Speaker 1: Hello, and welcome to What Goes Up, a Bloomberg weekly
Speaker 1: market podcast. I'm Sarah Ponzek, a reporter on the Cross
Speaker 1: Asset team, and I'm Mike Reagan, a senior editor on
Speaker 1: the Markets Team. This week on the show, two guests,
Speaker 1: two topics. First, this month marks the tenure anniversary of
Speaker 1: the infamous flash Crash. We're joined by the author of
Speaker 1: a new book. It's called Flash Crash, A Trading Savant,
Speaker 1: a global man hunt, and the most mysterious market crash
Speaker 1: in history. Also, later on, small cap companies have been
Speaker 1: pressured even more than the market as a whole through
Speaker 1: the coronavirus crash. Joh for Rizvi, a portfolio manager over
Speaker 1: at Harding Lovener, explains how to navigate the space, and
Speaker 1: as always, we will close out the episode with the
Speaker 1: craziest things we saw in markets this week. So if
Speaker 1: you saw something crazy, please give us a call on
Speaker 1: the hotline at six four six three two four three
Speaker 1: four nine. Oh, and maybe we'll play your voicemail on
Speaker 1: the show. Of course, you can tweet at us with
Speaker 1: your crazy market observations. Just tweet to the handle at
Speaker 1: Podcasts and let us know what you're looking at. And uh,
Speaker 1: Sarah obviously, as you know, the craziest thing is uh,
Speaker 1: my favorite part of the show. We're kind of lucky
Speaker 1: this week though, in that we don't get to talk
Speaker 1: about the just the craziest things we saw in markets.
Speaker 1: This week, we literally get to talk about the craziest
Speaker 1: thing I think I've ever seen in my career. And
Speaker 1: that was ten years ago this month. Um, I was
Speaker 1: the editor handling the daily markets wrap that I know
Speaker 1: you've you've written a million times. And as you know,
Speaker 1: some some days the market wrap is very easy to write.
Speaker 1: There's a clear explanation for why the the markets did
Speaker 1: what they did. Sometimes it's not so easy, and this
Speaker 1: was one of those days. You know. It was, um,
Speaker 1: probably a year after the market a little bit more
Speaker 1: than a year after the market bottom from the financial crisis,
Speaker 1: so people were still very much on edge, right, and
Speaker 1: all of a sudden the European debt crisis had just
Speaker 1: sprung into life and really caused another bout of volatility
Speaker 1: that that was worrying too too many people, um and
Speaker 1: causing some some swings in the market. Um. This swing
Speaker 1: was something else though, Uh, you know, I remember distinctly
Speaker 1: that the TV News channels, the cable news channels broadcasting
Speaker 1: these massive demonstrations in Greece, in Athens and other parts
Speaker 1: of Greece as people sort of rebelled against the austerity
Speaker 1: that was being imposed on Greece as as part of
Speaker 1: their bailout conditions from the European Union. Um. And so
Speaker 1: the market was understandably weak because of that. But then
Speaker 1: all of a sudden, the bottom just dropped out, and
Speaker 1: I mean within minutes, uh, every X was crashing. I
Speaker 1: think at the low point that Dow in the SNP
Speaker 1: had both dropped more than nine percent during the day.
Speaker 1: It was insane and and all of that within a
Speaker 1: matter of minutes, some blue chip company stocks were trading
Speaker 1: for literally a penny apiece. Um. So so needles to say,
Speaker 1: we didn't quite have a great explanation that day in
Speaker 1: the in the Market's wrap. It's ten years later though,
Speaker 1: and we're very lucky to have on the show someone
Speaker 1: who has uh an excellent book out on this topic
Speaker 1: and on the role of sort of one loner trader
Speaker 1: outside of London, the role he played on that day
Speaker 1: when the markets just went crazy. So very happy to
Speaker 1: have him on the show. His name is Liam Vaughan.
Speaker 1: He's an investigative reporter with Bloomberg News in London and,
Speaker 1: as you said, author of that new book flash Crash,
Speaker 1: which I know I'm a little biased, he's one of us,
Speaker 1: but honestly, I think this is gonna be one of
Speaker 1: those finance books that is going to be a must
Speaker 1: read for every on. It's going to be on everyone's
Speaker 1: bookshelf soon because from what I've read of it so far,
Speaker 1: it's just so excellently well written and well reported. Uh So, Liam,
Speaker 1: I hope you're not blushing too much, but welcome to
Speaker 1: the show. I can hardly thank you. Michael, no problem.
Speaker 1: So tell us briefly, I know, I mean I could
Speaker 1: talk about this for hours, but just briefly, sort of
Speaker 1: give us a portrait of uh this character nav Saro,
Speaker 1: who was uh this loner trader outside of London that
Speaker 1: the US prosecutor sort of zeroed in on for his
Speaker 1: role in this. But how did he get to that
Speaker 1: point where he's a guy that uh could at least
Speaker 1: play some role in what happened on the markets that day? Yes, so,
Speaker 1: Novenda Sings Around is a fairly ordinary in some ways
Speaker 1: kid from a pretty working class area of West London
Speaker 1: called Hounslow. He lived with his parents. They live in
Speaker 1: a pretty modest semi detached house which is directly below
Speaker 1: the Heathrow flight path. So if you go to his
Speaker 1: road you can literally look up at every five minutes
Speaker 1: you can see the planes fly by so close that
Speaker 1: you can count the windows and all conversations stops because
Speaker 1: you are you know, because you are that close to
Speaker 1: the flight path. So that gives you a sort of
Speaker 1: sense of of where he's coming from. Not a partial neighborhood,
Speaker 1: in other words, absolutely not. No. Um And he was
Speaker 1: a gifted, you know, kind of mathematician at school. He
Speaker 1: had um, you know, some academic chops and he found
Speaker 1: that he could multiply figures in his head with great ease.
Speaker 1: But he wasn't a great scholar. He was a you know,
Speaker 1: a bit of a sort of cheeky lad if you like,
Speaker 1: who loved playing football with his mates. Um And he
Speaker 1: was also a keen computer gamer, so he used to
Speaker 1: play the game Fifa, which is a soccer game, and
Speaker 1: he ended up being in the top seven hundred out
Speaker 1: of three million in the world. So he, you know,
Speaker 1: he was pretty de extrous, good reflexes, pretty obsessive um.
Speaker 1: And then after he'd finished university, he saw an advert
Speaker 1: in the Evening Standard newspaper which literally said wanted futures
Speaker 1: traders must work well under pressure, which is believable to
Speaker 1: how Goldman Sacks hires their Yeah, amazing. And the interesting
Speaker 1: thing about now is that he's kind of arrival into
Speaker 1: the market's coincided with this kind of evolution from the
Speaker 1: pits to the screens. So late nineties you had all
Speaker 1: these pits closing, and you have the beginning of kind
Speaker 1: of mascale or electronic trading, but you don't really have
Speaker 1: high frequency trading at that point, so you have all
Speaker 1: these kind of trading arcades that spring up there are
Speaker 1: a little bit rough and ready, And basically the system
Speaker 1: is that they will back you with money, um, and
Speaker 1: if you don't do well, they'll kind of coach you,
Speaker 1: give you some sort of tuition on how to use
Speaker 1: the software, how to read the markets, a bit of
Speaker 1: you know, economics, that kind of thing, um, and then
Speaker 1: they'll kind of let you loose, and if you have
Speaker 1: some potential, they'll keep giving you more money, and if
Speaker 1: you don't, then they'll let you go. Um. And basically
Speaker 1: the way that the business model works for those arcades
Speaker 1: is that you know, all you need is a handful
Speaker 1: of naves that are very good and they take a
Speaker 1: percentage on everything they make. They charge um, you know,
Speaker 1: per a round trip. And you know it was it
Speaker 1: was a good business model for a while. But most
Speaker 1: of those that walk through this the door of this
Speaker 1: firm few text, which is above a supermarket, you know,
Speaker 1: about forty five minutes outside and miles away from the
Speaker 1: kind of city of London. Um. And so nav you know,
Speaker 1: arrives there like all the other sort of rookies. Um.
Speaker 1: And he's taught a style of tray aiding called scalping,
Speaker 1: which has got nothing to do with kind of macroeconomics
Speaker 1: or looking at interest rates. In the long term. It's
Speaker 1: all about looking at orders coming into and leaving the marketplace, um,
Speaker 1: and looking for clues as to whether the markets about
Speaker 1: to fall or about to rise, and then taking very
Speaker 1: short term positions in and out and in a lot
Speaker 1: of ways it is a weirdly like a kind of
Speaker 1: computer game, you know, where you're reacting very quickly to
Speaker 1: information and data that comes your way. UM. So now
Speaker 1: have you know inevitably turns out to be incredibly gifted
Speaker 1: at this style of trading, and he goes from literally
Speaker 1: having no money at all to having two million pounds
Speaker 1: by the time he leaves few texts five years later,
Speaker 1: which might sound like small fryer, but this is a
Speaker 1: guy who's still living at home with his parents, um,
Speaker 1: and compared to most of the other traders on the floor,
Speaker 1: he was a complete start. So two thousand and eight
Speaker 1: he decides to leave. He's sick of sort of giving
Speaker 1: away his profits to the managers a few texts, so
Speaker 1: he goes home to his parents place, um, and he
Speaker 1: starts trading from there um. But something happens along the
Speaker 1: way which kind of changes I guess his destiny in life.
Speaker 1: He starts to become increasingly fed up with the arrival
Speaker 1: of high frequency trading firms because essentially, you know, what
Speaker 1: h f T or a certain type of HFT does
Speaker 1: is very similar to what navs doing. It's kind of
Speaker 1: looking at orders entering and leaving the market, looking at
Speaker 1: the queue for different price levels, and tries to jump
Speaker 1: ahead of you know, short term price moves. So people
Speaker 1: like navs suddenly found themselves really struggling to compete, and
Speaker 1: rather than quit the market, which is what a lot
Speaker 1: of his friends did. Nev decided that he would get
Speaker 1: in touch with a computer programmer and he would build
Speaker 1: essentially a kind of sophisticated spoofing mach shame, which he
Speaker 1: could not. Yeah, let me just set up because because
Speaker 1: I think that's that's sort of the plot twist where
Speaker 1: it gets really interesting. Because scalping is one thing, and
Speaker 1: correct me if I'm wrong, but scalping is a type
Speaker 1: of trading that's basically legal spoofing. Spoofing is when you
Speaker 1: you intentionally put try to flood the market with orders,
Speaker 1: either by orders to sort of send that futures price
Speaker 1: up or flood the market with sell orders to bring
Speaker 1: it down. Uh, And you don't really intend those orders
Speaker 1: to be executed. You put them in as as sort
Speaker 1: of a way to trick the other traders, whether they
Speaker 1: be humans or computer algorithms, into thinking that there is
Speaker 1: a supply demand imbalance going on. So I'm curious when
Speaker 1: was it when exactly did not make the leap from
Speaker 1: scalping to to actually spoofing. Did he do that as
Speaker 1: sort of a hand trader or was it not until
Speaker 1: he developed this, uh, this computer program that you're talking about.
Speaker 1: So that is a very good question at and I
Speaker 1: guess one that I'm saying I don't know entirely because
Speaker 1: the first time that he um sort of is on
Speaker 1: record as kind of getting involved with spoofing is in
Speaker 1: two thousand and nine, which is when he writes to
Speaker 1: this UM like developer and has a kind of blueprint
Speaker 1: for this algorithm program that he wants to build, and
Speaker 1: it's at that point in time where he's quite specific
Speaker 1: about wanting to exactly, as you say, have a machine
Speaker 1: that will be able to flood the market with said
Speaker 1: orders specifically and then make sure that they never get
Speaker 1: hit so the orders will be canceled. But by then
Speaker 1: other market participants, particularly algorithms that are making very short
Speaker 1: term decisions, will have reacted to it, and the market
Speaker 1: will have moved a couple of ticks, and that will
Speaker 1: be simultaneously trading and trying to sort of benefit from that. UM.
Speaker 1: I mean as to whether it was illegal, the actual
Speaker 1: spoofing rules themselves didn't come in until later until two
Speaker 1: thousand and eleven UM, but arguably what he was doing
Speaker 1: would have been caught up in other kind of statutes
Speaker 1: like fraud security. Yeah, exactly, so, so, Liam, can you
Speaker 1: help explain to us the mechanics of what actually happens
Speaker 1: during a flash crash. I mean, we constantly hear this,
Speaker 1: and I'm sure the mechanics are different in each one
Speaker 1: that has happened over history, But in the likes of
Speaker 1: the one that happened in two thousen, what were the
Speaker 1: actual mechanics underlying? And then how did nav actually get
Speaker 1: pulled into all of this? What was his role in it? Sure? So,
Speaker 1: May six, two thousand and ten, UM, as you was saying, Michael,
Speaker 1: was a very volatile day anyway. It was the kind
Speaker 1: of midst of the Eurozone crisis. Um. The kind of
Speaker 1: fear index was was rising very quickly throughout that weekend,
Speaker 1: increasingly on that day, and you just had prices that
Speaker 1: were we're kind of increasingly fall links throughout the course
Speaker 1: of the US morning, and up until about one thirty
Speaker 1: the market was down about three or four percent already. UM.
Speaker 1: And then you know, panned the camera to Kansas City
Speaker 1: and there is a kind of large pension fund called
Speaker 1: woodele and Reid that had been long stocks and had
Speaker 1: been benefited from a kind of big ramp up in prices.
Speaker 1: But on that day, the fund manager got skittish and
Speaker 1: decided that he wanted to hedge his position, so he
Speaker 1: so he he sold seventy five thousand e minis, which
Speaker 1: is worth about four billion dollars at the time. So
Speaker 1: this very large fund places this very large order. But
Speaker 1: the issue, one of the issues arose in the way
Speaker 1: that they executed the order because they used an algorithm,
Speaker 1: but they didn't include any kind of um like fail
Speaker 1: safe so for example, so the so the algorithm they
Speaker 1: used was to sell at nine percent of the market
Speaker 1: volume until the order was executed. And the issue arose
Speaker 1: in the because the markets were so volatile at that
Speaker 1: point in time, volumes actually spiked and this selling algorithm
Speaker 1: went into overdrive and was just selling and selling and
Speaker 1: selling and selling. There was no kind of price level,
Speaker 1: no stop loss there. So that arrives when you have
Speaker 1: this already highly volatile marketplace, and then there's a bunch
Speaker 1: of other things, weird things that happen as well. So, um,
Speaker 1: you know, this is happening in the the futures markets,
Speaker 1: but meanwhile in the stock markets there is there's like
Speaker 1: technical issues that day that just so happened to be
Speaker 1: happening on the New York Stock Exchange, which means that
Speaker 1: there's delays in prices that are arriving to people, and
Speaker 1: all of this creates a situation where market participants are
Speaker 1: just leaving in their droves um and then suddenly, at
Speaker 1: one forty one PM, the bottom falls out of the
Speaker 1: market and within the space of four minutes it's fallen
Speaker 1: another five per cent um, and you know, there's a
Speaker 1: complete and utter drought of liquidity at that point as
Speaker 1: everyone is kind of pulling the plug, and then the
Speaker 1: crmes stop mechanism kicks in because the pride, the volty,
Speaker 1: the velocity of the movie is so great that it
Speaker 1: pauses the market for five seconds and at that point,
Speaker 1: you know, it's the longest five seconds in the world
Speaker 1: while everyone's kind of waiting to see what happens. And
Speaker 1: then miraculously and again kind of confusingly because nobody knew
Speaker 1: really why at the time, but the market as soon
Speaker 1: as as soon as the market reopens, prices starts to
Speaker 1: rally again um and within half an hour they're back
Speaker 1: at the level they were before the drop. But meanwhile,
Speaker 1: in the US stock market, there are, as Michael mentioned,
Speaker 1: you know, some stocks that are trading at like no
Speaker 1: all point zero zero one cent others that are suddenly
Speaker 1: trading at hundred thousand dollars um because there's no liquidity
Speaker 1: in the market, so they've gone to these things called
Speaker 1: stop stub quotes, and and so in the aftermath of
Speaker 1: all this, there's a big period of introspection. There's an
Speaker 1: investigation by the CFTC and the SECUM and they come
Speaker 1: to the conclusion that a combination of the kind of
Speaker 1: changing marketplace and the increasing preponderance of electronic trading and
Speaker 1: high frequency trading, the extreme macro economic conditions, and this
Speaker 1: pension fund had all combined to create the conditions for
Speaker 1: this exceptional market event. Naver Sara is nowhere to be
Speaker 1: seen at this point. It's only two years later when
Speaker 1: another day trader happens to be kind of back testing
Speaker 1: his trading system on May six, two and ten, just
Speaker 1: randomly picks that day, and he notices that throughout that
Speaker 1: day in the order book there are hundreds of millions
Speaker 1: of dollars of sell orders that are just sitting there,
Speaker 1: never get hit. As soon as the price moves, they
Speaker 1: get canceled and reposted um. And to him it's just
Speaker 1: like a complete shock and an eye opener like, what
Speaker 1: the hell Like, you know, surely this had had a
Speaker 1: contributing factor as well. So he blew the whistle essentially
Speaker 1: to the CFTC. They've got a program now where if
Speaker 1: you lead to a successful conviction, you know, you get
Speaker 1: paid for it. So this guy who I interview in
Speaker 1: the book and I call him Mr X, blows the whistle.
Speaker 1: And that is the first time that Nav appears on
Speaker 1: the radar of the authorities. He probably wouldn't have done
Speaker 1: if he wasn't for this guy. And then fast forward
Speaker 1: to two thousand and fifteen and and Nav, you know,
Speaker 1: is asleep in his parents house, in his bedroom in
Speaker 1: hound Slow, and he gets a knock on the door
Speaker 1: and it's you know, a dozen FBI agents and police
Speaker 1: officers and they arrest him for manipulation in the market
Speaker 1: and for spoofing and over a period of a long
Speaker 1: period of time, but specifically as well um on the
Speaker 1: day of the flash crash um. So you know, one
Speaker 1: of the questions I attempt to grapple with is the
Speaker 1: extent to which Surround really had a significant impact on
Speaker 1: what happened that day, whether he was just a contributory factor,
Speaker 1: whether he had no impact at all, And there's people
Speaker 1: with views across that whole spectrum eving to this day.
Speaker 1: I know, and I think you and I had gotten
Speaker 1: a little bit of a Twitter conversation about that with
Speaker 1: some others. Um. And so it clearly, as you point out,
Speaker 1: there were structural issues with the market. There was you
Speaker 1: know what Ellen read a fund manager putting in a
Speaker 1: very aggressive, you know, ill advised sal ord or into
Speaker 1: the market. UM. I do think people sort of rallied
Speaker 1: behind the character of Nav because he's very much a
Speaker 1: sympathetic character, as you say, a blue collar kid. I
Speaker 1: believe he has Asperger's right. Um. Uh, you know Matt
Speaker 1: Wiz who sort of makes this small fortune on his own. Um.
Speaker 1: And he's kind of, you know, treating the market like
Speaker 1: a video game, playing at the way he best sees fit.
Speaker 1: And I don't wonder though, Liam, Now, if if there
Speaker 1: were some giant hedge funds, some multibillion dollar hedge fund
Speaker 1: or some uh you know, emerging high frequency trading firm
Speaker 1: that was doing what he was doing. I mean, he
Speaker 1: was he was responsible for what was it like thirty
Speaker 1: or forty of the seal orders on the spres that
Speaker 1: day something like. One statistic is staggering is that he
Speaker 1: was amongst the top five largest traders on the E Mini,
Speaker 1: which is one of the biggest futures markets in the world,
Speaker 1: for a period of five years. So crazy to consider
Speaker 1: one person day trading at home. Yes, I just wonder,
Speaker 1: what do you think, you know, Uh, would the sympathy
Speaker 1: be there for what he was doing if if did
Speaker 1: say it's been a ten billion dollar hedge fund, I
Speaker 1: won't name any names, or you know, a prominent firm.
Speaker 1: I think you're absolutely right. The thing about nav is
Speaker 1: that he was an outsider. He was like David taking
Speaker 1: on Golias. You had Michael Lewis's book that had just
Speaker 1: come out about high frequency traders and now throughout his
Speaker 1: whole career, and he put you know, there's all these
Speaker 1: emails that came out afterwards. He used to call the
Speaker 1: HRT firms nerds and geeks, and he used to complain
Speaker 1: about them. So he became like almost like a folk hero.
Speaker 1: So particularly so a lot of day traders. I do
Speaker 1: think that you are right, you know, And and there
Speaker 1: have been a bunch of both banks and hedge funds
Speaker 1: and large h of T shops that have now been
Speaker 1: done for spoofing, and that certainly doesn't seem to be
Speaker 1: the same level of of sympathy around it. Um. My
Speaker 1: view on the flash crash itself is it's, you know,
Speaker 1: it's it's almost impossible to reverse engineer what happened in
Speaker 1: such a complex and busy market. It's just sort of
Speaker 1: suffice to say that he was a major player. He
Speaker 1: was a major kind of seller, um, and other market
Speaker 1: participants were reacted to his orders. So I don't think
Speaker 1: you can really say that he had nothing to do
Speaker 1: with it. Um. But again, would it have happened if
Speaker 1: he wasn't there? Maybe maybe it would. So yeah, it's
Speaker 1: hard to prove the you know, the hypothetical what would
Speaker 1: have happened if he wasn't around? Hey, Liam, Like I said,
Speaker 1: I wish we could talk about this for hours, um,
Speaker 1: but I think that's all the time we have for today.
Speaker 1: I encourage everyone check out this book. I and I
Speaker 1: believe it's going to be made into a movie. Or
Speaker 1: is that correct? It is? Yeah, the Dev Patel, the
Speaker 1: you know, amazing Hollywood actor, has signed onto play nav
Speaker 1: if you could believe that, So congratulations and yeah, everyone
Speaker 1: everyone has to either download the book or purchase the
Speaker 1: book somehow, because it's the perfect quarantine rate. And if
Speaker 1: you need someone to play a frazzled stocks market editor
Speaker 1: trying to keep up with all of it, you know,
Speaker 1: I'm I'm I'm Availbule. I'm just saying, and the frazzle journalist, Liam,
Speaker 1: thanks so much for coming on the show. We appreciate
Speaker 1: it for having me, guys, it was a pleasure. All right.
Speaker 1: Now we're going to switch gears a little bit from
Speaker 1: the flash crash of two thousand and ten to an
Speaker 1: area of the market that itself has been pretty volatile
Speaker 1: amidst the coronavirus crash, right, Mike, Yeah, absolutely, Sarah, And
Speaker 1: I'm fascinated to talk to our next guest because, as
Speaker 1: we all know, the U S stock market is basically
Speaker 1: become dominated by the big five stocks. You know, Microsoft, Alphabet, Amazon, Apple,
Speaker 1: and Facebook makeup of the stock market right now. Um,
Speaker 1: But there's this whole other world of companies out there
Speaker 1: around the world, global small cap companies. And I think
Speaker 1: a lot of investors maybe get scared at the notion
Speaker 1: of global small caps just because it's unfamiliar. So our
Speaker 1: guest is gonna walk us through how he goes about
Speaker 1: UH screening through the universe of global small caps to
Speaker 1: find value and to find growth potential in You know, again,
Speaker 1: what I think is an area that most American investors
Speaker 1: aren't very comfortable with. So so hopefully we'll make them
Speaker 1: a little bit more comfortable, UH with some insights from
Speaker 1: Joffer riz Vey. He's a portfolio manager of the Harding
Speaker 1: Lovener Global Small Companies and International Small Companies Funds UH. Joffer,
Speaker 1: welcome to the show. Let's let's start with that basic idea.
Speaker 1: I mean, I think of the universe of small cap
Speaker 1: stocks around the world, and I don't know what it
Speaker 1: must be number in the thousands, if not tens of
Speaker 1: thousands of potential stocks. So how do you sort of
Speaker 1: um sift through that opportunity set? What is what's sort
Speaker 1: of your process for screening the whole world of small
Speaker 1: caps and and finding stuff that you like. Sure, so
Speaker 1: the global universe is well or ten thousand companies. In fact,
Speaker 1: some of the indusseries that we are benchmarked against, like
Speaker 1: the m c I All Country World Index, has about
Speaker 1: six thousand companies in it. So it's a very large universe.
Speaker 1: If you even think about the US the Russell two thousand,
Speaker 1: as the name suggests, is four times more than the
Speaker 1: SMP five hun group, So this is a much much
Speaker 1: larger universe than than large caps and on an absolute basis,
Speaker 1: in terms of how we screen through it, we use
Speaker 1: essentially four criteria and we are looking at companies about
Speaker 1: what to invest in. Topmost is the competitive position of
Speaker 1: the company. We look for a competitive advantage that's there
Speaker 1: today and that's sustainable in the long term. We then
Speaker 1: look at the quality of the management team, which is
Speaker 1: particularly important in small caps. Incremental decisions by management have
Speaker 1: a much bigger ripple effect in small caps versus large caps.
Speaker 1: Then we look at sustainable growth, how big is the
Speaker 1: market the company's addressing, can it take market share? And
Speaker 1: then last we look at financial strength, which is the
Speaker 1: quality of the underlying financials, the accounting, the balance sheet,
Speaker 1: things like leverage. So those are the four things we
Speaker 1: look at, and we could sometimes use a screen based
Speaker 1: on those criteria, which would be a quantitative screen, and
Speaker 1: sometimes it would be visiting these companies and figuring it
Speaker 1: out by ruling of our sleeves and traveling to their
Speaker 1: headquarters and things like that. Drop or are there any
Speaker 1: qualities that you've maybe been looking for even more so
Speaker 1: are placing more emphasis on in the past couple of
Speaker 1: months as we face everything going on. I mean, seems
Speaker 1: like measures of leverage and profitability have really come under
Speaker 1: the microscope. And that's part of the reason that when
Speaker 1: you do look at broad benchmarks of small cap funds,
Speaker 1: they've underperformed. So I'm curious if there's anything in this
Speaker 1: environment that you find to be even more important to
Speaker 1: be aware of. Absolutely, so we you know, first principle
Speaker 1: as we stick to our hinting, so we'll still look
Speaker 1: at these four criteria that I that I outlined, but
Speaker 1: as you mentioned, uh, financial leverage is very important. It's
Speaker 1: coming under the microscope. In fact, we looked looked at
Speaker 1: in quarter one which endined mark thirty one this year,
Speaker 1: we looked at different quintiles of performance. When the quintiles
Speaker 1: were based on interest coverage, which is a measure of
Speaker 1: the average UM. So when we looked at inface coverage,
Speaker 1: we looked at UM what did the most labored companies
Speaker 1: perform versus the least labored companies by quintile, and so
Speaker 1: we put them in five buckets and what we saw
Speaker 1: us there was about a thousand basis point difference between
Speaker 1: the least level companies, meaning that they underperformed much less.
Speaker 1: Now everything was down, by the way, but they were
Speaker 1: down much less than the most labored companies, and there
Speaker 1: was a little over a thousand basis for in difference
Speaker 1: between that. So that immediately makes us aware that this
Speaker 1: has been an important factor sort of speak. But we've
Speaker 1: always looked at it. As I mentioned that financial strength
Speaker 1: is one of the criteria we look at. UH In
Speaker 1: this environment, small caps particularly are going to be under
Speaker 1: the microscope in terms of financial leverage because it's you know,
Speaker 1: they don't have the flexibility of large caps. It's very
Speaker 1: easy for them to lose business in such a way
Speaker 1: that their free cash fows diminished significantly so that they
Speaker 1: can pay back their interest. So in this environment, if
Speaker 1: you flip it around and if a company does have
Speaker 1: strong financial strength, then it's actually going to give it
Speaker 1: competitive advantage as well. In other words, they can continue
Speaker 1: to invest while others are scrambling for cash or maybe
Speaker 1: even winding up. They can continue to invest in R
Speaker 1: and D and new plans. So we think it it's
Speaker 1: not just important in and of itself, but It's also
Speaker 1: important because it gives the company competitive advantage. So that's
Speaker 1: the single biggest thing. But again I would say that
Speaker 1: competitive advantage of the company, this continues to be one
Speaker 1: of the single biggest things we look at. You know what,
Speaker 1: I hear small caps, and and even when I hear
Speaker 1: international equities, I sort of I sort of think risk.
Speaker 1: You know, I I feel like there's a touch hole
Speaker 1: potentially more gains there. You know, small caps over the
Speaker 1: long run famously do better than big caps, but they're
Speaker 1: often is that trade off with sort of higher blatility?
Speaker 1: Am I wrong in thinking that? Jeffers is the sort
Speaker 1: of risk adjusted returns of small caps around the world? Um,
Speaker 1: you know, how does that compare to the US? So
Speaker 1: if we look at international small cap risk as measured
Speaker 1: by standard deviation of returns, globally, it is higher. We
Speaker 1: looked at the last twenty years and what we found
Speaker 1: is if you take the excess returns in the numerator,
Speaker 1: which is the access returns of small caps and believe
Speaker 1: versus large caps, and then you divide that by the
Speaker 1: access risk. In other words, this is the sharp ratio
Speaker 1: how much access returns am I getting versus how much
Speaker 1: excess risk am I taking taking and the net of
Speaker 1: that ratio is still positive and and statistically significant, meaning
Speaker 1: in simple English, and just hit for risk. I still
Speaker 1: have better returns in small cap historically looking into the
Speaker 1: last twenty years, which is a good basis of thinking
Speaker 1: about our small caps because this is multiple cycles, multiple
Speaker 1: market cycles. Well before we get to the craziest things.
Speaker 1: I know Mike especially is really looking forward to it.
Speaker 1: This week. I want to know, have there been any
Speaker 1: companies within your portfolio in the last couple of months
Speaker 1: where what's happened due to the coronavirus and people having
Speaker 1: to stay at home where the risk profile has just
Speaker 1: completely changed and you guys have had to go back
Speaker 1: and just completely maybe reevaluate your outlook on that company
Speaker 1: and the whole ding going forward. So so I give
Speaker 1: a few different examples here, uh, companies where the risk
Speaker 1: profile has changed unfavorably and in some cases, you know,
Speaker 1: surprisingly the company has been a beneficiary of mean innars
Speaker 1: of surprising but on the margin, you know, a little
Speaker 1: bit different than what we were expecting originally. So an
Speaker 1: example of a company that got directly impacted both because
Speaker 1: of coronavirus as well as the oil shop is core
Speaker 1: laps there and oil services company. They provide reservoir management
Speaker 1: services to large, large oil majors. And this company suffering
Speaker 1: is suffering from a lack of demand. And there's also
Speaker 1: some labor editions as well. So in cases like these,
Speaker 1: what we're constantly doing, and it's more acute in a
Speaker 1: crisis like this, is we're re evaluating the fundamental thesis
Speaker 1: that we had and against this again, against those four
Speaker 1: benchmarks of work is a good company? What is a
Speaker 1: quality growth company? If the company doesn't meet our criteria anymore, ideally,
Speaker 1: the analysts and the PM is raising their hand saying, look,
Speaker 1: we got the thesis wrong. One of the things we
Speaker 1: do continuously and again is brought into sharp focus in
Speaker 1: circumstances like these, is we have something called mileposts where
Speaker 1: we are measuring a company's growth against a pre commitment.
Speaker 1: So we say that we think this company is going
Speaker 1: to grow about the industry, that industry is going se
Speaker 1: we think this company will grow above the If it doesn't,
Speaker 1: if it reports quarterly or six monthly growth that's not
Speaker 1: in line with the milepost, and we will say, okay,
Speaker 1: the smile post is it's broken or it's failed or
Speaker 1: it's behind, and depending on that we revalue it. So
Speaker 1: in some cases. Another case would be Senior, which is
Speaker 1: a part supplier to the aerospace coming out of the
Speaker 1: UK out of the air to the aerospace industry out
Speaker 1: of the UK is again impacted because of lack of
Speaker 1: demand and lack of travel in aerospace. So the the's
Speaker 1: like these are examples where we'll either generically speaking, we'll
Speaker 1: either say, look our thesis is broken, we shouldn't want
Speaker 1: it anymore, or look everything is intact. It's just a shock.
Speaker 1: The long term still looks good, in which case it's
Speaker 1: become more attractive. Let's buy more of it, so the
Speaker 1: outcomes would be salad or added to it as you
Speaker 1: might imagine. The flip side is the flip side of
Speaker 1: this is companies where we've been surprised, where one example
Speaker 1: is one of the world's largest shipbrokers, again a company
Speaker 1: out of the UK called Clark Since where because of
Speaker 1: the demand for storage of oil. Because oil became cheap,
Speaker 1: demand for storage went up. This company supplies big oil
Speaker 1: tankers or pod carriers, and um it benefited from them.
Speaker 1: We did not expect that when we initially started the
Speaker 1: thesis is on this company, that was a boon for
Speaker 1: this I mean you didn't expect jagative oil prices to
Speaker 1: help the oil upstart. So I imagine that you know
Speaker 1: that was that was a little bit unexpected. A more
Speaker 1: expected outcome would be heavy. Like can Access which is
Speaker 1: a Canadian supply chain management software company, demand for supply
Speaker 1: chain management software went up because the companies are trying
Speaker 1: to figure a new supply chains and this company provides
Speaker 1: real time supply chain management software. You know where doing inventorieschool,
Speaker 1: which warehouses should they go to and where should I
Speaker 1: ship out from? And demand for these company's software went up.
Speaker 1: So so surprises on on on on both sides. Companies
Speaker 1: that we're negatively it to some companies that were positively
Speaker 1: it as well. And in those cases where there where
Speaker 1: where there's a where there's a positive outcome. What what
Speaker 1: we're doing is we're saying, what is the valuation of
Speaker 1: this company? Is the growth a little more attractive, can
Speaker 1: we hold it for a little longer, should be trimmed
Speaker 1: or should be selling evaluation? So again the food side
Speaker 1: of the cell trim decision in these cases, well, Sarah, uh,
Speaker 1: that's a great segue to the craziest things we saw,
Speaker 1: because um, the negative oil price shock is just the
Speaker 1: crazy thing that keeps on giving. And I'll start with mine,
Speaker 1: which once again has to do with just the amazing
Speaker 1: glut of oil around the world right now. So Wall
Speaker 1: Street Journal story talking about the creative ways people are
Speaker 1: lengths they're going to the store oil. Remember when this happened,
Speaker 1: a lot of my friends were joking like, oh, you
Speaker 1: can put it in my garage or fill my swimming pool.
Speaker 1: Well guess what people are really doing that this this
Speaker 1: journal story, it's nuts. There's there's uh, all these crazy
Speaker 1: schemes people have to buy oil. Guys buy an oil
Speaker 1: for like a dollar eighteen of barrel, uh, and they're
Speaker 1: trying to stick it in caves, abandoned rock mines and
Speaker 1: even giants swimming pools. There's and there's something called a
Speaker 1: fuel bladder that's some guys selling that is basically just
Speaker 1: a big giant rubber containment thing for for story storing oil. So, um,
Speaker 1: good luck to all these people filling their swimming pools
Speaker 1: with oil. I gotta say I hope that or else.
Speaker 1: That's a lot of effort for a whole lot of
Speaker 1: nothing and a good contribution from Twitter from a guy
Speaker 1: at Financial Gambler. His craziest thing in markets is similar.
Speaker 1: It's some how Goldman Sacks has been looking at the
Speaker 1: use of Zoom and that the user base of Zoom
Speaker 1: and other sort of video conferencing techniques to kind of
Speaker 1: suss out what the future demand for oil is, with
Speaker 1: the thinking obviously that if you're if you're doing more
Speaker 1: virtual meetings, you know you're gonna be taking less car
Speaker 1: trips and and business trips and air air trips and
Speaker 1: that sort of thing. So, um, it is the crazy
Speaker 1: thing that keeps on giving, for sure. It truly is
Speaker 1: it truly is you mentioned uh using zoom as a
Speaker 1: measure of looking at measures of oil in a way,
Speaker 1: but a lot of people have been looking at alternative
Speaker 1: data through what we're going through and my crazy thing, um,
Speaker 1: it's it's a little bit sobering, I will I'll preface
Speaker 1: it with that. Um. But there was data out of
Speaker 1: open table this past week showing that their forecast, they're
Speaker 1: calling for one in every four restaurants to go out
Speaker 1: of business by the time this all ends, which is
Speaker 1: really crazy to think about and it hard to wrap
Speaker 1: your mind around, because I feel like there's so many
Speaker 1: people thinking that once economy is reopen, we're just gonna
Speaker 1: snap back to normal. But that just really highlights how
Speaker 1: much everything might change. Right, So, Jeoffrey, I hope you
Speaker 1: don't have any restaurant chains in your funds. Have you
Speaker 1: seen any crazy things in the market this week? I
Speaker 1: think for us, the the the most. The craziest thing
Speaker 1: I would say is that despite value underperforming for so long,
Speaker 1: including you know, this year, even this past week, the
Speaker 1: discrepancy between the performance of small cap value versus small
Speaker 1: cap growth and it's just huge. I'm looking at US
Speaker 1: small caps for example, in the US value small caps
Speaker 1: are down ten percent in the last week or so,
Speaker 1: growth small caps are down five, so about that's a
Speaker 1: huge difference. And and this is after if you look
Speaker 1: globally small caps, small cap growth is down fourteen percent
Speaker 1: and small cap values down thirty percent, so you know,
Speaker 1: over twice as much. So despite the year to day,
Speaker 1: it just continues. And there are so many people calling
Speaker 1: for a turnaround in this situation with abridging change, where
Speaker 1: value starts are performing, and week after week, including this
Speaker 1: last week, it just it's the same story. Yeah, another
Speaker 1: even before the virus, everyone was predicting that was right
Speaker 1: around the corner. It's uh, someday, someday we'll get that rotation,
Speaker 1: even even within the large cap arena. I mean, an
Speaker 1: unbelievable statistic from this week. At one point on Thursday,
Speaker 1: if you look at an equal weighted version of the SMP,
Speaker 1: it was down eight and a half percent, whereas the
Speaker 1: SMP was only down about five percent on the week,
Speaker 1: And that was the largest weekly discrepancy in at least
Speaker 1: thirty years. So it just shows you that we continue
Speaker 1: to see, as you said at the beginning, mega caps
Speaker 1: just ruling really in the stock market and anything, um
Speaker 1: that's a bit smaller just it hasn't. Yeah, yeah, it's
Speaker 1: really hard hard to see any of that reversing until
Speaker 1: this sort of virus goes away or at least gets
Speaker 1: under control and the cyclical value stock start performing again.
Speaker 1: But um, oh sorry, you know, we did get a
Speaker 1: call from the what Goes Up hotline with a pretty
Speaker 1: good crazy thing. Let's let's take a listen, and my
Speaker 1: name is John, And to me, what the craziest thing
Speaker 1: is is that nobody seems to focus on the fact
Speaker 1: that the FED and the Treasury have eliminated capitalism. So
Speaker 1: these the bastillion of capitalism, the Federal Reserve has effectively
Speaker 1: stopped capitalism from working. And your buy back the hypothication
Speaker 1: of now obviously moving towards possibility that the FED is
Speaker 1: going to buy equities is a perfect example of that.
Speaker 1: The key component of capitalism is efficiency mechanism, which allows
Speaker 1: businesses to fail and that capital then gets reallocated. So
Speaker 1: not really sure why the society UM hasn't focused on that,
Speaker 1: except if it's just obstruction of that information. UM. Last crisis,
Speaker 1: Bloomberg had to sue the FED in order to get
Speaker 1: the information. Now it seems I don't know what's crazier,
Speaker 1: the fact that they're doing it or that no one
Speaker 1: seems to care. But that's a little negative. But that's
Speaker 1: my view of the insanity. Sorry, I thought a lot
Speaker 1: about that voicemail. It's it's a pretty uh intriguing voicemail,
Speaker 1: And at first I was thinking, well, that's a little
Speaker 1: bit of hyperbole on this guy's part. The FED killed capitalism,
Speaker 1: But yeah, when you think about it, I mean, the
Speaker 1: cure for this virus really was to shut down capitalism,
Speaker 1: or at least big chunks of it, huge spots of
Speaker 1: industry in this country. So I'm not sure if the
Speaker 1: FEDS the one who did it, or the actual government,
Speaker 1: local government, state governments, and the FED just kind of
Speaker 1: reacted to this new regime we're in. But I'm not
Speaker 1: I'm not sure he's he's too far off with that.
Speaker 1: And we did hear from Powell this past week who
Speaker 1: even said, as it stands, there's really not much more
Speaker 1: potentially that they can do, although they will do whatever
Speaker 1: they need to do, but they're now calling on d
Speaker 1: C and for more physical policy because at this point
Speaker 1: in time, unless they go negative, which they said they
Speaker 1: don't want to do at least for now. I mean,
Speaker 1: what more is there there for the FED to do?
Speaker 1: Crazy times? Indeed, uh Joffre, I don't know, what do
Speaker 1: you think? Did the FED kill capitalism? I hope it's
Speaker 1: not that easy to kill capitalism, that's right, very tough
Speaker 1: to beast to kill. Indeed, I agree, interestingly, that's so
Speaker 1: that voicemails a few days ago. I did see R
Speaker 1: I P. Capitalism trending on Twitter yesterday, so I don't know,
Speaker 1: I don't know, are catching on? Yeah? Yeah, but who
Speaker 1: who would have ever believed we'd be discussing whether or
Speaker 1: not capitalism was murdered in our time. Certainly not I,
Speaker 1: not I. But with that said, Joffer Risby, so glad
Speaker 1: that you were able to join us on the show
Speaker 1: this week. Thank you, Sarah, Thank you Mike. What Goes Up.
Speaker 1: We'll be back next week. Until then, you can find
Speaker 1: us on the Bloomberg Terminal website and app, or wherever
Speaker 1: you get your podcasts. We'd love it if you took
Speaker 1: the time to rate interview the show on Apple Podcasts
Speaker 1: so more listeners can find us, and you can find
Speaker 1: us on Twitter, follow me at at Sara pont Zack,
Speaker 1: Mike is that Reaganonymous, and you can also follow Bloomberg
Speaker 1: Podcasts at podcasts. What Goes Up is produced by Toper Foreheads.
Speaker 1: The head of Bloomberg podcast is Francesca Levie. Thanks for listening,
Speaker 1: See you next time. Before