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Ted Oakley, founder and managing partner of Oxbow Advisors, joins Jack Farley to argue that asset prices remain well above their fair value, and that the drawdowns investors have seen in 2022 are likely not over. Oakley shares his outlook on inflation, the business cycle, and the Federal Reserve, and he outlines where he is finding value and safety for his investors in this turbulent macro environment.
Filmed on September 6, 2022. -- Follow Oxbow Advisors on Twitter https://twitter.com/Oxbow_Advisors Follow Jack Farley on Twitter https://twitter.com/JackFarley96 Follow Forward Guidance on Twitter https://twitter.com/ForwardGuidance Follow Blockworks on Twitter https://twitter.com/ForwardGuidance
Get top market insights and the latest in crypto news. Subscribe to Blockworks Daily Newsletter: https://blockworks.co/newsletter/ -- 00:00 Introduction 01:38 Why Stocks Remain Overvalued 11:04 Why A Deep Recession Is Imminent 16:02 Energy 20:52 Fixed Income 28:14 Longer-Term Outlook on Inflation and Interest Rates 32:32 Is The Fed Still Behind The Curve? 41:44 Contrarian View -- Disclaimer: Nothing discussed on Forward Guidance should be considered as investment advice. Please always do your own research & speak to a financial advisor before thinking about, thinking about putting your money into these crazy markets.
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Oakley argues that asset prices across stocks, bonds, crypto, and real estate are in a super-bubble similar to 2000 and 1929, requiring a prolonged bear market to work out excesses before attractive opportunities emerge; investors should preserve capital rather than deploy it aggressively.
- Everything—stocks, bonds, real estate, crypto—is simultaneously expensive, a rare occurrence matching only 1929, 1973, and 2000 in 120 years
- Most investors have never experienced a slow-burning bear market lasting years; they confuse temporary rallies with trend reversal
- Capital preservation and optionality now beats aggressive deployment; best returns come after prices compress and multiples compress
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The stock selection strategy is to identify companies serving inelastic demand that will continue to be used regardless of economic conditions, rather than discretionary or luxury goods
“we have a lot of things we try to buy things that you you're going to use no matter what during this period”
Housing is a major economic driver that acts as a late indicator; it has only just started to deteriorate and will force people into illiquid positions where they cannot sell homes because they are locked into low mortgage rates and would face significantly higher rates if selling.
“one I think housing hasn't really started to hammer it yet but it will and people forget about housing being really a major driver in the in the economy and so when you look at that uh with housing being a driver it's just started to to show see housing comes in late it's a late indicator because it's slow uh same way with employment and so when housing comes in and gets weaker and weaker which we think it will we think it's just started and when that happens and gets you're going to get in a situation where people are locked in in other words they spent too much on a lot of different assets and particularly housing and real estate and they can't they can't be mobile with it”
In the 2009-2014 shale boom, natural gas companies and MLPs had too much debt despite producing at high volumes, causing bankruptcies and industry consolidation; today's producers are better positioned because they have deleveraged and maintained financial discipline.
“what happened back then was uh if you look at those companies and a lot of the industry including the MLP business by the way in the first you know first decade of the big 20 2000 2010 or 12. uh you know they had too much debt and that really that caused a shake-up in the industry not only the producers but for the pipelines because they had some companies would you know didn't make it because of that and that's what happened now there are a few companies that still have quite a bit of debt but generally they've been able to manage that pretty well”
High-yield or junk debt behaves similarly to equities and should not be bought until reaching a market low, as spreads continue to widen and many issuers face credit deterioration; municipal bonds offer better value because yields exceed Treasuries and benefit from tax exemption.
“when you're buying high yield or what we call junk debt it really equates to the same as a stock so you don't buy that until you get a low in the market because it's just going to keep on going down and there's a lot of those companies that won't pay those spreads will keep on widening and so you get into trouble I think we're where the value lies is in the municipal Market if you look at a municipal curve right now of yields there's a lot of yield out there that's over the treasury yield not not in the one in two and three year but you get out a little bit further say you know eight to Fifteen that kind of thing”
A year ago in September 2021 all 200 companies in Oakley's investment universe that they would like to own were completely overpriced, forcing them to raise cash from September through January rather than deploy capital.
“a year ago Jack what was happening is you know we have about a 200 stock universe that we we would own or we'd like to own if we could there are companies we like but a year ago they were all overpriced and it made us uh start to from that point forward all the way up through really January we were raising cash more than normal uh because we didn't it really was anything for us to buy in in that slot”
Recession-resistant sectors include payment processors (Visa, Mastercard), medical REITs focused on primary care offices (which rarely close due to economic cycles), natural gas pipelines (which have throughput regardless of economic conditions), and automotive aftermarket retailers (O'Reilly).
“if you get the right real estate and you have to be when I say the right real estate it has to be it has to be the parts of the market where you know that they're going to need what you have that's why we have Primary Medical we don't see but if you use demographics and you use the things that go into that we think that's an area that that while it could be somewhat affected it's usually not affected much you don't find many Physicians offices closing down because times are tough and that kind of thing so we you know that's an area we really still like we obviously think that's fine if you look at natural gas pipelines you know their throughput is is there no matter what so I mean you're going to burn natural gas you may be burning it at five dollars on mcf or ten dollars an MC up but you're still burning it”
Real federal funds rate must equilibrate with inflation rate; if inflation is at 6 percent and fed funds rate is only 2.25 percent, there is a 3.75 percent negative real rate that must eventually normalize higher
“if you take the effective fed funds rates probably around 230 or 2 40 that stated rate would be 250 and they're going to probably raise it let's say they raise it three quarters this month to three and a quarter there has to be a point to where your vet funds rate and your inflation rate are fairly close okay now I don't know where that is I don't know where that equilibrium is but it's somewhere uh and it's probably not going to be a two”
Many investors remain in denial that cryptocurrencies, SPACs, and unprofitable tech companies will not 'come back'—they believe in mean reversion, but companies with no revenues or negative cash flows have no fundamental recovery path.
“people are still then in denial on cryptocurrencies on spax on all these companies that have no Revenue that don't make any money well they're going to come back well you don't come back from nothing in Maryland Market letter last month I wrote a little piece that said nothing from nothing leaves nothing well that's true um and that that hasn't happened yet I think you have to get to the point where they just throw it in and say you know what I'm done”
'Nothing from nothing leaves nothing'—a market maxim Oakley cited in his newsletter indicating that profitless companies have no fundamental basis for recovery
“in Maryland Market letter last month I wrote a little piece that said nothing from nothing leaves nothing well that's true”
Last year valuations were so expensive that even with high assumed earnings growth rates, equity valuations could not be justified; every stock in the opportunity set was overpriced regardless of interest rates or inflation assumptions.
“the problem about last year was they were so expensive Jack that it didn't make any difference what the interest rates were everything was so expensive and if you even if you calculated a high earning rate for the next five years you still couldn't make it work and that's what we got into last year nobody could see it I mean they were all sort of drunk on the numbers but that's where we were last year”
Bear market recoveries typically begin gradually and accumulate gains over 1.5-2 years before investors realize they are in a bull market; early investors leave 25-30% on the table if they wait for obvious confirmation.
“typically off of a below and bear Market it's a gradual thing and people look up and say no we're not going up we're not going but you keep on going up and and then by the time you get out a year and a half or two years then oh we're in a we're in a bull market but you know if you left the first 25 or 30 on the table um but that that's usually the way they happen”
Oakley has made many errors and mistakes throughout his career but has learned to recognize them and adjust positioning accordingly; this flexibility and willingness to revise is the mark of good portfolio management.
“I will say this though we adjust and one of the things we really believe in is we've made an era and we made a lot of them we make an adjustment and try to move with it if we can I think that's the mark of a good money manager is you have to be able to say I didn't you know we didn't look at that correctly and we need to make a change”
Market bottoms are identifiable by a combination of technical signals (low multiples, high price-to-book compression, aggressive downside moves, 20+ to 1 down days) and fundamental signals (capitulation, investor disgust)
“one of the things we use technicals for is on the when you get in the lows in the market and what we look for is you know what will happen in those cases your multiples will be uh compressed you'll have low multiples Your Price to Book will be down it won't be like it has been the last two or three years price to sales will be down you know at good levels and that sort of thing”
Oil is an outlier because Russia controls significant oil supply and can move prices materially through export decisions, creating additional geopolitical risk to energy prices independent of Fed or economic cycles.
“I will grant you is an outlier because um if you look at Russia which controls a lot of oil if they want to cut back on that oil they can really move that price a lot and really put a lot of people in trouble so I don't know where that ends up the oil is certainly something you have to look at the next five years”
Earnings for FANG stocks as a group were down 10% year-over-year, with the declines driven primarily by falling advertising revenues and declining visitor traffic rather than cost increases.
“if you just take for example the Fang stocks you know as a group they were down 10 in earnings from you know from a year ago so they were that's the kind of thing you start to see now we own other thing a lot of things besides we don't that's not a big big area for us but I will say that what we're finding on companies in general is they're starting to announce now that we're not going to hit the number or they've decreased their expectations”
U.S. oil companies are not currently increasing production significantly despite high oil prices because the Biden administration has created regulatory headwinds and ESG concerns have made debt financing difficult; historically oil companies would have been aggressive in pursuing production growth.
“they've had them out of the market for finding oil now for a couple of years because of this Administration has been the one that really uh unfortunately has really you know been beat the oil companies up and so they've had a tendency not to be as aggressive but I think one of these days they will have to be because you'll run you're going to get you're going to get in a situation where you need more oil”
The primary short-term headwind to stocks is Federal Reserve policy, but the long-term headwind will be the economy; real recession (with rising unemployment) is still ahead and will force companies to make significant earnings adjustments.
“the short-term Jack would be Federal Reserve yeah because but I don't think that'll be the long term in the long run I think it will be the economy because what will happen is you'll have somewhere along the line you would have probably two quarters of you know reasonably significant downturn uh where it would get into the see we haven't gotten into unemployment yet but when unemployment starts Rising you get into real that's when you're in a real recession”
Geopolitical and supply-side headwinds in Europe and Far East could create a difficult winter, potentially extending economic weakness; this is an additional tail risk beyond U.S. domestic factors.
“maybe you know it could be wrong because maybe there's a Saving Grace out there I don't know but if you look at Europe in the Far East and you know if you look what's going on um you know it could be a tough winter for a lot of situations”
The Fed during 2020-2021 did not need to buy as much paper (QE) or keep rates as low as they did; by suppressing risk entirely, they created a massive credit bubble where weak actors persisted instead of being cleared out as healthy markets require.
“our problem with the fed over that two-year period was is that they didn't they did not need to buy that much paper number one they did not need to keep the rates that low and so they just created this incredible bubble of people borrowing money and uh and they put a floor under things so that nobody was afraid to do anything and they should have let the risk run because that's what really creates a thriving economy you get rid of the weak hands”
Most market participants and advisors from the past 10-12 years have only experienced the 40-day bear market in March 2020 and lack the experiential framework to handle a slow-burning multi-year bear market; they default to 'keep buying' which will not work.
“the people that have been around this last decade 10 or 12 years only saw they saw a bear Mark for about 40 days in March of 20. yep and so it's very hard for them to get their hands around this and that is okay this could last a long time and you can't and they're all in the same Mantra which is we'll just keep on buying well that will not work when you're in a in a tough Market you're going to have to have some preservation”
Mortgage-backed securities backed by Fannie Mae or Freddie Mac should only be purchased in declining interest rate environments because rising rates extend loan payoff schedules indefinitely, reducing portfolio turnover and reinvestment opportunities.
“when we want to buy mortgage bags is when we feel like that you're going into a lower interest rate environment and I don't think people realize this but if you take a group of mortgage-backed Securities and rates keep going up that means people never pay those loans off so you can't use and what is a normal definition of we're maybe an average maturity may be so that's the problem on a rising radio environment they keep getting extended we'd rather buy the mortgage bags in a declining rate environment for this reason we want to get paid off every month or every quarter with more paper in other words it keeps us walking you know it keeps us really a little shorter term”
Milton Friedman's principle that only governments can create inflation through money printing is operative; the 2020-2021 monetary and fiscal expansion directly caused the inflation spike that followed.
“as Milton Friedman would say the only person that can create inflation is a government because they've got money that's where we are”
During the 1975-1982 period, the market experienced repeated 20-25% sell-offs followed by rallies, with inflation pressures making conditions difficult throughout; Oakley witnessed this but did not participate in the 1973 crash.
“I wasn't in the market in January 73 but I was in the market in 75 and 76. and we had you know tough times with inflation but so you know in the late 70s up to 82 we had every year we'd have a 20 25 sell-off and they would rally back and that kind of thing we had a lot of inflation”
Stock market bear markets do not typically bottom until valuations reach extreme compression—multiple expansion of 18x earnings becomes compression to much lower levels—and current prices reflect multiples higher than what will ultimately prevail over the next 12 months.
“normally that doesn't come until you get to the look the low end of a bear Market normally that's when your multiples you know let's say everybody's thinking that okay hey we were at a 22 multiple and now we're at an 18 mole well we don't think we're in an 18 multiple we think the multiple as you go forward over the next 12 months is much lower than that”
Natural gas prices in Europe are 10-20 times higher than normal cycle levels, putting European energy-intensive industries and consumers in severe stress; this represents an ongoing crisis distinct from the U.S. situation.
“I think Europe is definitely in an energy crisis with you know natural gas prices in Europe 10 to 20 times higher than they they normally are during a cycle and yeah literally 10 to 20 times higher”
Natural gas companies are increasing production because natural gas prices are elevated at $8.50 per mcf and producers are incentivized to extract and sell, but future production will be limited by capital constraints and policy
“on the other side you look at natural gas and a lot of companies are producing more natural gas because it's in the U.S it's around 850 and mcf so you know they're starting to produce they like to produce it”
Europe's energy policy response, including capping Russian oil prices and reversing nuclear policy, may prove more damaging to Europe than to Russia long-term despite being well-intentioned.
“if they start to play hardball like that um it's probably going to be more damaging to them than it would be Russia in the long run”
Growth stocks that previously warranted 15-18% growth rate assumptions must now be purchased at lower prices because growth rate expectations have been reduced; Oakley will buy growth stocks again, but only at significantly lower valuations.
“in the common stock area what happens is um a lot of the growth stocks that you know we might look at once you know it could maybe this company could grow at 15 percent or 16 18 what we would like for it to we've had to reduce those down and when you reduce them down you got to buy them cheaper uh and that's where we are”
The Fed spent 2021 calling inflation 'transitory' while it was actually building underneath their analysis; they could not see it despite supposedly having all the data and analytical resources available.
“just look at last year all year it's transitories transit to where it's going to be okay and of course all the while it was building right underneath them and they couldn't see it”
Inflation will likely remain in the 5-6% range rather than reverting to 2%, because the Fed and fiscal government injected too much money into the economy over the prior decade; this represents a structural regime change from the prior 10 years.
“we probably will not go back to that again I doubt seriously uh and people will say well you know we're not going to have eight and a half or nine percent inflation but we'll have five or six well five or six will be a different investment world than what it is what it has been the last 10 years so I I think you will get to levels that you won't go below I'll be surprised if you go below that because they just pushed too much money out there”
The Federal Reserve has a very poor track record, making its guidance and communications unreliable; past Fed statements and predictions have repeatedly proven false, so investors should not base positioning on Fed guidance.
“we don't really and never have really believed anything the FED says I mean if you look at their track record it's very very poor and so people that want to get around and talk about the fed I'm not certain why because if you look at what goes on there's nothing there would lead you believe they can give you any insight to what's really going to happen”
Paul Volcker's approach of minimal communication and decisive policy action was correct, in contrast to both Greenspan-era opacity (which creates mystery) and Powell-era over-communication (which creates confusion); money supply discussion should be central but is absent from Fed communication.
“the only a big Governor you know if you if if you look if you look back really volcker was the was the only fake Governor I thought really did it correctly which was we're not going to tell you a whole lot we're just going to take care of what we should take care of and one of the things that I think they miss is that they they forget to talk about the money so you know how much money is out there what goes on”
Only 4-5 super-bubbles have occurred in 120 years (1929, 1973, 2000, 2008 housing crisis, 2022); they take a long time to work out because 'nothing from nothing leaves nothing'—companies with no revenue cannot recover.
“I think there's only been maybe four or five super bubbles in 120 years and that you know 29 like I said 73 2000 this was one and it takes when you get something like that and people do the craziest thing and pay the craziest prices for things that don't matter then it just takes a long time to wring it out”
The Federal Reserve comprises unelected officials who have caused significant economic trouble over 20 years; they are currently tightening monetary policy during a recession, which is backward and has never been done before.
“if you look for the last 20 years this is a whole group of people they were unelected by the way these are not elected people that have caused a lot of trouble for this country and really for the economy and if you look at the last nine months just think about it uh what you know what's going on with them they're really hanging their head on unemployment and they're tightening into already a recession they're tightening into slower times which is really reverse of what you should be doing and we've never seen that before”
Speculative excesses will not be wrung out of the market until people are 'disgusted' and capitulate; market bottoms occur when investor sentiment hits extreme despair, not when technical levels are reached, and current conditions show investors are far from that psychological state.
“all of those speculative excesses will have to be run out of the market until you get to a point where people are just basically disgusted that's when you get a low and you think we're nowhere close to people being disgusted now I don't think so I think it's a I think it's a way and you've got it longer to go”
Netflix demonstrates a recurring pattern where subscribers access the service, watch the two shows they want, then cancel, preventing consistent revenue retention and forcing the company to compete on churn-driven retention rather than value growth
“if you take Netflix as an example okay people uh go on uh they take the service they watch the two shows they want to watch and they drop it and so you know it's that kind of thing where they can't really keep that consistency up so I think that's where a lot of companies are headed in here uh with their numbers just won't match up”
This market is a super-bubble comparable to 1929 and worse than or comparable to 2000 or 1973; everything—stocks, bonds, private equity, real estate, crypto—was simultaneously in a bubble, unlike 2008 which was primarily housing-focused.
“the difference between this and say 2008 for example is this this Market was a Super Bubble Market I've never seen as many things uh in the last 18 months that were so expensive and not just stocks but I'm talking about bonds private Equity private real real estate you name it I asked crypto I could go down the list everything was in a bubble and that's more like 2000 or 1973 January more like 1929”
A rapid melt-up in the S&P 500 (4% weekly for extended period) is very unlikely because the March 2020 melt-up only occurred due to extraordinary Fed money printing, and Oakley believes the Fed has learned from that error and will not repeat it.
“it happened in March 2020 because of the FED not because of anything else it wasn't right yeah you know it wasn't any there was any reason for that other than fact if you if if you produce enough money uh to buy something you're going to get back into it and I don't see that happening again though I think they realize that the era of that and I'd be surprised if that really surprised that that happened again”
Even if the stock market falls 40-50%, the Federal Reserve would be unlikely to aggressively cut rates or provide stimulus because the entire system would be falling apart and conditions would not warrant monetary rescue.
“I think what would happen is and this is where you can't believe them let's just say that all of that happened and the market gets down 40 or 50 percent I doubt seriously at that point that they're going to keep really keep getting their foot on the on the gas here I doubt it I'm not saying there wouldn't but it would take it'd be really unusual for them too because by that time everything would really be falling apart”
Companies are lowering forward guidance and announcing miss expectations relative to old guidance, which masks the severity of actual earnings revisions because investors perceive 'beats' when companies are actually performing worse than six months prior.
“people will think they beat the beat the number when they really didn't if you go back six months from then you know they they didn't beat the number at all um and that's where we are in this stage of things and I think there's more of that to come”
The Federal Reserve leadership lacks main street economic experience and relies too heavily on PhD economists in 'ivory towers' who lack empirical understanding of how businesses operate
“all these people with that group that uh none of them haven't experience on Main Street so that's they just they just go along with the phds that are in the in the Ivory Tower”
If Oakley's bearish thesis is wrong, investors can still make adjustments and deploy capital gradually over time, but if he is right and investors ignore his warning and remain fully invested, they will miss the crisis and have no optionality—therefore capital preservation is the correct asymmetric strategy.
“we could very well be wrong that it's going to be a tougher time the next two to four quarters no question about it that I I would say that you don't have to believe me on that I we're we're not infallible but what if we're right okay and I always use this as an example to say well if you're wrong you can make an adjustment and get money into the market over the you know in in time you don't have to stay in cash but if we're right and you do have liquidity and you've got some preservation and capital it does set you up to where it gives you a lot of choices on what to do”
Oakley's conservative income strategy holds approximately 75% in securities maturing within 36 months to capture rising yields in short-term U.S. Treasuries, with a small position in longer-term bonds and exposure to dividend-paying cash flow investments, because he expected rising rates.
“if you look at you know we have three strategies but if I'll just take the most conservative strategy which is really just called conservative income and we have probably um 75 percent of that strategy is uh within 36 months or so of maturity and we had a lot of we got a lot of heat for that last year but we felt that's where we should be going with it because we could see rates we're going going to rise”
Oil companies are discounting a recession or slower economy in their current valuations, making them potentially attractive long-term buys but not in the short-run as prices decline
“what happens on the oil side probably is happening is that you know it's starting to Discount a recession or a slower economy now that doesn't mean long term it's not a great buy but in the short run that's what it looks like to us”
Tech stocks and the 10-12 mega-cap stocks that institutions own will be hit harder and stay under pressure; many speculative companies with no revenue or minimal revenue will need to be 'wrung out' of the market along with crypto and SPACs that are down 90-95%.
“what sectors do you think will be the hardest hit as people buy less and spend less well everybody owns Tech High Tech and they you know they they owned it especially you know there's 10 or 12 stocks that they all own and everybody owned them um those will be hit harder I think I think those will will stay under pressure as you go along I think a lot of that has to be run out of the market and then you have so many companies Jack that really didn't make any money some didn't even have any revenues oh yeah and people are hung up in them and I think all of that has to be wrung out you already see it in the spec Market you know you see so many specs that are down 90 90 95”
If the S&P 500 is higher in September 2023 than current levels (mid-2022) at 4,400 or 5,000, it would signal that inflation is under control, interest rates have stabilized, corporate earnings have resumed growth, and unemployment has reversed—all of which would invalidate Oakley's bear market thesis.
“if that happens it would have been something where they've got a handle on inflation interest rates quit going up uh companies you know started making more money or seeing that they were going to make more money and and you had a period where you'd already gone through let's say higher unemployment now it's going back the other way you're starting to employ people and that sort of thing”
In July 2022, meme stocks and speculative names rallied sharply as if the prior sell-off had not occurred, suggesting investor capitulation has not begun and therefore market lows are still far away.
“yes you in July interesting the mem stocks everything just came right back as if nothing happened”
High-yield preferred stocks and convertible preferreds currently offer 6.0-6.5 percent yields, providing income with some upside potential if stock markets stabilize
“we own a lot of the uh great preferreds and some convertible preferreds um you know we're getting six six and a quarter six and a half percent on all of those”
Brigham Resources (a royalty company) was recently acquired and represents the type of opportunity Oakley seeks: companies with stable cash flows and attractive prices
“in the U.S uh we own you know we own oil we own natural gas pipelines that sort of thing just have one of our companies get bought out today so Brigham&'s a stock that we own for really for a number of years now it's a great you know great royalty company”