Nov 17, 2022 • 51M

Vitaliy Katsenelson on Real Estate, Real Value and having "Soul in the Game"

Plus his journey from Russia to the US, how he got into Stoic philosophy and plenty more...

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A podcast about mobs, markets and manias. Each week, Joel Bowman sits down with a member of Bill Bonner's private research team to discuss the pressing issues of the day. From high finance to lowly politics, irrational markets and international real estate, great wine and classical books, nothing is off the table in these freewheeling discussions. New episodes every Sunday.
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Welcome to Episode #77 of the Fatal Conceits Podcast... 

In today’s conversation, I’m joined by author, value investor, student of life and editor of the popular ContrarianEdge newsletter, Mr. Vitaliy Katsenelson. 

I’ve been reading Vitaliy’s work, on and off, for over a decade now. In fact, we used to publish his columns and market insights occasionally in The Daily Reckoning, a publication I managed for Bill Bonner back in the 2000s, in what seems like another lifetime...

Vitaliy describes himself as “Born in Russia, Made in America,” a distinction we talk about during our conversation. He’s also a professor of finance, CEO of Investment Management Associates and a keen world traveler. 

Over the course of an hour or so, I asked Vitaliy about his insights into the beleaguered American housing market, what the Fed hath wrought for the US economy at large, the challenges facing bottom up value investors like himself and where to for stock markets over the short and medium term. 

We also talk about his newly published book, Soul in the Game - The Art and Meaning of Life.

Please enjoy - and share! - my conversation with Vitaliy Katsenelson, below...

Cheers,

Joel Bowman

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TRANSCRIPT:

Joel Bowman:
All right, well, welcome back to another episode of the Fatal Conceits podcast, dear listener. If you've not already done so, please head over to our Substack page. You can find us at BonnerPrivateResearch.Substack.com, where we have hundreds of articles, research reports, and many more conversations just like this on the Fatal Conceits podcast tab at the top of the page, where we talk about everything from high finance to lowly politics and everything in between.

It is my pleasure today to welcome a gentleman to the show whose work I've been reading on and off for years, and as we were just talking about before we pressed record here, our email correspondence has gone back over a decade, so it'll be great to connect again. Vitaliy Katsenelson is the author of Contrarian Edge. Head over to his website there. He's got plenty of excellent material, mostly about investing, but a few life lessons in there, some political musings, lots of travel stuff. He's also the author of two investing books, Active Value Investing, and the Little Book of Sideways Markets, and most recently, a book that I hope we get to chat about today, Soul in the Game: The Art of a Meaningful Life.

So, first of all, Vitaliy, welcome to the Fatal Conceits podcast. I feel like it's long overdue.

Vitaliy Katsenelson:
I know, Joel, it's a pleasure. Thank you. We're looking forward to it.

Joel Bowman:
Outstanding. And as we were also just mentioning, if this background looks familiar, you were recently on a podcast with Anya Leonard, who runs the Classical Wisdom website. We sit about 10 feet away from each other. Being husband and wife, we share a home office, so if this is a little bit of deja vu...

Vitaliy Katsenelson:
Absolutely. Yeah. No, that's still there.

Joel Bowman:
All right, so there's lots of stuff I want to get to, Vitaliy. You covered such a wide breadth of subject matter in your musings, and again, people should head over to Contrarian Edge to check out your work there. But for readers who are just coming upon your work for the first time, I think they might be interested just in a bit of a Vitaliy origin story, because it's a very interesting one. You put it as “Born in Russia, Made in America,” which I thought was a very entertaining juxtaposition. How did you make that journey and come to that distinction?

Vitaliy Katsenelson:
Yeah, so today I live in Denver, and I have a wife and three kids, and I run a value investment firm, IMA, and I also write, and I wrote several books, but I write articles all the time. And by the way, we have a Substack as well, so you can just look for my name on Substack. You can subscribe to the articles.

Joel Bowman:
I'll put all the links to these links in the transcript.

Vitaliy Katsenelson:
Perfect. Yeah. But I was born in Russia and I moved, my whole family moved to the United States in December, 1991. What's interesting about this, actually, I was not living in Russia. I was living in the Soviet Union, and then literally a month later it stopped, it ceased to exist. The reason we moved to Denver, because my father's youngest sister left Moscow in 1979, and she moved to Brighton Beach. If you watch Moscow on the Hudson, that movie basically describes her life.

Joel Bowman:
Wow. Okay.

Vitaliy Katsenelson:
And then she married the Rabbi, and Rabbi had a synagogue in Cheyenne, Wyoming, out of all places, which is, I don't know if there are any Jewish people there, but yeah, that's a different conversation. But anyway, she invited us over. There was an organization that does a lot of good things, actually, not just for Jewish people, called Jewish Family Services. They were in Denver. So my aunt decided that it was better for us to move to Denver than to Cheyenne, Wyoming, and I keep thanking my aunt every day just for that decision alone.

Joel Bowman:
And so, I believe you were first studying and then lecturing at, was it the University of Denver?

Vitaliy Katsenelson:

Yeah. Yes. I studied, I got my undergraduate degree and a graduate degree at University of Colorado at Denver. And then I taught finance as an adjunct, which is a fancy word for part-time. So if you are a professor, and if you say part-time professor or part-time lecturer, it doesn't sound as interesting.

Joel Bowman:
It sounds a little casual. Yeah.

Vitaliy Katsenelson:
But adjunct, because most people have no idea what it is.

Joel Bowman:
Right.

Vitaliy Katsenelson:
And so suddenly, you sound important. So I taught finance for about seven years, and the reason I actually quit, because two reasons. Number one, I absolutely hated the part where I had to give out grades. I loved giving out As. I hated giving out Ds and Fs. And so, I hated that. But the second part is that after you teach the same class over and over again, it gets old.

And I realized when I write, I can teach, because every article would teach something, but I don't have to repeat every article. I don't have to repeat this semester after semester, so I can get to learn new things all the time. And so, I quit in 2007, so I haven't taught in 15 years.

Joel Bowman:
And also, I guess as you mentioned with your Substack and with your Contrarian Edge page, you get to reach a much wider audience than just how many people can fit in the auditorium, right?

Vitaliy Katsenelson:
Oh, absolutely. Yeah. I can help a lot more people with my writings than just in a classroom. Yes.

Joel Bowman:
Excellent. We were back and forthing a little bit email-wise, and I'd been reading some of your work recently on the housing market, the US real estate market, and I wanted to kind of get into that, because I think that's, to use a popular phrase, “top of mind” for most people at the moment, with obviously the Fed having met recently. You and I are talking on November the 7th, for our readers' edification, here.

But it's been five days since the widely expected rate hike of 75 basis points that I think most people were paying attention to, most people had kind of expected that, but they were paying more attention to the tenor of Mr. Powell's remarks afterwards. He seems to be speaking fairly directly in his remarks, saying that the job of the Fed is not done at present. We're not looking to pause. "Talk of a pause is premature," I think were his exact words.

I wanted to get your take on how you think that shakes out in the housing market, because obviously there's a lot of Americans, in particular the middle class, with wealth tied up in that asset class, and you've written that you think it's quite worse than people think. Why is that?

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Vitaliy Katsenelson:
All right. If you look at the housing prices from 1999 to today, they basically went up about 40%. In less than four years, they went up 40%. Most of that increase happened actually over a three-year period. So, the median house today in the United States is about $440,000, probably a little bit less than that, but that's what it was at the beginning of the year.

The problem is, those prices were fine from an affordability perspective when interest rates were around a 30-year mortgage at 3%. But when inflation is at 7-9%, interest rates had to go up. Even if the Federal Reserve did not raise them, they would have still gone up, I would argue, because who would've wanted to buy this paper when inflation is 9% and pay 1% or 2%. So interest rates, I think, would've gone up anyway.

So, today when the mortgage rate is over 7%, basically if you are a new buyer and you want to put 20% down and you want to buy a house, it's basically going to cost you almost twice as much. 

Let me just give you a couple numbers. If you bought a house in 2019, or even in 2021, it would've cost you roughly $420,000. Interest rate was 3%, so it would've cost you roughly about $15,000 a year in mortgage payments.

When rates go up from 3% to 7.6%, as they are today, now the mortgage payment goes up to $30,000. This is, what's important to understand is that the median American household makes about $75,000 a year. $75,000 a year, or about $60,000 after tax, roughly. So in other words, when interest rates were 3%, it used to consume 25% of someone's income. Today it would consume, if you were to buy a house at today's prices, at these interest rates, would consume half of someone's income.

So, housing today is unaffordable. So, what has to happen is that, for the housing market to return to the prices, to return to the affordability of 2019, of 2020, of 2021, they basically have to decline like 30 or 40%.

Joel Bowman:
Yeah, I saw those numbers, 30 or 40%. I've read those numbers in your write up, and I think for a lot of people that's difficult to conceptualize, because they've been living high on the hog with cheap and abundant credit for so long that they think, “Hey, it's been so good for so long, how could this possibly come to an end?” But you tap into the emotion of owning a house, how it's different from stocks, it takes a lot longer to come down, but prices can run up pretty quickly. But there's an emotional component to owning a home that counts, too...

Vitaliy Katsenelson:
Yeah. In the American Constitution, there is a guarantee of pursuit of happiness, but there is no guarantee of rising housing prices every year. But over the last 30 years, we are basically, because interest rates actually declined for most of our adult life, right? So therefore, we've been conditioned that housing prices only go up. But they can decline. 

Joel Bowman:
That'll come as a shock to some people, I imagine. I'm Australian, you can probably hear from my accent, but there’s a very similar macro setup in Australia, where they've had access to just an exorbitantly large amount of cheap willing credit for so long that they've been led to believe that this is just sort of par of the course.

But one of the things that I read in your full letter, that I thought was very interesting, and I think it's an important point for people to grasp, is that a lot of people will sort of trot out the argument, where they'll say, “Hey, look, we already had interest rates during the Paul Volcker years, or during the '70s and '80s, when they were 14, 16, 18%. And we had a lot of other similar macro setups as well. We had high inflation, we had high unemployment, we had an oil embargo from a major producer of the world, the Nixon price shocks, all of this kind of very pessimistic, sour macro setup. But we were able to muddle through, and then we were kind of off to the races after we got through the hard part. But this time's different. I agree with you, but explain to us why, in your mind, this is not just the '70s and '80s redux.

Vitaliy Katsenelson:
Because in the '70s and '80s, if you look at the ratio of housing prices to median income, it was half of where it is today. In other words, yes, the interest rates went up a lot, but the housing prices were much, much cheaper in relation to what people made. By the way, we still had a recession, don't get me wrong. We still had a recession. People forget about it. But I think this time, the impact will be greater.

Also, this is very important to understand. When we are in an economy that has very low interest rates for a long period of time, our behavior changes. When I say “our,” that includes individuals, corporations, and government. Let's say, let's start with the government. That's the most obvious one. We have our debt to GDP at the highest probably in the country's history. We may have to go back to the World War II era to see what it was then. It's much higher than it was in the '80s. If you look at just how we get used to finance everything. If you bought a new car, you could get 0% financing. That is gone. I mean, well, 0% financing is basically gone, and therefore what you're going to start seeing that now, everything is going to become a lot more expensive.

So, what's important to understand is where we're coming from. We're coming from, it's almost like 0% interest rates to meaningfully high interest rates, and therefore the cost of everything will go up. And it's going to slip into every single corner of the economy, and it's impossible for high interest rates not to cause a recession at this point.

Let me give you one other important element about the housing market. Most Americans today basically have a mortgage, a fixed rate mortgage. 90% of Americans have fixed rate mortgages, where they probably pay from two and a half to three and a half or 4%, because people refinance and the industry has declined.

So, here's what happened. Let's say you bought a house for $300,000 and let's say you have a mortgage. Actually, let me give you actual numbers. The average American has a mortgage of about $260,000 if you put together the first mortgage, second mortgage, okay? So in other words, the average American as of right now has $180,000 home equity.

Joel Bowman:
Okay, right.

Vitaliy Katsenelson:
Now, let's say housing prices stay where they are. Let's say they don't decline. If you want to move, if you want to sell your house today and move into another house a few blocks away, you're going to sell your house for $440,000. Hypothetically, you take $180,000 of equity, you put it in your house. So, new house is going to cost you for $440 minus $180, so $260. Your mortgage is not going to change except one thing. Now you'll be paying, instead of 3% interest rate, you're going to pay 7.6. And so, suddenly that move where you still buy the same four walls, same picket fences, now it's going to cost you $10 to $15,000 more a year.

Joel Bowman:
Right.

Vitaliy Katsenelson:
And that's a lot of money. So therefore, I think what's going to happen, what's important in the sense is this, when the housing prices go up, when the stock prices go up, people feel wealthier, because they feel like the house is worth more, they have more home equity. People feel wealthier, and therefore, if you feel wealthier, you are more certain about the future, you go out and spend money.

The opposite happens when they decline, when assets decline, from stocks to housing prices. And when that happens, when housing prices have declined, people are going to have less home equity, but also they're going to feel less wealthy and therefore they're going to spend with less confidence. And that in itself is also going to help to weaken the economy.

So again, I'm not an economist. I'm a guy who analyzes, I'm a kind of bottom up guy who analyzes stocks. But I look at this. It took me about 20 minutes to go through all this data, and just to see that it's basically impossible for us not to go into recession.

Joel Bowman:
Yeah, and even a technical recession this time. I know in the old fashioned days, it used to be two consecutive quarters of negative GDP growth. I'm sure the government has defined that out of existence. But yeah, I think most people are expecting them to even have to admit that we are in a recessionary environment at this point.

Vitaliy Katsenelson:
Yeah. Let me tell you, I'm going to define recession this way here: when unemployment will start going up. The reason the government got away with saying we are not really in recession, and they could get away with it because it was supply chain issues, et cetera. A lot of one-time stuff. Fine. And we had 3.3% unemployment, so that's how they could get away with it. But when unemployment goes from 3% to 6%, it's going to be very difficult to say that we are not a recession. And I don't know where unemployment is going to go, but I'll tell you this, if you are in California, if you are in Silicon Valley, I think the recession there is going to be even more significant than in other parts of the country.

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Joel Bowman:
Yeah. Well, let's talk about that then. You mentioned, of course, your work as a value investor, and we were just powwowing about our mutual acquaintance, Chris Mayer before. I wanted to just sort of pivot from the real estate market to the work that you do with investing, because obviously this is one of the other big asset classes, stocks, so-called risk assets, that are impacted by Fed policy.

As Chris and I were just saying a couple of weeks ago, it would be lovely to live in a world where we could just do fundamental, bottom up health of a business research and due diligence and invest in the best companies, but the Fed can muddy the waters sometimes. So, explain to me and explain to our listeners how the kind of deep value investing that you're doing, that Chris is doing, which is driven more by, let's say, fundamentals than fad, or price over promise. How is that impacted now, even after we've had, with the exception of October, which I think was maybe the best month ever, we've had a very tumultuous year, to put it mildly.

Vitaliy Katsenelson:
Yeah. To paraphrase our ex-president, high interest rates made value investing great again.

Joel Bowman:
Right.

Vitaliy Katsenelson:
So, what is value investing in general? Basically what Chris and I are doing, we are analyzing companies as if they were, even though they're publicly traded, they don't have to be. Our analysis would not be much different if they were not publicly traded. Say I'm analyzing Apple, I'm analyzing Apple as if I was buying the whole company. I say, would I want to be in this business? Do I understand it? Do I like the management? What do I think the cash flow is going to be over the next 10 years? Okay, what do I think the company is worth? And then, once I figure this out, I say, well, how much discount do I need to its fair value for that to be an attractive investment? And you just keep doing it over and over again over different companies.

And what's important to understand, is the instant liquidity that the stock market provides you, it's both a feature and a bug. It's a feature because it allows you to buy and to sell something. Like if you want to sell a house, first of all, it takes you a long time to find a buyer, and transaction costs are very high. If I want to sell a stock, like an average stock, I can sell it in seconds, and the difference between the bid and ask spread is going to be a tiny, tiny, tiny number. Okay, so that's a feature.

The bug is that, because you can sell it so instantaneously, your analysis changes, and a lot of times what happens, people get tricked. Let me give you this analogy. When you go to Las Vegas to gamble...

Joel Bowman:
When somebody else goes to Vegas. I would never.

Vitaliy Katsenelson:
Yeah, let's... Yeah.

Joel Bowman:
You and I would never do that, Vitaliy. We're responsible adults, here.

Vitaliy Katsenelson:
Especially, your wife is 10 feet apart, so totally.

Joel Bowman:
Exactly.

Vitaliy Katsenelson:
Okay, when somebody else in Vegas goes, yeah, that person is not going to be thinking that he's investing or she's investing, because when you're in the main casino, you know they're gambling. And if you don't, then you have a much bigger problem.

Now, because you are buying stocks and selling stocks, a lot of people get tricked that they're investing. But the thing is, what I described as value investing, when you analyze businesses, that's investing. When you buy in full stocks and you treat them basically as if you were renting them for a day and selling them, you're not investing, you're trading. Or it's both.

Joel Bowman:
Or speculating. Yeah.

Vitaliy Katsenelson:

Speculate, exactly. Gambling. Yes. I was kind of, Joel, I was on a... This is six months ago. I was on an AMC GameStop call in one of the Twitter spaces. I just wanted to understand what people are thinking. Oh, and at some point, I tried to explain to them that guys, you're all going to lose money, because this company is worth 95% less than what you're paying for it, and just went through the math. They didn't care.

But there was one thing that one woman said that really stuck with me. She said... At this point, GameStop already declined maybe 20, 30%. And she said, "I bought the stock. I go to the movies all the time. I talk about the stock all the time, and it's still declining. Why is investing so difficult?" See, that person thought she was investing, but she wasn't.

And so, what I do is investing because I'm treating companies as if I'm buying as businesses. And I think that's the biggest distinction. And I have a long term time horizon.

Joel Bowman:
I was just about to mention the time horizon too, because again, I've spoken to Chris many times about this, but the idea that if the money that you're investing in the market, you need it in five years, you need to pay for the kids' college or whatever, you may want to question whether that money should be in that particular investment. A longer time horizon, where you can insulate yourself against emotional overreactions that we all tend to have. We panic if things aren't going our way, or we get greedy at the upside, or whatever. But if you have a long enough time horizon and you do the due diligence and study the fundamentals in the beginning, even significant drawdowns or bear markets that we're seeing right now, if you've sitting on companies that you would want to own, whether they were publicly traded or not, certainly that contributes to a fitful night's rest.

Vitaliy Katsenelson:
Joel, let me give you this insight. If you have a shortened time horizon, volatility becomes your risk, right? In other words, you want a stock, and it declines, and you need the money at this point in time to pay for kids' education, then you have to liquidate the stock. And now the decline that could have been temporary becomes permanent, because you had to sell, because your time horizon was small.

When you have a long term time horizon, volatility is really not the risk. A lot of times in opportunity, the risk is a permanent loss of capital. So when it declines, when the company, when stock declines and fundamental reason, the value of the company has declined as well, and that's a permanent loss of capital. When the company's earnings power gets demolished, or when you bought something, like let's say you bought those dotcom stocks that just crashed 70%. I bet if you bought almost any technology company, I'm generalizing, like last October, you're probably going to have a semi-permanent loss of capital. In other words, it's going to take you 10, 15 years to get your money back.

Joel Bowman:
Right. It takes a lot longer to build up percentages than it does to see them back down.

Vitaliy Katsenelson:
Absolutely. Absolutely. Yeah. Absolutely. Absolutely. But yeah, so a long time horizon becomes extremely important.

Joel Bowman:
Yeah. Okay. Let's sort of step back a little bit. I've got so many questions here that I want to get your take on, Vitaliy, and it's been 10 years since we caught up, so I've got a backlog. But I wanted to run something by you that we've been writing about at Bonner Private Research of late, and it ties into what we're talking about here, and this is the end, or at least a pause in the gushing of cheap and abundant credit. This may be, for the first time in multiple decades, or the first time in many young investors' or homeowners' or stock owners' lifetimes, the first time they're seeing persistent hikes like this, which we think may remain higher for longer.

But there are a couple of other drivers that have led to this, in our worldview, that have led to this moment of plenty, this age of abundance that we find ourselves in, where if we want any food delivered from any style of restaurant around the world, we can call up, it'll be on our plate in minutes. We fly around the world using cheap jet fuel and travel in a way that kings wouldn't have been able to travel just going back a hundred years. And we take this all for granted.

So, along with cheap and abundant credit, which is looking a little shaky, we also have cheap and abundant labor that was essentially because half a billion Chinese entered the marketplace and provided us with cheap goods. This is maybe another one of those “one time” events. And then, of course, cheap and abundant energy to power both the manufacturing and the distribution of all of those things.

But we're seeing now, because of various geopolitical concerns, that each of those drivers is, in its own way, kind of breaking down. Whether it's, some would argue, weaponization of the dollar, or let's just say higher interest rates and a contraction in the credit markets there. Maybe we can go through those other ones, and just get your general take on that.

Vitaliy Katsenelson:
Let me go through them in the reverse order. If you look at the energy, right before the pandemic, we started to buy – unfortunately, I did not see the pandemic coming – we started to buy energy companies. Why? Because energy prices were so low, so low for so long, that we sold the supply. There was just this disbalance between supply and demand, just because low oil prices lead to decline in supply. So, even before the pandemic, you already had a shortage of supply, long term supply.

Pandemic made it a lot worse. Then the war in Russia, I'm sorry, in Ukraine, makes it even worse because, number one, the Russian gas is most likely going to be out of the market for a very, very long time.

Joel Bowman:
Looks like.

Vitaliy Katsenelson:
Yeah. Yes. And it's going to be very difficult, and it's going to take years before Russia is going to be able to get it out of Russia to other countries. It takes years to build a pipeline to China, whatever, so it's going to be a while. It's very difficult to say exactly how it's going to play out, but also most likely, the production of Russian oil will decline as well.

And the problem is, number one, the Western companies left Russia. So, they didn't just provide capital, they provided the knowhow, how to get that oil out of the ground, in very difficult places. And once production declines in the cold climates, it is difficult to restart it. Again, very general statements, but I would argue that it's safe to bet that production of oil out of Russia is going to be lower. And it's the third-largest producer in the world. So, low supply before the pandemic, after pandemic at war, it's very likely the supply will be constrained.

On the demand side, you could argue that recession will reduce the demand. However, historically, the demand hasn't declined. Just a tiny bit during the recession, but not a lot. Okay, so I would argue we are probably going to see that decline. Oh, and by the way, I did not even mention ESG. I promise not to make it political, and if we had a different president from a different party in the White House, and one day he said, "Oil companies have to drill," and then next day he says, "Oil companies should not drill, and if you are..."

Joel Bowman:
It's a disaster. And the messaging is a disaster.

Vitaliy Katsenelson:
But if you are Exxon or any of those companies that have been villainized for doing what people need, then do you invest billions of dollars in new field developments, if tomorrow the government comes in and says, "You know that ‘excess money’ you're making in the high oil prices? Yeah, we want some of that."

Joel Bowman:
It's windfall tax time. It's nationalization time. Yeah.

Vitaliy Katsenelson:
Yeah. My point is, it makes it very, actually, those things make things even more problematic, that we're going to see low oil prices. Okay, so that's oil.

You mentioned that we had a globalization over previous 20 years basically, right?

Joel Bowman:
Yep.

Vitaliy Katsenelson:

Globalization was deflationary. Today, we are going through selective deglobalization. The reason it's selective, because it's not like we are saying, let's say, if there's a factory in Mexico, we're going to take it out. No, we're going to say, we are going to now divide our trading partners in two groups, the ones that we can trust long term and the ones we can't. Ones that have a democratic political regime and the ones that don't.

And so, I think what's going to be happening is that we're going to bring a lot more manufacturing from China to countries that are more politically stable, and some of that is already coming to the United States. I mean, we are investing tens of billions of dollars in building some of the data plants in the United States, and they do it for geopolitical reasons. But that means also, most likely, semiconductors will be more expensive to manufacture here than in Taiwan.

So, deglobalization, selective deglobalization is inflationary. By the way, China has its own issues. China has a significant demographic problem. In addition to everything else, they have a zero Covid policy, which has been hurting them and their reputation...

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Joel Bowman:
And their supply chains.

Vitaliy Katsenelson:
Exactly. Apple now is looking at China and says, “do I really want to have my factories in China, or all my factories there? Maybe I should move some of them into the United States, some between, just some move to other places.”

Joel Bowman:
Or do we want to have our chip manufacturers or our chip suppliers in Taiwan if Taiwan is going to become a dragon snack, to put it bluntly? I used to live in Taiwan about 12 years ago, and they were talking about it then as “not an if, but a when” proposition. And yeah, that was 12 long years ago, so it seems more of an inevitability.

Vitaliy Katsenelson:
Yeah, and I tell you this, very few people talk about this, but I would argue the restrictions we just put on China in the semiconductor sector, that is the first shot, a significant shot of a cold war with China. We basically told China that... actually told American and Western European companies, you cannot sell them advanced microchips. You cannot sell them equipment that helps them to manufacture those advanced microchips. And this is the interesting one. If you find yourself an employee in China, working for one of those factories that manufactures advanced semiconductor chips, you're going to lose your citizenship. So, our relationship with China is not getting better, it’s just getting worse. Anyway, another reason why more and more companies will be taking out their production out of China.

By the way, there is some positive here as well, because that means we're going to manufacture more in the United States, which actually helps our labor, but it's also going to make our labor more expensive as well, by the way. So, it's a more nuanced discussion, here.

But anyway, you look at this, from that perspective, everything, what you and I discussed so far is inflationary. Now, if you look at the United States, at higher interest rates, and when I say higher, they don't need to be at this level, they can just be higher than they were a year ago, are incredibly inflationary for the United States. Why? We have a... Sorry, I forget how much debt we have. $31 trillion, right?

Joel Bowman:
$31 trillion. Just passed last month.

Vitaliy Katsenelson:
Yeah. So, just think about 1% increase in interest rates for the federal government. That's $310 billion. If you look about, that's how much, roughly how much we spend on education. A 2% increase, that's roughly how much we spend on defense. A 3% increase, that's roughly how much we spend on social security. So again, I promise you one thing, I'm quite sure of this, none of those things will get canceled or reduced, because that's not what politicians do. This is how you lose your job as a politician. But what's going to happen, you just going to print more money reaches inflationary.

So I think, if you and I talked a couple years ago, I would've sounded a lot more wishy-washy, like inflation versus deflation, and basically I would've said, I don't know, and here's the argument for both sides, and I'm going to invest as if both are going to happen. Today, I think the probabilities have shifted more towards inflation, long-term inflation, than deflation, even though in the short term, if you go into recession, a recession is deflationary.

Joel Bowman:
And it's not as if we're starting from anywhere near the Fed's acceptable range of when it claims to desired inflation at, around that sort of 2% sweet spot, as if it knows what the perfect number ought to be. But I mean, we're already at whatever it is, eight-plus percent. We're going to get another read this week, I think, so we'll keep our eyes on that. But we're a long way, in real terms, in real interest rate terms, we're still a long way behind the curve, as they say. So, there's a lot of catch-up still to do, and a lot of things can break in the interim before they get to that terminal rate, as they say.

Vitaliy Katsenelson:
Joel, I want to, just one topic, it just really bothered me. When Ben Bernanke received Nobel Prize...

Joel Bowman:
Ooh!

Vitaliy Katsenelson:
I actually have a perfect analogy to explain it. Actually, this makes so much sense actually, if you think about it. Because you have to look for the reasons why they gave it to him. They basically said they've given it to him because he understood the relationship between the financial system and interest rates, or something.

Joel Bowman:
I thought it was because he had the “courage to act,” Vitaliy. Wasn't that the name of his book, right?

Vitaliy Katsenelson:
That's right. The Courage to Act. But then I realized, here's my analogy for this: It's almost like giving a prize to a person who starts the fire, then puts it out, and then writes a book about it.

Joel Bowman:

Right. And my Courage to Act, Joel "the Arsonist" Bowman.

Vitaliy Katsenelson:
Yeah. It's like really giving the prize to an arsonist who also put out the fire. But here's the thing, this is a very important point. What's going on today in our economy is the direct consequence of what's been happening over the last 15, 20 years, or probably longer than that. And so, yes, our economy did not go to the Stone Age in 2008, 2009, so thanks Ben Bernanke for that. But number one, you did start that fire to begin with, and then you put it out. But arguably, the fire we have today has been caused by the Federal Reserve's policy over the last many, many years, as well.

Joel Bowman:
Right. That's a good point to raise, too. I think a lot of people, 12 or 10 years is a long time in the memory of a 30-year-old investor or a 25-year-old investor, so we're going back into ancient history for a lot of people who are just around the traps now. But Mr. Bernanke's career was one distinguished without, I think, a single success, where he failed to call pretty much every meaningful and significant moment of his time, including the mortgage backed security crisis, which grew up underneath his nose, which brings us full tilt back to the housing market.

But I realize as we're speaking just here, and we've covered a little bit of ground here, but I don't want to sound just pessimistic, that we're sort of identifying these negative things around the world. Certainly we have to be mindful of them, but I want to talk a little bit about your latest book, because in addition to investing in turbulent times and keeping abreast of the latest geopolitical fracas, such as it is, we still have to get up and put our pants on one leg at a time and enjoy our family and make the most of the day. So, tell us a little bit about why you wrote your latest, which is called Soul in the Game. I'm assuming that's somewhat influenced by Mr. Taleb's Skin in the Game. Is that?

Vitaliy Katsenelson:
Absolutely. Absolutely.

Joel Bowman:
Okay, very good.

Vitaliy Katsenelson:
Yeah. And he actually endorsed, actually, this book too, so it's good.

Joel Bowman:
I saw that. Yeah, that was a nice feather in your cap. Congratulations.

Vitaliy Katsenelson:
That's right. But Joel, let me, I'm going to ask you a question, but let me, I want to end the investment part on the positive note, as well.

Joel Bowman:
Please.

Vitaliy Katsenelson:
As a value investor, I've never been more excited in my life, because it's suddenly, stock picking is back again. Being a rational investor, making rational decisions. When interest rates are very low, the bigger the story... The greater part of your imagination the story can capture, the more money you're going to make as a public company. This is why you had all these companies trading these insane valuations, right? Because there were not trading fundamentals. They were, because it didn't matter, because they can say, Listen, in 2040, we're going to make this much money. And since the interest rate's at zero, it might as well be today, because of the discounted 0% interest rate.

Now today, what high interest rates did, they deflated a lot of bubbles, and they brought back common sense. So as an investor today, I'm more optimistic about investing than I've been in years. So, that's from one perspective.

Now, let's go to the book. I've been writing about investing for a long time, and then at some point, I had this realization that, and I'm going to quote Freddie Mercury, who said, "There must be more to life than this."

Joel Bowman:
Oh, I thought you were going to say, "We will rock you." Okay.

Vitaliy Katsenelson:
And we will rock you. No, that's my next book. That's my next book.

Joel Bowman:
Okay. A geology textbook. Great.

Vitaliy Katsenelson:
That's right. Yeah. No, and this is when I realized that, this is when I start writing about topics that are outside of investing, so to write about parenting, Stoic philosophy, classical music, which I'm a huge fan of. And over time, that became a very big part, today maybe 40% of my writing actually focuses on other topics other than investing. And it's very dear to me.

So this book, let me try to put it this way. When I help clients at IMA, I just help 300-something families. So, my impact is significant on a small number of people. When I write investment articles, I help a larger group of people, but again, it's still limited to people who just care about investing.

With my articles that talk about parenting or classical music... Maybe classical music is not the case here, because it's usually a much smaller segment, but my articles about parenting have a significant audience. My articles about parenting or Stoics can help a lot more people. And this is why I wanted to write this book, because I wanted to help more people. This book is a completely altruistic endeavor. I just really want people to read the book and have a net positive impact on them. That's it.

Joel Bowman:
And I know my wife, Anya Leonard, again at Classical Wisdom, read the book. I have it on my list here. And she was interested in the Stoic aspect of it, of course, writing about classics herself. And so, it's not hard to understand, I think, why we are enjoying this recrudescence of Stoicism, given everything that's going on around the world. But in a kind of nutshell, how have you found the philosophy, some say the art, of practicing Stoicism in your own life, especially during moments of uncertainty such as we experience?

Vitaliy Katsenelson:
I feel, I tell you this, I feel somewhat conflicted about what I'm about to say, and here's why. Because I'm a contrarian at nature, and I usually don't like kind of... When I find that everybody agrees with me, that I find kind of a little bit... What's a good word for this? A little bit uneasy.

Joel Bowman:
Unsettled. Yeah.

Vitaliy Katsenelson:
Unsettled, yes. But over the last three years, I picked up three different things that became like three biggest facts. I'll give you all three. Chess, pickleball, and Stoic philosophy.

Joel Bowman:
Okay, I don't know what pickleball is, but I'm down with the others. I think the Queen's Gambit had a lot to do with chess.

Vitaliy Katsenelson:
Yeah, absolutely. By the way-

Joel Bowman:
Philosophy's off to the races. But what is pickleball?

Vitaliy Katsenelson:
You don't know pickleball?

Joel Bowman:
I'm either terminally uncool, or just late to the game. Or both.

Vitaliy Katsenelson:
No, it's a huge sport in the United States now. It's, imagine if you're playing kind of, it's like a miniature version of tennis with a different ball. They play it a lot in Paris. And I go play with a buddy of mine who is about my age, and you play against people who are 70 years old and they kick our butt. So it's a very, very popular sport.

Joel Bowman:
Good for some humility while you're on the court.

Vitaliy Katsenelson:

There's a lot of humility, yes. But anyway, Stoic philosophy... what happened was, I read this quote by Epictetus, and the quote said, it talked about the dichotomy of control. And it said, "Some things are up to us. Some things aren't."

Joel, this is probably the most obvious quote you're ever going to read. But then he goes to explain, what are things that are up to us? And then you find out that there are so few of them. It's basically your values and how you act. Everything else is not up to you. Nothing else is up to you. Once you realize that, that is actually incredibly liberating.

So, I went back and started to read more about Stoic philosophy, and I was blown away by that. Why? Well, it started 2000 years ago in Greece. And what's interesting about this, is how little people have changed over the last 2000 years. It's a blink. It's a blink. You read Epictetus or Marcus Aurelius or Seneca, those are the kind of three main Stoics whose writings live through the day. You find that they're talking about things that we're talking about, debating about today.

I'll give you one example, which is where Seneca has this expanse, this whole paragraph talking about how people are wasting their time, how they're constantly distracted by frivolous things, and it goes on and on and on about things like this. You would think he's talking about iPhone, Facebook, and Snapchat. 

Joel Bowman:
This is from his piece On the Shortness of Life.

Vitaliy Katsenelson:
Yes, I think so. Yes. And this is when you realize that... I think if I was a marketing agent for Stoic philosophy, I would call it Stoic practice. The word philosophy, which actually means just love of wisdom, is somewhat intimidating, because we think about kind of skinny, weak white guys, old white guys with beards, who philosophized about things we don't understand, right?

Joel Bowman:
Sure.

Vitaliy Katsenelson:
But Stoic philosophy is really Stoic practice, and all it's trying to do is minimize negative emotions in your life. Just trying to bring more tranquility to your life by removing negative stuff. And so, when I realized this, I was completely smitten by that, because what happens, the way I look at it, it's basically an operating system for life.

When we are born, our parents basically tell us, kind of help us to navigate through life little by little. Then our friends, then the books, then things happen to us, and we try to adjust. It's a Frankenstein kind of operating system based on now a whole bunch of random factors. Stoic philosophy is, I think, I would argue, or Stoic practice, is lot more organized. It provides a very well-structured operating system. That's what really attracted me to Stoic philosophy.

Joel Bowman:
Excellent. Well, Vitaliy, I think you've put enough on the table to whet people's appetite if they haven't already checked it out, both in your book, and I'll link to this again in the transcript of this podcast, but Soul in the Game is the name of the book. Vitaliy, thank you so much for spending an hour of your afternoon with me. I really appreciate it. I'm sure our listeners will appreciate it too, and we hope to have you back on again sometime soon.

Vitaliy Katsenelson:
Joel, thank you very much. Thank you.

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