One of The Biggest Economic Changes We'll Ever See -> 2023

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Estimated read time: 7 minutes 36 seconds

1. 10x'ing Your Financial Literacy in 2023

2. One of The Biggest Economic Changes We’ll Ever See -> 2023

Good morning and happy Monday - let's get smarter

10x'ing Your Financial Literacy in 2023

In March of 2020, COVID hit the US and financials markets were obliterated

YEARS of gains erased in a few hours

I was absolutely pissed, I did what every book, course, person said to do

Own the S&P 500 ETF and get what the market gives you

From that moment on, I spent countless dollars and hours on market research and taking my financial literacy to a new level

Being a "finance guy", I had to get over the fear of not knowing things and google, watch YouTube videos, and learn, just like everyone else - no fear no shame

I spent the next 2 years learning as much as possible about finance - to take it to the next level

My biggest conclusion was: 99% of the books, courses, CNBC shows, are pure trash

Not only is the investment advice garbage, but you don't gain knowledge, which is even worse

They don’t discuss macro data, they don’t discuss how to read a balance sheet

If you follower Jim Cramer, you might not want to open your TD Ameritrade account

I made a goal in 2022 to share everything I know now and everything I learn

When I say finance, I mean it broadly

When I say “finance” I mean understanding things such as:

1. Financial statements

2. Accounting

3. Debt

4. M&A

5. Markets

Finance people do this thing where they use big words to make things seem complex - but it’s not

Example of a Non-Complex Term Finance People Made Complex

During the Great Financial Crisis of 2008, there was an investment vehicle that banks were selling called CDO, Collateralized Debt Obligations, that caused a lot of the financial ruin for banks

Sounds complex right?

What is a CDO? A package of really shitty mortgages balled up into an asset that you could buy, like buying an ETF

The banks made money selling these balls of shit to people like you and I

What makes it worse?

Moody’s and Standard and Poor are credit rating agencies and their job is to evaluate these assets and rate the creditworthiness of this debt obligation

It’s like their credit score

They determined that although these CDO were just a bunch of subprime (aka dog shit) mortgages that people like couldn’t pay, because there were lots of them it was diversified and gave this asset a very safe rating of AAA

Debt obligations rated AAA are “judged to be of the highest quality, with minimal risk”

In other words, if you bought these CDO assets, it was determined to be very safe with huge returns (what a win!)

But you were really buying a package of Bill and Susie and Fred’s mortgages on their 5th and 6th house that they couldn’t afford

And big shocker - the house of cards collapsed when the people with these mortgages couldn't pay them, and then these assets fell apart

My point? Collateralized Debt Obligations sounds scary and complex

But now you know it was dog shit mortgages packaged together and sold by banks as an investment vehicle just like the S&P 500 ETF

Much more simple right?

They WANT it to be sound complex and scary so you won’t bother to ask questions and dig

Here is a clip from The Big Short of Selene Gomez explaining in basic terms mortgage-backed securities, not complex:

Or the term in private equity “Leveraged Buyout” or LBO

What's a Leveraged Buyout?

Using a combination of debt (the banks money) and equity (my money) to buy an asset/business

Financial literacy is a super power

Asking why, googling terms, sounding dumb is a super power

The only thing dumb you can do is NOT ask

My goal for 2023 is try and 10x everyone's financial literacy along with mine

One of The Biggest Economic Changes We’ll Ever See -> 2023

People hate being told they were lucky

It implies that they weren’t smart or skilled but that the universe just worked their way / a ball bounced in their favor

Warren Buffett talks about being lucky in what he called “the ovarian lottery”– the random accident of why you were born with one time, place, and identity rather than another

If you and I aren’t lucky, then explain to me what we did to be born with our IQ?

Nothing - we did nothing

If you were born with a high IQ, you hit the ovarian lottery and were lucky

And there isn’t a damn thing wrong with that

If you have been alive for some part of the past 40 years, then you have been LUCKY to be a part of a 40 year period where interest rates declined

My favorite investor of all time Howard Marks mentions how in 1980, the interest on a loan would have been 22.25%, four decades later it would have been 2.25%

Think about that in terms of % decline -> a decline in interest rates 89.89%

So why were we lucky?

Here are some of the economic impacts of declining interest rates:

1. It helps accelerate economic (GDP) growth by making it cheaper to borrow to buy goods and services or for companies to hire new employees, purchase new factories -> increase productivity and grow

2. The cost of borrowing goes down which increases profitability of businesses

   1. Interest expense goes down, net income goes up

3. The value of an asset = it’s future cash flows discounted back to today (time value of money)

   1. If the discount rate/interest rate falls, the present value of those cash flows goes up, so the asset value goes up (see below)

4. If the value of your assets (real estate, businesses, house) are all going up with interest rates going down, you feel wealthier

As the discount rate decreases, the PV of the cash flows increases, increasing the value of the asset

An example from Howard Marks

I buy an asset (company, property) for $100 and can generate a 10% return on it

I want to borrow 75% ($75) from the bank to pay for it -> I determine my cost of capital (or my cost of the money I am borrowing to buy the asset) is 8%

8% cost is < 10% return -> Let’s do it!

The power of a leveraged buyout: Using 75% debt with a cost of capital of 8% to generate a 10% return would generate me a levered return (return using $75 of debt rather than $100 of my own money) = 16%

Now if my debt has a floating interest rate (variable) and goes from 8% to 7%

My levered return goes from 16% to 19%

You see the power of declining interest rates?

I did nothing with the asset or the business, yet a 1% decline in interest rates on my $75 of borrowed money to buy my asset increased my return 3%

So now think what happens if this starts to go the other way for investors?

Think about all of those bullets points above about the impacts of low interest rates and now think about what happens if they start moving the opposite way?

The zero interest rate, fear or loss, take on risk environment is starting to shift

A recession in 2023 (Q1-Q3) is the highest probability outcome

The federal reserve’s ability to combat inflation through raising interest rates will determine how deep this recession is

But the important thing to understand is that it’s unlikely the next 40 years will have 0-2% interest rates

Per Howard Marks: The overall period from 2009 through 2021 (with the exception of a few months in 2020) was one in which optimism prevailed among investors and worry was minimal. Low inflation allowed central bankers to maintain generous monetary policies. These were golden times for corporations and asset owners thanks to good economic growth, cheap and easily accessible capital, and freedom from distress. This was an asset owner’s market and a borrower’s market. With the risk-free rate at zero, fear of loss absent, and people eager to make risky investments, it was a frustrating period for lenders and bargain hunters.

This will be a time period where most of us will have to un-learn a lot that we learned about investing/allocating our capital during the end of covid, 0% interest rate, crypto and SPAC boom

The positive side is finding undervalued assets, bargains, or deals will come back as asset prices fall as Marks mentioned

Change is good, but it will be very good for those who are prepared

Those who have cash, who have financial literacy to spot great deals, and to capitalize on them

Follow people on Twitter or read blogs from people who have thrived during recessions like 2008

People who are great at multi-family real estate, or stocks or bonds or buying businesses

Trust people who have done it before in the arena you want to be in

Trust people who are willing to show you their wins AND their losses

Just because Bob is smart at real estate doesn’t make him in an expert on stocks

Intellectual brilliance is no guarantee against being dead wrong - Carl Sagan

With all of that - I continue my goal from 2022 into 2023

Democratize HIGH quality / better financial information that is driven by data and math over feelings and emotions

If the damn data says GDP is slowing and there's a recession, the data doesn’t give a damn about your feelings or opinions -> it's just math

So how am I preparing for 2023 based on the data?

Heavy cash, buying the US Dollar ($UUP), investing in businesses, buying ETFs that outperform during recessions like consumer staples and utilities

Buying Gold ($GLD) and likely soon buying bonds ($TLT)

Avoiding crypto, SPACs, high risk assets, like TSLA (companies that don't make money)

Cheers to 2023

Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.