In one sentence: Prices are more sensible but still not cheap, so Phil and Danielle explain why the market was so expensive before the crash, what someone who stayed fully invested should consider, why valuation now must account for a possible depression, and why they won't hand out stock picks.
Key ideas
- More sensible, not cheap. The S&P 500 P/E was about 17, above the 15 to 16 average. Total market value to GDP had hit about 175% (Phil's figure) against a long-run average near 80%. [01:00–05:00]
- Shiller P/E. Robert Shiller's cyclically adjusted P/E (ten-year earnings, inflation-adjusted) averages around 15 to 16. It had passed 30 only in 1929, 1999 and 2008, and was at about 24 to 25 on the recording date. High levels have tended to be followed by low long-run returns (Phil says under 5% a year over 20 years). [05:00–07:00, 13:00–14:00]
- Not timing the market. Selling because prices are too high by valuation is different from selling because the drop scares you. The second is timing and, by the emotional rule of investing, the market tends to go the opposite way once you act. [08:00–11:00]
- A legitimate reason to hold cash. Danielle argues an older person with enough money may want to preserve capital. Phil agrees, but says someone who can't afford further loss must consider how far down they can stand: a deep recession has meant falls of 50% or more, and about 80% in the worst case. [11:00–18:00]
- Dollar-cost averaging breaks in a crisis. The method assumes you keep buying. In a recession people lose jobs and stop, so the average ends up made of high prices. [18:00–20:00]
- Prospects. Phil cites JP Morgan's worst-case 14% unemployment by year-end, and Bill Gates saying large gatherings won't resume soon. Banks are tightening credit. [14:00–17:00, 22:00–25:00]
- Where is the money going? Danielle asks why stocks hold up if there is nowhere to put money. Phil says it's going to cash and short bonds, and long lending has dried up. [20:00–24:00]
- Value in a possible depression. The usual price rule: 10 times owner earnings or free cash flow. But you can't use a boom year's number. Use Chipotle as an example: will it survive, can it handle leases? Ask "would this company do well in 1931?" [26:00–30:00]
- What did well in the Depression. Small luxuries (Coke, movies, makeup), utility-like monopolies (AT&T) and energy. Also plan for three paths: recovery, depression, or stagnation. A company that can do well in more than one is the target. [29:00–37:00]
- State intervention risk. Airlines, banks and healthcare could see partial nationalisation. Ownership risk is a reason for caution in some sectors. [37:00–40:00]
- Currency devaluation. Argentina's cut in the currency's value is Phil's example of governments reducing debt by devaluing. Real businesses, gold, farmland and rental real estate may hold up better than cash over years, though cash is useful now. [40:00–43:00]
- No stock tips, conviction instead. Smart professionals disagree about any company. If you buy because someone says so, a price fall will scare you. You need your own conviction. [45:00–47:30]
How it maps to RuleOne
- Market valuation is a context line, not a screen input: RuleOne ranks companies one by one. But the Shiller P/E explains why the screen may show few candidates in expensive markets.
/holdings/can show how much of the portfolio sits in cash, matching the "cash as a position" idea.- The "10 times owner earnings" price is the rough valuation used in the stock pages; this episode adds that the earnings input must be stress-tested.
Buffett, Munger and Graham links
- Buffett has said total market value to GDP is "probably the best single measure" of valuation (Fortune, 2001). That is the origin of the 175% figure's relevance.
- Graham's Intelligent Investor (ch. 8) frames the market as a mood-swinging partner.
- Munger's inversion: consider what would break the company, such as a depression or lender pullback.
Words to know
- Shiller P/E (CAPE): price over the average of ten years of inflation-adjusted earnings.
- Dollar-cost averaging: investing a fixed amount at regular intervals.
- Nationalisation: the state taking ownership of a company or industry.
- Currency devaluation: a government cutting the value of its money.
Try this
Take one company from your watch list and compute a rough value as 10 times free cash flow. Then redo it with free cash flow cut by 40% to represent a bad year. Compare both with the price on its /stock/TICKER/ page.
Check yourself
- Why can selling after a drop count as market timing, while selling at the top may not?
Answer
The first is driven by fear of price moves. The second is driven by valuation, because nothing is cheap enough to buy. - Why might dollar-cost averaging fail in a deep recession?
Answer
People lose jobs and stop buying, so they end up averaging only the higher prices. - What question does Phil add when valuing a company in a possible depression?
Answer
Would the company do well in 1931? That is, can it survive and keep earning if conditions are far worse than last year?
Short quotes
"You can't buy it on that basis, because if it starts going down like a brick you would be scared to death." (Phil, ~46:00, auto-transcribed)