Charlie Munger: We Are In A Stock Market Bubble

Do you agree that there is a close parallel to the late 90s and this therefore quote must end badly? Yes, I think it must end badly, but I don't know when.

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All right guys, welcome back to the channel. In this video, we are doing yet another Charlie Munger video. And again, we're going to be focusing in on the two-hour Q&A session that he recently held for Daily Journal shareholders. Now, I have already made one video on this, but I limited that video to all of the GameStop-related content from that meeting. He did have a lot to talk about when it came to GameStop. If you're interested, link's coming up to that video.

But in this video, what we're going to be focusing on is all those other investing nuggets that he left in that Q&A session. And we're going to be talking about Charlie Munger's thoughts on whether the stock market in 2021 is a bubble and how we should be navigating it. So let's get stuck straight into it.

This first clip I wanted to show is right at the start of the Q&A session, and it's Charlie Munger getting asked on why he believed the Daily Journal shares spiked up so dramatically in 2020. Let's have a listen.

"In this year's annual letter, you mentioned the share price increase was driven by speculative frenzy and forced index buying. I would imagine that applies to the broad market too. What are the psychological implications of this type of market behavior? What could investors do to cope better with periodical frenziness?"

"Well, these things do happen in the market economy. You get crazy booms. Remember the dot-com boom, when every little building in Silicon Valley rented at a huge price, and a few months later, about a third of them were vacant? There are these periods in capitalism, and I've been around for a long time. My policy has always been to just ride them out. I think that's what shareholders do. In fact, what shareholders actually do is a lot of them crowd into buying stocks on frenzy, frequently on credit, because they see that they're going up. And of course, that's a very dangerous way to invest."

"I think that shareholders should be more sensible and not crowd into stocks and just buy them just because they're going up, and they like to gamble."

So in this first clip, Charlie Munger talks about the two main factors as to the large increase in the stock price of the Daily Journal. Now, for context, last year the shares went from a March low of $214 to a year-end high of $404 per share, so up 88% in less than a year. And Charlie puts this down to two main reasons: forced index fund buying and also crazy speculative frenzy.

Firstly, talking about forced index buying. This is where the shares of a business get bought in large quantities simply because they are dragged up in an index. And of course, there are a lot of ETFs and index funds which have to abide by their investing objectives and therefore buy the shares of that business. Now, we all know that in recent years, there's been an incredible rise to the popularity of passive investing. Passive investing is, of course, staying widely diversified, using investment vehicles like ETFs or index funds tracking a particular index and continuing to invest in that index over or in that investment vehicle which tracks the index for a very long period of time. So that, in a long period of time, you average out to the average annual return of that index.

So because this has gotten so popular, there's more and more money going towards passive investing. So any business that is caught up in any particular index is going to have a lot of index funds and ETFs buying their shares, which adds to the buying pressure, which pulls the share price up. In a funny old way, a lot of the times passive investing is kind of like a self-fulfilling prophecy.

But that's the first reason. That's what he's talking about when he's talking about forced index buying dragging the Daily Journal share price up. And then, of course, the second reason he describes why the Daily Journal share price went up is because of this crazy speculative frenzy that we're currently seeing in the market. This is something he focuses on a lot in this whole Q&A session. I mean, he's drawing similarities between the dot-com bubble and where we are today.

There's no doubt Charlie Munger definitely thinks that we are in this period of stock market euphoria, of heightened speculation where a lot of investors, new investors particularly, are just getting in and treating the stock market like a casino. They are just gambling their money away in the stock market, right? They are buying stocks not because they present great investment opportunities where you're buying the shares for less than what they are worth. No, no, nothing like that. They're just buying the shares because the shares are going up.

And clearly, periods like this are pretty dangerous for investors. And Charlie's advice here, he basically says, you know, he's been around for long enough that he's seen these situations happen before, and his policy is always just to ride these situations out. Don't get sucked in and just stay rational.

Many observers see market behavior that reminds them of the dot-com bubble: wild speculation, endless facts, and IPOs soaring on their first day of trading. Do you agree that there is a close parallel to the late 90s? And this therefore quote must end badly.

"Yes, I think it must end badly, but I don't know when."

There you go, there's the Charlie Munger we know and love: short and sharp! So this kind of builds on what we're talking about before. There's no doubt Charlie Munger believes we are in some sort of bubble. But it's important to remember nobody knows when that bubble is going to end. Nobody has that crystal ball, regardless of how expensive their course might be. Nobody can actually tell you when this stock market bubble is going to end.

Like you could have been sitting in 2005 thinking that the American housing market was a bubble, as Michael Burry did, but it still took another two and a half years before that bubble popped. So you can't predict when these bubbles are going to burst.

So the best policy is to not let it affect your investing. I mean, if you're a passive investor, well, if you're a passive investor, you only have one gear, and that's buy. And as per your dollar-cost averaging plan, you just keep showing up regardless of what the market is doing.

But even if you're an active investor, still don't worry about where the market is or how expensive the market is or how much of a bubble we're in. As an active investor, we should just be solely focused on our own circle of competence, on those five or six companies that we feel like we've got an edge on.

We study those in depth, and we just stay patient, and we only buy the shares of those high-quality businesses when we can get them at a margin of safety price, at a discount to intrinsic value.

So long story short, yes, we probably are in a bubble. However, as Charlie says, you don't know when that bubble's going to end. So don't let that have an impact on your investing.

It seems like everyone, including actors, athletes, singers, and politicians, are getting into the business of promoting their own SPACs. What do you think of all of the SPACs and the promoters pushing them?

"Well, I don't participate at all, and I think the world would be better off without them. I think this kind of crazy speculation in enterprises not even found or picked out yet is a sign of an irritating bubble. It's just that the investment banking profession will sell as long as it can be sold."

I find this to be a really interesting clip because we've definitely seen the rise of SPACs in recent times. I think SPAC stands for special purpose acquisition company, but it's essentially where an investor forms a shell company, and the idea is that investors buy the shares of that publicly listed shell company that doesn't actually do anything by itself.

The purpose of that company is that it will then use investors' money to acquire a private company. So it's essentially a way of bringing a private company onto the public markets but not through the traditional IPO process.

Now, what's really interesting about SPACs is that a lot of the time investors don't actually know what that SPAC is going to end up trying to acquire. I actually pulled this straight from the Investopedia page on special purpose acquisition companies. It says, "In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don't identify that target to avoid extensive disclosures during the IPO process." This is why they're called blank check companies.

IPO investors have no idea what company they ultimately will be investing in. As you can imagine, someone like Charlie Munger is going to have absolutely no interest in something like a SPAC. It's important to remember that it's when you see this kind of opportunistic money-making, whether it be through SPACs coming up and online, whether it be through record numbers of IPOs, or extensive capital raising by established companies, that's often a very good sign that you are in the height of the market, that you're in bubble territory.

Because you have to remember that people that are managing these companies are trying to get the best bang for their bucks. So if they're selling shares to the public for the first time or if they're an established company that just wants to capital raise and sell a bunch more shares, then they want to pick the best times to do that.

They want to pick the times where investors in general are just hungry for any sort of shares they can get their hands on. Right? These managers want to bring their companies online when they can sell their shares for the highest amount possible.

And that's what we've been seeing, you know, a massive increase in things like special purpose acquisition companies, a massive increase in recent IPOs, a massive increase in just normal capital raising too, while a lot of companies' share prices are really, really high.

And to be perfectly honest, I am not surprised in the slightest that Charlie Munger just steers well clear of all of this.

Previously you have said, "It takes character to sit with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities." In the past few years, equity prices have increased significantly, and cash has arguably become riskier due to central banking policy. Have you considered amending this quote or lowering your standards?

"Well, I think everybody is willing to hold stocks at higher price earnings multiples when interest rates are as low as they are now. And so, I don't think it's necessarily crazy that good companies sell at way higher multiples than they used to. On the other hand, as you say, I didn't get rich by buying stocks at high price earnings multiples in the midst of crazy speculative booms. I'm not going to change."

"I am more willing to hold stocks at high multiples than I would be if interest rates were a lot lower. Everybody is."

So there you go. It's not surprising that good companies are selling for much higher multiples than they used to because of this very low interest rate environment. However, as Charlie was saying, he didn't get rich by buying great companies at expensive valuations.

No, no, he got rich, obviously, by finding great companies and waiting patiently until he could buy the shares at very undervalued prices. So what he's kind of saying here is that it's easier to hold on to the investments you've already made in this very low interest rate environment while all of our investments are seemingly very overvalued. It's easier for us to hold on during these times.

Because at the moment, like savers are losers. Like the people holding cash are the people that are in strife. However, that doesn't necessarily mean if you're holding cash you should just try to flood that into the market during these crazy speculative times where everything's really overvalued. Because as Charlie Munger said, that's not how he got rich.

So you still, as an active investor, have to have your wits about you. Right? You have to find those businesses. You have to just be solely focused on finding businesses that you understand, that are high quality, that have the competitive advantage of the management team to push them through.

And you do have to have that rational thinking to wait until you can buy them at a fair value or, better yet, at an undervalued share price.

All right, let's move on into this last clip. And the last clip is a nice one. It serves as a little bit of reassurance for us value investors who are trying to do the right thing and stay rational and stay patient but are unfortunately seeing the market just get stupider and stupider by the day.

Do you think value investing is still relevant in a GDP decreasing world? And what about passive investing?

"Well, that is easy. Value investing the way I regard it will never go out of style. Because value investing, the way I conceive it, is always wanting to get more value than you pay for when you buy a stock. And that approach will never go out of style."

"Some people think that value investing is you chase companies which have a lot of cash and they're a lousy business or something, but I don't define that as value investing. I think all good investing is value investing. It's just that some people look for values in strong companies, and some look for values in weak companies. But every value investor tries to get more value than he pays for."

"What is interesting is that in wealth management, a lot of people think that if they have a hundred stocks, they're investing more professionally than they are if they have four or five. I regard this as insanity, absolute insanity. I find it much easier to find four or five investments where I have a pretty reasonable chance of being right that they're way above average. I think it's much easier to find five than it is to find a hundred."

"I think the people who argue for all this diversification, by the way, I call it divorcification, and which I copied from somebody. And I'm way more comfortable owning two or three stocks which I think I know something about and where I think I have an advantage."

So, don't worry team, value investing definitely still works. It can't go out of style because at the end of the day, it's just the practice of trying to get more value than what you pay for. So let's stay rational, let's stay patient, let's continue to find those businesses that are smack bang in our circle of competence, that we can understand, that have moats, that have great management teams, and let's stay rational and stay patient and only buy the shares when we can get them at a discount to intrinsic value, at a margin of safety price.

Let's follow in the footsteps of people like Charlie Munger, people like Warren Buffett, that have followed that strategy in the highest of high markets and the lowest of low markets. Continuing to follow that super rational strategy has made them some of, well, in Warren Buffett's case, the best investor in the whole world.

So let's stay rational, let's follow the advice of people like Charlie Munger and Warren Buffett and just trust the process. Right? It's obviously very difficult at times like this when the market's just way up here. You look at great businesses, you might find, you know, a Facebook or a Google, and you want to buy the shares, but the shares are just here, and your valuation, your fair price is like here, and you imagine the safety price is somewhere through the floor.

So we just got to stay rational, keep a clear head and act accordingly. Anyway, I hope you enjoyed those clips from the Q&A discussion, the Q&A section of the Daily Journal shareholder meeting. If you enjoyed the video, leave a like on it. It takes me a long time to sift through all of these videos or all of these clips and actually put it into some concise format for you guys to consume.

So if you enjoyed it, please leave a like on the video. And of course, if you want to learn about Charlie Munger's investing strategy, Warren Buffett's investing strategy, that value investing strategy that they talk about, then check out Profitful. Links are in the description down below. That'll take you over. You want to check out Introduction to Stock Analysis? That's the real meat! So check out that course if you're interested. And of course, it definitely helps out the channel as well, so I appreciate it.

But that'll do me for today, guys. Hope you enjoyed it. Subscribe to the channel for more content similar to this, and I'll see you guys in the next video.

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