Preston Pysh  03:48

Stan Druckenmiller, when you hear an interview with him, he often will caveat something at the end when he says, “Well yeah, I have this opinion about gold today, but I might change my opinion 10 minutes from now.” I think that’s probably a better way to approach it if you would be talking to friends or families. 

It also goes to this consistency bias that you’re talking about where if you do say something and you change your mind, you just don’t feel too bad about it, because you’ve already caveated it, I guess.

Michael Batnick  04:19

This goes beyond investing but certainly with markets, people are loath to change their mind on an opinion that they had, right? It takes a very big person to say, “Hey, you know what, I was a little ignorant. I didn’t have all the information, or I simply changed my mind. That’s okay.” I think that’s like a really healthy thing, but it’s hard for most people to do.

Preston Pysh  04:40

I guess for me and you see this is so prevalent, how does a person overcome that? What can they do to start getting in the habit of being not scared to say those things?

Michael Batnick  04:56

I’m sorry, the question is, how do people change their mind? 

Preston Pysh  04:59

No, but how can people develop the habit to be more Buffett-like in the way that they approach their mistakes, because I think that’s what a lot of it is, of being able to change your mind in a public setting. I know your real point is just don’t talk about your picks, and like become an identity with you.  

However, if people would have a conversation about it, and they do want to say, or caveat with, “You know, this is my opinion today, but I could be dead wrong.” How does a person develop that, that sense of comfort to be able to discuss things and discuss their potential for being wrong?

Michael Batnick  05:31

It’s easy for Buffett to laugh about his mistakes with $80 billion in the bank. I don’t think anybody thinks he’s a dummy for making a few poor investments. However, for the rest of us, I think there’s two easy things that we can do: we can say, “Hey, I like this stock because of this reason, because of what they’re doing here. If that reason changes, then I would re-evaluate.” 

Or probably an even easier thing to do for the average investor is, “Hey, I like this stock at $80, but I don’t want to get married to it. If it goes below $70, then I will either sell half or exit entirely or reconsider.” 

Though I think that, especially for individual stocks, so asset classes mean revert. Individual stocks do not. JPMorgan did a great study showing that 40% I believe is the number, 40% of all stocks have had a catastrophic decline, meaning 70% drawdown from which they do not recover. So if you know that 4 out of 10 stocks are going to get annihilated, at least give yourself an exit strategy.

Stig Brodersen  06:35

Very interesting and a stat that I’ve never really seen before. One of the things I really liked in your book, Michael, was your story about Jesse Livermore, really an iconic figure on Wall Street. 

For those of us who are not too familiar with him, who is he in the first place and what can we learn from him and his mistakes?

Michael Batnick  06:58

He is the first person to make maybe not technical analysis but I guess that makes sense, studying the tape, following price. He is the first person to make that famous and he is one of the earliest, most successful traders… I guess the most successful there’s a big caveat there.  What he is known for primarily is he was so eloquent with words. He is probably the most quotable trader of all time. 

So every time he would make a mistake, he would journal it down. He would come away with this amazingly profound observation and just this beautiful slew of words for why he was foolish and why he won’t do it again, and some of the things that he learned. 

The irony is that he couldn’t even follow his own rules but he wrote the rule book: Don’t fight price. Don’t fight the trends.” All those sorts of things. He wrote the rulebook. In 1929, during the Great Depression, or when the great crash came, he was heavily shorted. He made, I think $100 million in actual dollars on inflation adjusted. Then he gave it all back over the next decade. Then when the securities exchange commission was enacted, and there were some laws involved, he could not adapt. He  ended up taking his own life, absolutely broke. 

He made and lost several fortunes along the way. If you read his words, and it’s just… there is an irony there that he is the most quoted trader of all time, and he cannot follow his own quotes.

Preston Pysh  08:33

I hate to backtrack on you a little bit but going back to when we were talking about Bill Ackman, there was a part in that section that was talking about Carl Icahn putting on a position. From what I’ve studied on Carl Icahn, he’s like this master chess player, always looks at things from like this chess standpoint. 

With Bill Ackman, he’s basically being a seller at pretty much any cost and you talk about this in the book. Do you think that Icahn’s play was purely because he knew what the other guy was going to do?

Michael Batnick  09:11

Yes. I haven’t read Scott Wapner’s book yet, “When the Wolves Bite.” I think about those two characters… I doubt that Carl Icahn even knows what Herbalife does, but I think that Bill Ackman was so publicly on a crusade that he was going to give the profits to charity, that he was going to go to the end of the world, whatever it took. Then Carl Icahn very shrewdly said, “Are you kidding me? Okay. Let’s do it.” I mean, obviously, if you’re managing that’s that type of money, 

I don’t see the appeal to be so public. I just don’t get it.

Preston Pysh  09:48

Yeah, no. Knowing some of the stuff that I’ve read about Carl Icahn, that seems like totally his play like, “Hey, let’s take advantage of this dummy. What’s he doing?”

Michael Batnick  10:00

Yeah, and he wasn’t the only one.

Preston Pysh  10:03

Yeah, I think you’re right. I think that he wasn’t the only one.

Michael Batnick  10:06

As a matter of fact, I believe that Dan Loeb did the same thing. I think even George Soros bought Herbalife.

Preston Pysh  10:14

Oh man.

Stig Brodersen  10:17

Michael, one of my favorite stories and perhaps the favorite story that you’re telling here, and that’s the story about Long Term Capital Management. We had Jim Rickards on the show multiple times. We also heard about his version of what happened with that company. He was the general counsel. It’s very interesting to hear your take and really how it debunks everything that you really talked about in academia. 

So what can we learn from this dreadful experience in the late 90s?

Michael Batnick  10:51

What happened with Long Term Capital Management is they were just a hedge fund composed of the best and brightest, multiple Nobel laureates. They had more brain power than the staff at MIT, I think was aligned, something like that.  

I said that avoiding talking publicly about your investments is one of the most common mistakes. I would say that the lessons that we can learn from the LTCM failure is nobody thinks they are below average intelligence, right? People that have the money to invest in the first place, it’s generally because they were successful in other walks of life. They’re doctors, they’re engineers, they’re educated people, and they think they’re smart and can beat the market. It is often the opposite.  

The irony of all of this is that if you just buy a global equity index fund and do literally nothing for the next 40 years, you’re probably going to beat the smartest people out there.  

One of the reasons why is because they are so smart and there’s so many of them. Their intelligence cancels out. It’s like LeBron James playing LeBron James every single night. There’s not a sustainable edge there.  

So these guys calculated the probability of everything, except the thing is that we need to remain humble because the past is just one example of what could have been. We haven’t seen all of the examples and potential outcomes in the market. Things are so random. You can’t treat the stock market like a physics experiment. There are too many variables to control for all of them.  

In LTCM’s case, the chart of their returns us up, up, up, up and then zero. Straight to zero. They got caught up in the Russian default to 1998. I think, at one point, there was a crazy stat in Roger Lowenstein’s book that I think I quoted but they were making more money at one point than McDonald’s or something like that. They were just printing money and then what happens is economics 101. 

They attracted competition, the spreads of what they were doing compressed. They needed more and more leverage. Then when it blew up, they got carried out real fast. 

So the lesson for the average investor reading that story is if these Nobel laureates, people that wrote the Black Scholes formula, if they got carried out, how could you not be humble?

Preston Pysh  13:22

Yeah, in their returns, I think the other thing that sucked in so much capital, when you talk about this in the book, is the amount of their returns when they first started were huge. I mean, 20-30% annually.

Michael Batnick  13:38

Not only were their returns huge, but their Sharpe ratio or their risk adjusted returns were off the charts because to their credit, they had found an inefficiency, and they exploited the heck out of it. Other people said… Companies like Goldman Sachs said, “Hey, wait a minute. That’s a good strategy.” Then Morgan Stanley said, “That’s a good strategy.” 

Then that’s what happens, the opportunity’s compressed and they piled on leverage and then kablooey.

Stig Brodersen  14:03

Well, having said that, Michael, I’m curious to hear what you think about Dalio’s Bridgewater Associates, and how they might be attracting competitors into what they do in risk parities.

Michael Batnick  14:17

I don’t think so because I don’t know how big all weather is, but I’m making this up, let’s call it $30 billion out of the $200 of something that they manage. It’s all in like stock futures, bond futures, and super deep liquid stuff. I’m not necessarily concerned that any replication of that sort of strategy is going to send tremors to the market.  

There was an experience like that, the Quant Quake in the summer of 2007, where all of these quants were doing the same thing and that potential for disruption in the short term. I mean, that certainly exists. It is not something that keeps me up at night but I wouldn’t be surprised if we had another August 2015 type moment at some point in the future. 

Preston Pysh  14:56

One of the figures that you talk about later in the book is a very interesting investor because it’s a venture capital play. You mentioned Chris Sacca. I didn’t see in your book that you talked anything about Chris when he first started off. I don’t know if people know this but when Chris was at Georgetown, I think he was in the hole a million dollars or a couple million bucks or something before he went to Google, which is just fascinating.   

I really liked how you laid out his four rules in the book. Talk to the people a little bit about Chris Sacca. Tell his story and some of the companies that he’s invested in and the stages that he invested. It’s fascinating. This is really an awesome story you put in here.

Michael Batnick  15:38

By all accounts, Chris Sacca had the single most successful venture capital fund ever. Everything that guy touched was gold. I think that his story is interesting because it’s so applicable to us.  

Let’s say you bought Apple a few years ago, you kick yourself for not owning more of it. I mean, there’s always something to distract you, to veer you off the path that you’re going down. His story is a great example of that. It’s not that he didn’t get the opportunity to invest in the following companies. He literally had the opportunity, got the pitch, and said, “Thanks, but no thanks for various reasons.” Dropbox, Snapchat, and Airbnb, three of the biggest unicorns that exist in unicorns are privately held companies that are valued at a billion dollars or more.  

The point is, you’re not going to bet 1000, you’re not going to be even close. There are going to always be things that you wish you invested in and the problem with this is that hindsight bias creeps in and it’s really hard to counteract that.  

It’s really obvious now that Amazon was destined to be this giant company, but of course it wasn’t. Of course, it really wasn’t, otherwise everybody would have bought it.  

The lessons with Chris Sacca is that even the most successful people will have regrets. That is just part of the game. One of the dangerous things about regret is that it paralyzes you and it sort of develops this like scar tissue in your brain and you can’t be objective going forward. 

This just goes back to the whole thing. People just underestimate how truly hard investing really is.

Stig Brodersen  17:22

Yeah, because specifically talking about Chris Sacca, it’s easy to talk about how he invested in Twitter. I think he owned 20% of that at some point in time. So a huge, huge success, but really what you’re getting at here is that that’s really his big misses, right? Dropbox. Snapchat. 

Talk to us more about those misses and really the key takeaways from that.

Michael Batnick  17:50

Dropbox, Airbnb and Snapchat. Like I said, three of the biggest, most successful private companies. It’s not that he got the app, he did have the opportunity. Each of these founders came to him and for various reasons… Dropbox, he said, “What are you kidding me? Google’s going to crush this.” 

Airbnb, he thought there would be murders in people’s homes. He said, “What sort of maniac would fund that sort of company?” Then Snapchat, he said, “Send pictures of expletives?” He’s able to laugh it off because his success so overwhelms the three misses.

Preston Pysh  18:29

I think self-awareness, just the fact that you’re talking about it is step one into something that some people just never realize how paralyzing that can be, by constantly going back and saying, “Oh, I missed this.” Then they feel like they have to make it up as they get their next opportunity. So they double down or triple down because they feel like they have to make up for that missed opportunity.

Michael Batnick  18:52

That’s exactly right. I think that the best investors, and a good example of this is Harry Markowitz, who basically I discovered modern finance. Somebody asked him, so what do you do with your money? His was the mean variance optimization framework for stocks, bonds, and different asset classes. 

He said, “I split it 50-50, 50% stocks and 50% bonds to minimize my regret.” If that’s good enough for Harry Markowitz, then something like that should be good enough for the rest of us.

Stig Brodersen  19:23

Interesting point. In your book, you talk about a lot of different failures, a lot of misses. Which failure was most profound for you? Perhaps, which one did you enjoy researching the most?

Michael Batnick  19:37

Probably Mark Twain. Man, that guy would be deadly with a Twitter account. He was an absolute genius and I don’t use that lightly with language. He made a mistake that is absolutely common with many people, and that is he got married to a really bad investment.  

It was something called a typesetter, which I guess was like pre-typewriters. There were 180 pieces of equipment and it was just totally complex. He just kept putting good money after bad. He doubled down until he was basically bankrupt. He was forced to literally go around the world on a stand-up comedy tour to repay his debts. Some of the lines that came as a result of his failures and investing are just absolutely gold.

Preston Pysh  20:38

I just want to read a quote from your book. This is a Mark Twain quote that you put in here that I think is just stellar. Here’s the quote: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”  

Wow, that is some powerful stuff, especially for investors because you see a lot of people out there that run around saying… Well, Bill Ackman is the perfect example. I mean, 100% sure Herbalife is a Ponzi scheme, you know what I mean? Then look where that got them. You have to have an appreciation for how wrong you can be sometimes. I just find that quote awesome. 

Michael Batnick  21:17

The funny thing about Twain is that it wasn’t just this one. This was one of a laundry list of examples. He was enamored with entrepreneurs and inventors, not just that but also with stocks. He had a terrible fear of missing out when there was an opportunity to be made in money. He ended up all right, but there are just some really fascinating stories about how awful of an investor he was. Think about the IQ of that guy. Again, it just goes to show that brains do not equal success.

Preston Pysh  21:48

I think you talked about it a little bit. It’s the process when you see a person who has a process that has worked for them and they continue to replicate that process over and over again. They typically see some of the best results. It reminds me of this story that Mohnish Pabrai told us when he was talking with Charlie Munger. 

Mohnish was saying that he was asking Charlie, “Why didn’t you guys consider this? Or why don’t you do this differently?” Charlie’s response to him was really profound. I distinctly remember this. He said, “Mohnish, that’s just not part of our process. That’s just not our process. It’s just not the way we do things.” 

So even though I think Charlie might have had an appreciation for how good the idea was, it was outside of their comfort zone. It wasn’t part of the thing that had worked for them for so many years. They just didn’t even consider it, which I found quite fascinating.

Michael Batnick  22:39

A lot of investors have gotten absolutely blown to smithereens that way. Michael Steinhardt in the book is an example of that. When he tried to do the macro thing in foreign countries, he got blown up.  I think it’s very important for skilled investors to stay in their lane. For the rest of us, maybe don’t even don’t even try to compete with these people. It is not just not a winning proposition.

Stig Brodersen  23:04

Of all the failures that you studied, what can a newbie really take away from this? Say that you’re in college or you just graduated, and perhaps you do not have a big portfolio just yet, but you would really like to go into the field of stock investing? What can we learn from the very best investor? Which kind of story could you highlight to the novice investor here?

Michael Batnick  23:29

The future does not have to look like the past. I think that people rely way too much on history. I think the best and I study a ton of history, because I think I find it fascinating, but the most important lesson that I learned from history is that none of the outcomes was preordained. None of what happened was obvious to anyone at the time. So we could look back at charts at whatever, but a lot of truth gets lost in a chart.  

To go back and to read Benjamin Roth’s diary of the Great Depression, or John Brooks’ book, “The Go-Go Years,” it just gives you an appreciation of what was actually happening at the time. Don’t rely too much on history to lead you forward.

Preston Pysh  24:08

Well, I’m curious because you’re a heavy reader. I like on your Twitter account how you said you’re a long-distance reader. I love that statement. That’s pretty cool. So out of all the books that you’ve read, what book would you say has had one of the biggest impacts on your investing approach or just kind of has shaped you? If you want to throw out more than one, go ahead.

Michael Batnick  24:33

Oh, this is tricky. I’ve had a long journey. I think that a lot of these books, it’s just sort of like compound interest. It’s not one book that did it. It’s just over time. So as just a quick example of that, I believe the first book that I read was “The Intelligent Investor.” 

I was so enamored with the whole Mr. Market thing. I remember reading it to my mother because I was so excited. I said, “Oh, it was like a light bulb. This is so incredible.”  I was enamored with valuations and fundamental analysis, and then I tried doing basic work, and that didn’t work. 

Then, I read “Reminiscences of a Stock Operator” by Jesse Livermore, and it was another light bulb, “I’m going to be the next Paul Tudor Jones. This is so easy, just be patient. Don’t fight the trend and all the sort of things.” So it was really just a long, long, long evolution. 

I would say that probably my favorite investment book is the “Money Game” by Adam Smith, which was written in 1968, I believe. By the way, his name is George Goodman. It was the pseudonymous, Adam Smith. It was written in 1968 and that could have been written today. He was such a wordsmith. 

It was so funny and some of the observations that he made on the human nature of investing are just hilarious so that if I had to recommend just one, maybe not to start with but if you have, if you’re already a seasoned investor, I would say, I definitely recommend it. Definitely, pick that one up.

Preston Pysh  25:56

Well, Michael, thank you so much for coming on the show. The name of the book is “Big Mistakes: The Best Investors and Their Worst Investments.”  Michael, if people want to learn more about you, give them a hand off so that they know where to go.

Michael Batnick  26:10

Sure. So it’s not that hard to find me. I have a blog: MichaelBatnick.com. I do a podcast every week with my friend and partner, Ben Carlson, called “Animal Spirits” where we discuss a dozen topics that are going. Not so much the trading stuff, but just, “Hey, what’s happening in the market, in the world?” Then we shoot the breeze. That’s where you can find me.

Preston Pysh  26:30

Awesome. Thank you so much for coming on the show today, Michael.

Michael Batnick  26:34

Yeah, my pleasure. Thank you so much for having me.

Preston Pysh  26:36

All right. So this is the point in the show where we play a question from the audience. This question comes from Spencer.

Spencer  26:42

Hey, Preston and Stig. My name is Spencer Point. I’m 18 years old, and I’m from Ontario, Canada. I just want to let you guys know that I listen to your show every week and you guys are really the ones who introduced me to investing. So thank you! Keep up the great work.  

My question this week is do you think value investing in the principles taught by Ben Graham and made famous by Warren Buffett are still effective in today’s society, not in the sense of current market conditions rather in the general sense, in the sense that the number of Graham and Dodgeville type investors has grown so much? 

Do you think that the increasing number of value investors has affected the overall efficiency of the market? I guess my question, in essence is, is it still possible to find Buffett type investments even in a down market? 

Thanks, and I hope to hear from you guys.

Preston Pysh  27:30

So Spencer, my personal opinion, is yes.  There’s a ton of value investors out there, but I think there’s still a lot of speculators out there. I would say that the speculators are on par or at parity with the value investors and maybe more than the value investors.  

The other type of investor that I think has come into the fold, especially in this last credit cycle are the ETF investors. I think that if you were going to look at how many people out there are investing just through straight ETFs and not really doing anything beyond that. I think the number would be staggering. I wish I knew what it was, but my expectation is that it would be very, very high.  

So considering that you have those other market participants, I think that yes, there are people out there that can still implement a value based approach. And the last, I don’t know the exact stat. I know The Wall Street Journal came out with something showing how poorly value has performed in the last 10 years relative to other strategies. I think that that’s another reason why value investing might work really well moving forward into the next cycle.

Stig Brodersen  28:38

I’ll definitely say that markets tend to become more efficient as they mature. I think even Buffett mentioned that in more of the Berkshire episode that we released not too long ago, that was when he was talking about investing in China.  

Efficient hearing means mispriced and to its extent, it is mispriced. For instance, when Buffett started out his investing career, there was no cash flow statement, so he made his own cash flow statements for the companies you’re looking at. He would cross the market and he could invest into strong cash flows that no one really saw out there, which is, for obvious reasons, harder to do today.  

But I agree with Preston in the sense that there will always be value to gain. I mean, more than anything you need to understand what you’re investing in. That’s also why inefficient does not mean that it’s a good market.  

Buffett was asked [if he] would invest in China, and he said no, because I don’t know anything about China. He will still invest in the US and that’s not because China might or might not be cheap. It’s because there was not his circle of competence.  Another reason is that even among value investors, they value stocks differently. 

So what is an undervalued stock to me is not necessarily undervalued stock to you.  Then there is this… Let’s call it systemic inefficient one way or the other, you have your active management who can invest for the long run. They might say so but as we also talked about a few times here on the show, they make two thirds of the money on fees and underperformance.  

Then, more than anything, they would need to be good with marketing, and continue to invest in stocks that do not look too ugly, which value stocks tend to do. Then you have the thing with indexing which Preston briefly mentioned before. 

At least the way it looks like is that all the indexing will give you more volatility, say it might give you a flash crash. I mean, there’s still value to gain, but perhaps not as much as in the past, but I still think there’s a lot of value if you’re willing to gain.

Preston Pysh  30:52

Alright, so Spencer, thank you so much for asking such a great question. Thanks so much for listening to the show. As a token of our opinion, we’re going to give you a free subscription to our Intrinsic Value course. This is a paid course that Stig and I created inside of our TIP Academy and we’re going to give it to you completely for free for calling in and asking such a great question.  

If anybody else out there is listening to this and you want to ask a question and potentially get it played on the show, go to asktheinvestors.com and you can record your question there.

Stig Brodersen  31:21

Alright, guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro  31:29

Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. 

This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.