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00:00It's actually easier to be a value investor, but because of this momentum changing,
00:05chasing, as you would say, and because of this euphoric feeling in a very, very narrow
00:14group of investments, it opens the opportunity set for value investors. Ultimately to us,
00:21as value investors, we believe a company's price should be determined by the cash flow
00:26which that business generates. Now, in markets like this, people don't care about cash flow.
00:32They don't care about earnings growth. They just care about, as the word you use, momentum,
00:37and the flavor of the day, the shiny new toy, as you said. And even though it's painful to miss this,
00:45when we do see a return to fundamentals, it will become quite rewarding. Because remember,
00:50as investors, we're buying financial assets. And those financial assets ultimately have to be
00:57tied to a cash flow stream. To your point, David, not only are they not rewarding cash flow,
01:03it's the tech giants that have pushed cash flow, free cash flow to the side, and are just getting
01:08rewarded for CapEx. The more you spend, it seems the more happy investors are. To you, how out of whack
01:14does that feel with fundamentals? And how painful, then, does it look when we do move back to
01:20fundamentals? You know, this is typical of a behavior of kind of a mania. What happens, you know,
01:26here's an example, optic fiber craze of, you know, to the early 2000s. Everyone was building capacity.
01:34Everyone wanted to the, you know, cable companies, the suppliers, everything involved with optic fiber.
01:40Three or four or five years later, you have massive oversupply. Why? Because everyone does
01:46the same thing at the same time. And Econ 100, we'd call it a massive shift to the supply curve
01:53to the right. Now, it's fun while it's happening. But when it's all said and done, when everything's
01:58all built, and you're operating at 30 or 40% of capacity, it's not so fun. And all of a sudden,
02:05earnings get stretched. And you'll see, even before this happens, the rotation of money
02:10out of some of these things. But right now, it's all fun and games. They're all building up.
02:14You know, the data center bubble is probably going to continue to get built. People are going to keep
02:22investing. People are going to want to have any involvement in any of these things that are tied
02:27to AI. And they'll buy first, and they'll worry about oversupply later. But the oversupply will come.
02:34That's what markets tell us. Because industry participants don't know how to put the brake on.
02:39If everyone is doing it, why can't we? If it feels good, do it. And that's what happens.
02:44As an investor, we have to look ahead. We have to be able to assess whether all this capital being
02:52spent is going to earn a return. So if you think of a billion dollars, in your mind, you should be
02:57thinking, where's the $100 million, $150 million that I'm going to get out of that billion that was
03:03spent? And I think right now, people are ignoring that. And they're just looking at
03:08the go, go, go momentum. And, you know, where the hot money is going. So again, not good for value
03:16investors at first. But eventually, everything comes back to the fundamentals.
03:21If I can play devil's advocate, because for those who are really bullish on this sector,
03:25David, what they would say is this is a transformational technology. And the potential for
03:30it, not just in the tech advancements, but the potential revenue coming in with the widespread
03:34adoption of AI is something that's even hard for us to wrap our tiny little human brains around.
03:40So maybe, therefore, the fundamentals, what you're pricing into the future is also hard
03:44to understand. And in the words of Mark Zuckerberg, it's better to overinvest
03:48than underinvest. Does that argument have any merit whatsoever?
03:51Well, clearly, it's very transformational. And we've gone through these. Look at the last couple
03:57hundred years. The railroads, transformational. Electricity, transformational. The automobile,
04:04transformational. The internet, transformational. All these things created step changes. Joseph
04:11Schumpeter called it creative destructionism. There's no doubt about it that what we're seeing
04:17today with artificial intelligence and advancements in technology will be transformational. However,
04:24that is the theme. Eventually, as an investor, you have to be able to make money out of it.
04:30How many railroads went bankrupt? How many electric utilities went bankrupt? Because what happened was
04:35you had oversupply, a very, very heavy foot on the investment pedal in narrow areas. And then when
04:42things begin to slow down, it's as if the tide goes down and all of a sudden the emperor has no clothes,
04:48absolutely transformational. And there will be winners. And there are companies that will be huge
04:53beneficiaries of this. And even industrial businesses or business services, all kinds of
04:59companies will have lower cost space as a result. And today they're not even being considered
05:05in this whole AI euphoria. Let's talk about where you can find the value. David, you are,
05:13of course, a prolific investor in Europe. And that's a bet that has paid off this year. Europe
05:19is still outperforming the U.S., but that gap has been closing. Can the outperformance continue
05:25through the rest of the year? Well, to be honest, a lot of this gap is due to a little bit of a rebound
05:30in the euro and the European currencies. The dollar's come off its all-time high. The dollar
05:36index, the DXY, I think, at 108, 109. And now it sits at 98.99. Don't forget, in 2014, this was in
05:44the mid-70s. So the dollar has really, since 2013, 2014, it has climbed very aggressively. And that has
05:53hurt the returns for U.S. investors and the foreign equities. And this is why, for such a long period of
06:00time, people said, well, why should I go overseas? Look, the S&P 500 has outperformed. So you've had
06:06this dollar headwind. You've also had a massive increase in the valuation differential between
06:13U.S. and foreign, specifically European equities. Traditionally, you see a 16% discount. Europe to
06:22the U.S. Today, I believe it's around a 35% discount. So this has manifested itself in a much
06:28higher P.E. of U.S. stocks, 25, 26 times. And actually, European stocks are now only at 13 or
06:3614 times. So you see this huge valuation differential that has also been a headwind,
06:43also been a headwind for the performance. This year, we're seeing a slight turn, just a slight
06:48turn. So I think we're in about the second or third inning of maybe a bit of a rebalancing.
06:54Investors are still very weary. They don't want to go outside the U.S. You know, U.S. exceptionalism.
07:00But I think with the currency turning and the earnings growth coming through in Europe that
07:05makes those valuation differentials even seem larger, it's still very worthwhile to get non-U.S.
07:12exposure. One needs to be diversified, especially when we see turns like this beginning to happen.
07:18There's always the individual company risk that something unforeseen happens. BNP, for example,
07:22David, has been a really good holding in your portfolio. It's been outperforming.
07:26It started to flatline. And then you had yesterday where shares plummeted off the back of this ruling
07:31over potential liable for its role in enabling genocide in Sudan. Does that make you rethink
07:38your holdings of BNP?
07:39You know, every stock you own at any given day. I mean, we had Reck and Binkheiser with, you know,
07:46the lawsuits in the U.S. We had Bayer and glyphosate lawsuits. You know, you could wake up
07:51any morning. And this actually was kind of a surprise because this seems to be very frivolous
07:56and it seems to be something that's going to be, you know, rapidly overturned. But, you know,
08:01absolutely, it's something you have to look at. And as a bottom-up stock picker, you are exposed to
08:07these types of events. And even, you know, when the no confidence vote happens in France and in
08:12one day the market's down six or seven percent. We went through a couple of those in the last year
08:17or so. But ultimately, what you have to do is analyze and see what these events, what these shocks
08:26have actually done to the underlying intrinsic value or the ability of the business to generate
08:32cash flow streams for its owners. And if the answer is it's had very little impact through
08:38time, then these types of things become a buying opportunity. Because even though the price moved
08:45quite dramatically, the fundamental change in value in many of these instances hasn't at all. It's
08:51maybe a little too early to examine B&P, but it sure looks like it sure looks like that the market
08:57way overdid that movement down yesterday in price. So David, you're not yet buying the dip in B&P or
09:04you are? Oh, we can never talk about our trading, but nice try. Worthy a try. David, how about this
09:11one? Just taking a step back and looking at financials in general, there is this concern
09:15that maybe we're starting to witness the turn of the credit cycle, that you have regional banks like
09:20Zion's, for example, Western Alliance, that are exposed to late cycle dynamics where underwriting has
09:27gotten lazy or certain things or maybe fraud has been overlooked. Should this be a real concern for
09:33equity investors? Are there the cockroaches still out there that you need to be wary of?
09:39I am a bit more concerned about what's happening in the private credit world because it's less
09:47regulated. There's less eyes on it. I think the banks, of course, have increased their underwriting
09:54standards since the financial crisis. Look at the capital on balance sheets for banks. I mean,
09:59we've gone from three or 4% to 10, 11, 12, 13%. Even if there are a few more losses, there is a much,
10:05much stronger capital buffer than existed pre-global financial crisis. In fact, one might even say in
10:13the case of commercial banks, many of them are still overcapitalized. So I'm less worried about that.
10:19But when you had so much money going into private credit, it becomes a theme of the day.
10:25You know, then the recipients of this money think, oh, we got to put it out. And maybe they become
10:31less picky on who they put it out or give it out to. So I'm less worried about the banks. And I guess
10:38I'd be a bit more worried about what's happening in the whole private credit environment. Having said all
10:44of that, the U.S. GDP is growing at 3% or has been. We're still at basically full employment.
10:53The consumer is generally healthy because we are at full employment. Of course, there are strands
11:00within the demographics that are less healthier. But we're not in a distressed consumer state. And
11:06don't forget the consumer is 66, 67% of GDP. So I think in order to get softness and the credit
11:13cycle, you need a much weaker consumer. And we just don't see that. And we don't really even see an
11:18overlovered consumer. So I think there will be spots. There will be more roaches. You know, as they say,
11:24when you see one, there's many. But I'm not so worried about the commercial banking system, given the
11:29state of the economy, the state of the consumer and their state of capital.
11:33Yeah, these earnings have been remarkable, whether it be GM or Coca-Cola. Today, the consumer is buying
11:37everything from trucks to sodas. David, I know that there are some private credit players who would
11:41definitely defend themselves and say it is not us. It is the banks. But if it is private credit,
11:46and you don't have the issues of deposits going wrong, there's not that risk within it.
11:51Is there a systematic risk? Could there be a wider spread impact if there are real concerns
11:56with private credit? I'm sure it will filter a little bit into the banking system. You will see
12:04a little bit of this. But you're exactly right. When you have a crisis is when the depositors
12:11worry about the financial institution, and they line up to take money out of the bank. Because
12:17remember, we have a fractional reserve banking system. As George Bailey would say, your money
12:22is in your neighbor's house. And so it's certainly less of a problem with private credit. And if we
12:36have a good visibility in their underwriting standards, and if they could demonstrate that
12:41as a result of the flood of money, they haven't loosened up their underwriting standards, and they're
12:46well covered, then it won't be a major problem. But I think that's the if. And the question is,
12:50do we have the visibility into their standards and to their loans, like we do with commercial
12:57banks that are often audited by state and federal agencies?
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