget deficit a lot of times, the down channel of that is, it's pumping additional money into our economy, right, which is driving up consumption, right? Therefore, we're not producing enough to satisfy consumption. So, to some extent, we start importing, right, right? And it sort of drives that, that trade deficit, you know, even wider than what it otherwise might be,

Yeah, I mean, it's all one equation. When you calculate GDP, right, you've got consumption plus government spending plus, and you know, investment plus the net of exports over imports. And so, I think that a lot of the federal deficit has actually found its way onto corporate income statements, right? It's translated into profits for corporations, but the deficit actually reduces GDP, right? Because it's imports minus exports in the GDP equation. So, if you have a trillion-dollar deficit, which we're at, like 90, 91 Billion, or something like that, then you're actually reducing your top line GDP number because of the negative impact of the imports, exports minus imports, right? And then the federal deficit is closer to 2 trillion. So not only are we spending 2 trillion more than the government brings in in revenue, but then we're also spending a trillion more on top of that by importing more than we export. So, all told, it's $3 trillion a year or so that we're spending more than we're producing, which translates to about 10% of the entire economy, right? So, if you think about that, if you make $100,000 a year, but you spend $110,000 a year, how long is that sustainable on a household budget, right? You could probably do that for a few years, right? But eventually those payments are going to start to drag on your ability to use the rest of your income for consumption, right? 

So when one of our listeners, or one of our viewers is looking at this, and they're, you know, they're obviously seeing the headlines. They're seeing the banter and the discussion about, are tariffs good or are they not, and is the end result worth the potential short term pain, right, to implement that economic model, certainly they're also seeing the volatility in the markets. And you mentioned that the sense that maybe a lot of our fiscal deficit spending is trickling its way into corporate income statements, right? So, is that something that we could look to and say has sort of been a significant contributing factor to some of this volatility, is it? Is it the markets trying to figure out, are we actually going to suck some of this excess spending out of the economy, and what does that look like when that cash is no longer showing up on corporate income statements? Exactly.

Yeah, and I think we're arguing about the wrong point. If you have the family meeting on a Sunday and you say, hey, we're spending 10% more than we earn. We have to stop that. There aren't going to be any good feelings coming out of that meeting, right? We have to, we have to live on less. And not only do we have to go back down to what we're producing, but we're going to have to consume even less than that, because we have to pay back some of the few. Consumption that we've already pulled forward to now. So, there's no way to go about this discussion that doesn't involve less consumption. And so, when I see the people arguing on the news about we're going to have to spend less, well, yeah, that's kind of the whole point. The whole point is we've been overspending on what we're producing. So yeah, it's going to be painful for everyone. 

So in this case, the short term effect is going to be higher prices, because you're going to have less goods circulating, and you're you know, the entire economy has to balance through the equations. And if you have less goods coming in, but the same amount of money sloshing around, then the prices, the mechanism by which that corrects is price increases, right? And all that is a translation into, you have to consume less, right? Because there's we're not going to be

we're not going to be consuming more than we earn anymore. So there's no way to look at this and say, All right, here's how we consume more if we're going to solve our deficits unless we're going to export a significantly higher amount of goods and we're going to bring in more tax revenue. Those are the only ways to balance this that don't involve huge amounts of pain for us. But if that happens, then there's obviously losers on the other side of the equation. So, it's either, do we lose internally, or do our foreign trading partners lose? And that's what all the arguments are about, right? The tariff policy doesn't necessarily directly impact the trade deficit, but it's a big influencing factor. And I think there's also some disagreement on whether the tariffs are being put in place specifically to raise money or just as a bargaining chip in order to get more production happening in the US. Because if you're a Japanese auto manufacturer and you move your plant to the US, you get to avoid the tariffs, right, right? And so, I think that there's a lot of negotiations going on to bring more manufacturing back to the US, and that's a completely different discussion of, you know, do we want more of our things produced here when we don't have a comparative advantage to other countries when we think about comparative advantage? So, this whole post-Keynesian argument about, you know, free global trade hinges on comparative advantage. One country can do things more efficiently than us, so everyone specializes in the things that we're good at. But what it's rolled down to is that the very first comparative advantage that all these other countries had was cheap labor, and so we moved to exploit the cheap labor, but by taking advantage of that cheap labor, we built other comparative advantages for these countries, like the infrastructure that they have, right? That's where the factories are now, right? So not only is it where the cheap labor is, but it's also where the production capacity is, and then there are natural resources in proximity to these locations. So, there's another comparative advantage. So, we've sort of caused the comparative advantage to shift by relocating the factories in the first place. And the question is, do we want those to come back here? I think in certain regards, we definitely should have, you know, we shouldn't have to rely on anyone else to produce medicine or to produce weapons. That puts us in a very poor spot if there's ever any sort of global conflict, right? So, if you go back to COVID, there were export freezes on certain medical components. And, you know, so if we're not able to make insulin in this country, you're going to, I mean, I can't imagine a bigger catastrophe than people dropping dead on the street because we can't make medications. So, I think there's a national security interest in some of these things being produced domestically. And then there's the next step of that argument, which is that the middle class has sort of been hollowed out by jobs relocating overseas. I don't know if you can put that toothpaste back in the tube, though, right? I think the way that we produce things in this country has changed. I mean, there's a lot more automation. It's not like the 1970s in Milwaukee, where the guys were all on the conveyor, on the assembly line, you know, making beer, or in Detroit making automobiles. I just don't think factories run that way anymore. So, I don't know if you onshore production, if you would get the large amount of jobs that you, you know, would have had if we did this in the 70s, right? Because certainly

there'd be the argument that argument that if they do make attempts to bring that back here to your point, the factories don't exist. You've got to build them from the ground up. And if you have the opportunity to build them from the ground up, you're probably going to attempt to do it in the most efficient means possible, right, which, in today's world is going to involve a lot of automation.

Yeah. And so, the other thing is that it reemphasizes the capital intensity of our businesses, right? So that capital has to come from somewhere. So, how do we fund those manufacturing facilities? You know? Because a lot of that funding might be coming from foreign investment, capital investment in the form of, you know, the excess of imports over exports, right? Because that money has to go somewhere once it gets here. And so, you know, are we going to see a big drop in the stock market just based on the fact that now it's more capital intensive? That's something we need to think about. That's a medium-term complication. I would say that's, you know, that's in the five-year to 10-year range. You know, the very short run effect is, man, things are more expensive. There are less goods out there. There may be shortages because we haven't had time to move production over. And if you look at the Port of LA right now, it's dwindling, as far as the number of containers showing up. And you've got some little indicators of this, like, you know, there's a Twitter for everything, right, right? Truck driver Twitter where they're talking about there are no loads to haul. Yeah, right. That doesn't hit the stores for a few months, right? There's, right now we're operating on, you know, previous inventory. Well, at some point, if the containers aren't arriving and the trucks aren't moving, we're, you know, we burned through that, and we felt that during COVID, absolutely, we did. Yeah,

right. I mean, that was a lot of the initial shortages, you know, were more perceived than real, right? Well, the first one was right. People run out and buy toilet paper because we were going to run out. So, it was sort of self-induced and sort of fate, but oddly enough, that's one of the few things we make for ourselves, right, isn't it always right? 

But you know, the true impacts of the shortages, you know, really didn't roll through for several months, right? And then they persisted for a long time. I mean, you think about the challenges automakers had, you know, vehicles were coming off the line without certain chips or certain features, because that whole supply chain was just, well, there

was that story about defense manufacturers ripping chips out of washing machines, right? You know, because we had a huge, huge shortage. So you might have a period of time of that kind of stuff. If we're going to be serious about this, the problem I have is that some parts of the political spectrum aren't serious about this, right? They're trying to, they're trying to squash it. Our worst-case scenario is that we go through a couple years of pain and then we give up, right? And then it ends up being worse. Because, you know, when you try to do, I'm going to cut 10% of my spending thing, and it fails, you're no longer just 10% right? Now, you're at 20 or 30% over budget. It's like anything

in life, right? I mean, people, you know, you make your New Year's resolution, you're going to go to the gym all the time, and you go to the time, and you go to the gym for the first two times, and your body hurts, and so you stop, right? I mean, you kind of got same effect going on.

And so what I mean, to summarize, pain is a bad indicator of whether or not these policies are going to be successful, because whether they work or whether they don't, there's going to be some economic change, right? And most of that's going to be lower consumption, right? And we're going to feel that right? That's less, that's less going to the movies, that's hamburger instead of steak, that's, you know, those are the kind of changes we have to make.

So, there was another question that came in, which is, how should investors think about market volatility? I think it's a good time to maybe talk about that, because, you know, what you're laying out is sort of a narrative of, there's a lot of unknowns here, right? About, you've got the issue of short-term pain. How do we react to that? What are the real you know, what are the real impacts of that short term pain? Obviously if things are more expensive and people can't buy as much or spend as much, you know, that could have real impacts to earnings for companies, right? You've got sort of that, that midterm effect of, or medium term effect of, if we do attempt to follow through with onshoring, some of the production, and essentially some of the things we're trying to do, you've got to transition in. As you said, it just the cost of being able to construct that stuff and build those facilities and train those workforces and hire those people. You know how much of that is what's being digested right now by the markets. You know, it hasn't been that long. Just a couple of weeks ago, you know, headlines were all red and markets were going crazy, and then we've sort of had this rebound effect. It hasn't hit all of the market equally either, which is interesting, you know. So, what should we be thinking about market volatility here, both what's happened and then, you know, potentially, how this looks over the next 3,6,9 or 12, 24, months

Well, first and foremost, I think we should think about market volatility itself. I think there's this, this sort of misconstrued notion that the market itself is giving you a signal of what things are worth. And that's unfortunately, that's just not true. I mean, Ben Graham likes to talk about your wily neighbor named Mr. Market, who you know would come over every day and offer you some sort of price for your stocks. And on certain days he was really happy and stocks were highly valuable, and on certain days he was depressed and. Stocks were really cheap, and all you had to do was say yes or no. And I think we've sort of forgotten that relationship, that the market's not comprised of actual companies, it's comprised of pieces of paper that derive their value from those companies, and we're just using it as a tool to gain exposure that's liquid, but what we really own is businesses, and the value of those businesses does not fluctuate nearly as much as the prices of those businesses, right? And we always try to buy things that are generating a significant amount of income, whether that be in the form of earnings or dividends in relation to the price, so that we have a good idea of how much we should be compounding at the price is independent of that stuff. Well, maybe it's loosely connected. I've heard it said that it's like two drunks tied together by a rope. You know, they can get pretty far apart, but eventually they pull on each other, right? But they've got a lot of latitude to move around when they're when they're close to each other. And I think that relationship exists sort of between the market and the companies themselves. So, volatility shouldn't concern us unless it's giving us a real indicator that the companies are becoming less valuable. Sometimes it does, and sometimes it doesn't, and then it also depends on how you're defining the market. Are you talking about the S&P 500? Because that is all the S&P 500 is a list of stocks. It doesn't have any sort of inherent quality that makes it valuable. And I think there's this notion that all you have to do is buy the S&P, no matter how it's priced, and you're going to be good forever. Well, History says that. That's not true. There are very good times to buy that portfolio, and there are very bad times to buy that portfolio, and we happen to be going into this sort of economic volatility at a time where the where the S&P 500, the market was highly overvalued. And so that's, I think that's the bigger contributing factor to the intense volatility, is the fact that the market was already overpriced. And the combination of uncertainty and an overvalued market is a lot of times what leads to some sort of correction.

And as far as the distribution of that volatility, it seems to have been heavily concentrated, at least so far, in a lot of the well known big tech names, right, which were the most overvalued, we haven't seen sort of that widespread effect where everything is getting washed out, right? In fact, there's been some stuff that's performed fairly well right through all that volatility, you know. But 36, 38, 40% of the S&P 500, to use that example, was the Mag Seven, right, right? I went into this whole thing. So, you know, as those go, so goes the S&P 500.

So if we start to run into actual economic dislocation, then the things that suffer from a recession will start to go down as well. I mean we have exposure to oil. Oil goes down. If you're heading into a recession, it has no indication of what the price is going to be in 10 years. That's purely short-term volatility. We don't have the capability right now to retool our entire energy infrastructure and change over. And so there's reductions in price based on the fact that you bought something that was overvalued, and the dynamics have changed. And then there's also volatility in the form that you know, this thing is cyclical and we're heading into a recession, we would use that as an opportunity to buy more of it, not less of it. If you look at the oil companies or PE ratios of 10 to 12, that's giving us somewhere between an 8 and 10% cash on cash return based on their earnings. And that tells us that that business is going to get, continue to get more valuable, even if the price fluctuates wildly. If you buy something at 100 times earnings, you have very little room for the business itself to compound. You're relying on the fact that they're going to increase revenue, increase profit margins, or increase earnings over time. And so you depend on things going perfectly. If you own a company that is generating 10% earnings based on what you paid for it, that money is going to go back into the company and be reinvested, and that company is going to become more valuable over time, unless you have really terrible management. Don't get me wrong, there are managements out there that can, you know, burn 10% or more right on an annual basis, but that's the whole point of qualitative analysis, that's why you want to have a good business with good management at a good price. All three of those things are necessary. And I think modern finance has had a really hard time dealing with qualitative factors, right? Because all this stuff is formula driven, and if you can't put it into numerical form, then, you know, I think modern analysts sort of just discard that, right? And Graham tells us, in security analysis, the qualitative factors can be just as important as quantitative factors. And I think having management that you can trust, and having a good business, a business with good fundamentals that's, you know, that's well run, even though they're not necessarily numerical, they're just as important to the decision-making process. This is what it protects us from the vagaries of the future, 

And certainly in a period where there's a lot of uncertainty, right? You've got economic uncertainty, you've got trade uncertainty, you've got you just have a lot of uncertainty, right? So knowing that you've sort of got that margin of safety built in the things that you are investing money into, it seems kind of critical. It's not the time to be running where everything's got to be exactly perfect in the plan.

And you know, Buffett has said that you should buy stocks that you wouldn't care if the market closes for five years, right? This shouldn't be the money that you're trying to spend. These are investments, and I think that daily liquidity has maybe served us poorly in the fact that now we think that markets derive their value from fluctuations in stock prices. It's how we measure everything. Right? All of modern portfolio theory is about trying to predict future stock price fluctuations, and that's why it's an impossible game, because those things are stochastic over time. In the short run, they could be random. And so, you know, you want to buy a business that's worth a billion dollars today, and it's going to be worth $2 billion in two years, and at any point over that period of time, that price could fluctuate from 250 million to 20 billion, right? But we were basing it on what it's worth, and we're trying to make that worth become higher, and when we would sell it is when the market's willing to pay us more than what it's worth, right? 

You don't have a crystal ball? No, I'd be in Vegas. Better crystal ball, right? It's probably on Amazon, probably with a tariff, yeah, it probably doesn't work attached to it. So, this kind of brings up interesting transition to another question that we got, which is, what's the place for private equity in a retirement portfolio? Or maybe just more broadly, what's the place for private equity? And the thing that got me thinking that might be a good one, you made the comment in there about the day to day pricing, right the mark to market nature of S&P 500 and publicly traded companies. So, you know, private equity, by definition, is something that's not publicly traded, right? So, you don't have some of that structural nature of being able to go and log into a website and see what the price of that is every minute of every day? Well, you can, but it doesn't change, right? Right? 

Well, it's like your house, right? Yeah, you don't know what it's worth at 9am in the morning one day, versus 10:30 the next day, right? So, you know, that is a question that comes up from investors from time to time, is, you know, why? Why do we invest in the public markets versus participating in the private equity markets? 

Sure, so if you go back to my previous statement about we're buying companies, not you know, not stocks, all private equity is a wrapper, right? It's an LLC instead of a corporation, and it buys companies that aren't publicly marketable. So, you're doing 100% or not. You're not always buying the entire company, but you're buying it from another entity, as opposed to buying it on an open market. And so, when you have pricing that isn't daily or intraday, like stocks, they lend themselves to using leverage, right? So you buy your house with 20% down. Well, I mean, you used to now I mean I think you can buy one with no money down, but the reason that you can do that is because the price doesn't fluctuate, right? If your house was marked every day like the stock market, you wouldn't be able to carry debt on it, because at some point the bank would say, hey, I want my money back, right? Well, private equity is the same way, their prices don't fluctuate on a daily basis. So, it lends itself more to using large amounts of leverage. The problem with leverage is that it magnifies returns regardless of direction. It magnifies your returns to the upside, and it magnifies your returns to the downside. But in investing, we have this thing called survivorship bias, and that is, we only look at the companies that are still around, right? We don't think about all the private equity funds that have folded over the years. We think about the survivors. And by definition, because they're using leverage, they have really high returns. You know, the institution started getting into private equity 30 years ago. And, you know, I think at one point, Yale's portfolio was like, you know, some ridiculous percentage private equity, like, 40%, they're actually starting to liquidate some of those positions. And you know, perfect timing now it's available to retail investors in their IRA account. So really, what's happening is the institutions are liquidating these companies they've been holding, and they're, you know, sort of dumping them off on it. 

They need buyers on the other side, right? So we'll invite random Joe in to head it to his IRA, 
 
 And you know, you got to remember when these foundation or endowment CIOs were evaluating private equity. First of all, it was a very underserved market. There were a lot of mom and pop shops out there to work with the big thing on finance Twitter right now is buying HVAC companies. Mm. Yeah, imagine the work involved in going to every small community and evaluating the HVAC company in order to try to create economies of scale and utilize leverage, you know, to get these independently operating businesses on one platform. And that's really what the big boosts from private equity came from. You know, in the mid-70s was really when the first time major private equity was used before that. I mean, I think 1946 or so, when all the troops were coming back from World War II, is when the first venture capital funds were started, because they wanted to take all this new labor force that was trained by the military and be able to deploy them. So, there were a couple of venture capital funds in the 40s that sort of capitalized on that. And then from the 80s until recently, when you have a highly leveraged vehicle like a limited partnership, and you have declining interest rates that drop from 16% to zero, that's a big tailwind, you know. So, I think that when this debt starts resetting at higher rates, you're going to see a big drag on private equity you have over the last two years, private equity has performed very poorly over the last couple of years, and you see that at big foundations, right? Big foundations overallocated to private equity, and now they're having trouble getting their money back. And that leads me to the main reason I would buy a portfolio of private equity based on the companies in it, right, just like I would buy a mutual fund or a stock. So, it's not private equity itself that I'm trying to avoid. It's the valuation of the companies. They're trading at very high multiples of EBITDA, they use leverage, which I can't control, and it violates my principal and liquidity, especially for a retired investor. So, for my average retirement portfolio, they're not going to have a big position in private equity due to liquidity constraints, due to the fact that once you're in it, you can't get out, at least in a stock if you end up being wrong on the on the direction you can change your mind. You can't really do that once you've committed to a private equity holding. And then the returns the way they calculate them. They calculate them based on the internal rate of return instead of the annual return. So, there are some weird math tricks that go on there that make the returns look a little bit higher than an actual investor would receive by being invested from point A to point B, right?

What would you say to somebody you know, you brought up foundations as a good example of this, that you know in recent years many of them have added a substantial portion of allocation into private equity. And, you know, obviously not withstanding the liquidity component of that, that hey, if I need the money out of that, I may not be able to get it right. May not be able to sell that right. Now, looking through at how those are held on balance sheets for foundations, since the prices aren't being marked every day, you don't really know the value of it, right? So, one of the challenges that comes in looking at private equity is held up really well compared to the volatility I'm seeing in the S&P 500, yeah, by design, by design. But the reality is, if you walked out and tried to sell that private equity stake, or tried to sell that underlying private company today, it may not be worth what it's currently showing on the statement.

It's worse than that, because people who are liquidating now might be getting inflated marks. So, let's say you've got a billion-dollar fund, and Yale endowment wants to take half their money out, and the last mark, you know, is a little stale. Now, they still try to market, I think, quarterly or sometimes monthly, but they're using valuation services. They're not using the market right? So, they don't go down as fast as market returns go down. So, let's say that your whole portfolio is really only worth 750 million if you're trying to liquidate it, but you're letting your investor out at what the last mark was. So, in this case, you've got someone taking 500 million out of a billion dollar fund, but it's really only worth 750 that means the remaining investors only have two 50 million left, so they've got a phantom loss of half their money that just sort of was vaporized off the off the balance sheet by allowing the institution to get out. So, you have to be one of the things I always pay very close attention to, is to make sure they have current pricing. Especially since we're usually large shareholders in our funds, we could be at a huge disadvantage if other people are getting out on assets that haven't been properly marked, and you could end up with nothing left at the end. So, I mean, I think it's a warning here that if big institutions start liquidating, you're going to want to make sure that those marks are current, because there's a lot of there's a lot of gamesmanship that goes on in marketing. Right? If you can have a $40 billion investment, but you do a billion-dollar capital raise, the whole price is based on what that billion dollar sold for, right? There's a lot of that going on in Silicon Valley a few years ago where, you know, you needed to get a bump on your private equity valuation. So, you did a real small capital raise. And, you know, the whole thing was adjusted based on that small capital raise, even though, if you really tried to sell that whole thing, you're getting, you know, a fraction of what it what it's showing. The balance sheet. And that even became a problem for some of the big mutual funds. Big mutual funds started tucking little private holdings onto their holdings list, and a lot of those were way overvalued, even, you know, even on the NAV calculation. And so, if you have shareholders taking their money out at nav, but you've got some assets that are 30% really below what the nav shows. You're basically transferring money from the remaining shareholders to the exiting shareholders.

And if you think about the broader context of this whole conversation, with all the uncertainty that's floating around, you're seeing the day-to-day price fluctuations as markets are trying to digest, what are things worth, right? And so, you're seeing that piece of it. You're also getting, you know, a lot of public disclosure in public markets about, you know, what internal management believes the impacts of tariff and trade policy or any other policy, for that tax policy, or anything may be on the profitability of that business, and, by extension, the value of that business. You don't have that transparency in the private equity space, exactly, and that's what your premium is for, right? You're getting a liquidity premium. The fact that you can't cash it in means you should get a higher return than something that you convert to cash today, and that's typically how the term structure of interest rates works, right? But I think it's more of a disadvantage, because I'm not trying to control volatility. If I were running a mean optimization and my number one goal was to reduce volatility, sure, I took a bunch of private equity in there. So, I think it's more the fundamental foundation of finance that's pushing asset allocators towards this asset class, because they can get a big bump up in their Sharpe ratio by having assets in there that aren't priced right. I think a lot of the easy money has already been wrung out. I mean, how many HVAC companies are out there for, you know, for someone to come along and actually, they've made sort of a bad reputation for themselves. I mean, people sort of get upset when their business gets bought out by private equity, because they know that someone's going to come in and try to ring out every last dollar and then resell it, right? So as an institution, I don't know that it's actually good for the, you know, for the economy itself. It's really more of an arbitrage situation where you're trying to find inefficiencies and you're trying to ring them out, or you're trying to combine multiple individual units into one and achieve economies of scale. You know, if your whole point is to build economies of scale by buying a bunch of independent locations and then putting them on a centralized software system, and now, you know, the unit cost per location goes down by 20% you know, there's only so much of that you can do in an economy. And I think that that's sort of, sort of run its course, right? 

So, awesome. Well, I think we kind of covered a lot of ground, yeah, so it's probably a good place to sort of draw this to a close. I think the big message that that folks should probably take out of this is, you know, and we say this a lot, it's ignore the noise, right? Try to focus in on what's real. There's going to be a lot of opinions. There's going to be a lot of changes in policy. The impacts may not be known for years, right? Right?

Yeah. And then also make sure that you're focusing on the things you can control. I think there's way too much focus on things that are completely out of our control, like stock market fluctuations. You know, there's this, there's this feeling, I think, that we should try to beat the market in every conceivable time period, no matter how you slice it. And that's just not what we're trying to do. We're trying to make sure that your money lasts for the rest of your life. Well beyond

that, that's impossible, right? There's never been anybody in the history of investing that's been able to outperform in every snippet of time, right? In every way?

Yeah, it's really more about the longer term, because hitting single scores runs, and there's way too much swinging for Grand Slams here, and there's not even any runners on the base. So, right, right, yeah.

And when you try to swing it, swing for grand slams, the strikeout ratio goes up exactly. And you know, most people, they just want to know that their money's there, that they can afford the things that they want to do and live out their life and leave some for their kids and take care of the people they love.

It would also be a mistake to think that we're not trying to get higher returns. We are. We're just trying to do it carefully, and we're doing it by protecting on the downside instead of trying to maximize volatility on the upside. And, you know, over time, avoiding mistakes will magnify your returns a lot more than you know, picking one out of 100 good stocks. So, it's really more about consistency. It's about portfolio management. It's about making sure that we have things that work in all environments, and continuously scoring, and it when you look at 10 or 15 or 20 years, you're actually better off than if you ride the volatility wave and probably with a lot less heart attacks along the way. 
 
 Yeah. I mean, I like to say we want to make it so people can eat well and sleep well. You know, a lot of people just choose the first one, right, right?

Perfect. Well, great discussion kind of covered a lot of ground there. So we really appreciate you taking the time to join us here on The Point again, we're always open to receiving questions, so if you're watching the news, reading headlines, nervous about something, reach out. Send us a submission through our website, basepointwealth.com talk to your Basepoint Wealth advisor, let them know, and we'll see if maybe it shows up on the list to talk about on a future episode. So, until next time, take care.

Thank you for joining us for this episode of The Point Podcast, sponsored by Basepoint Wealth, as always, you can submit questions or topics you'd like to hear discussed. To info@basepointwealth.com. Be sure to subscribe so you don't miss any future episodes. Basepoint Wealth LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to consult with a qualified financial advisor and or tax professional before implementing any strategy