Virtual Strategic Investment Conference 2020

Interview of Leon Cooperman (Omega Family Office) by David L. Bahnsen (founder, Managing Partner, and Chief Investment Officer of The Bahnsen Group, a private wealth management firm)

Please note: The following is a transcription of the audio interview. Please forgive any typographic or grammatical errors.

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Leon:

• What happened. I’m very un-involved politically to be honest with you. I go with the dictum that you can tell a politician is lying by watching their lips move, whether it’s the Republicans or the Democrats. I’m a registered independent. So, what happened is I gave a talk at a conference much like this one, not as large, not as successful. And at the end of my presentation, I said nothing about politics. The moderator asked me what I thought the market would do if Elizabeth Warren was elected president. And I said that, I thought the market would go down 20%. And I said, maybe they wouldn’t even open the market as a little bit hyperbole, for sense of humor. And the very next day, she tweets not knowing anything about me, what I stand for, what my plans are to do with my money.
• She tweets Leon, I’m only asking for 2% to give others a shot at the American dream. Now, without bragging, I’ve been very fortunate, having been born in the right country, have the right instincts, and I’ve taken a “giving pledge” with Warren Buffett.
• And I told Mr. Buffett, nine years ago, when I took the pledge that asking for half isn’t asking for enough, I pledge to give away all my money back to society, but I decided to take the high road with her. You know, Michelle Obama said, when they go low, we go high.
• I wrote her (Elizabeth) a rather, you know you saw enough of the letter, I guess, to include it in your book. I wrote a rather decent letter, very respectful. And she didn’t respond to the letter the next day she tweets again, rather stupidly, insider trader and he owned stock in Navient.

(SB here – Lee was accused of insider trading.)

Leon:

• Number one in the, my case with the SEC, I’m not supposed to say I won or lost, but everybody knows, basically, anyone who knows anything about the facts knows that I won.
• Bottom line, Elizabeth Warren is a socialist. Bernie Sanders, thankfully he’s out of the race, is a communist.
• I’m a capitalist, you know, Winston Churchill said the main vice of capitalism is the even distribution of prosperity. The main vice of socialism is the equal distribution of misery.
• So, you know, she proved to me to be a politician in the worst sense of the word. I gave her a respectful, good, well-reasoned letter. Okay. And what did she do? She didn’t respond to anything in the letter. She just went off on a tweet, but you know, she fell from grace.
• She’s not in the running. Hopefully, she’s not a vice presidential candidate with Biden, but we’ll have to wait and see.

Leon on Taxes:

• I think the central debate for the country is the following: wealthy people should pay more in taxes.
• I believe in the progressive income tax structure as a nation, we have to coalesce around the question, what should the maximum tax rate be on wealthy people? That will define the revenue yield to the government. That government basically has to size themselves, that revenue.
• Now, for one, I’m willing to work six months a year for the government and six months for myself that feels about right to me. Okay. You asked Bernie Sanders, he probably liked the marginal tax rate at 90%. Liz, suggested a 70% wealth tax. Most countries that have used a wealth tax have repealed it. It doesn’t work. That’d be the most bullish thing they could do for gold.
• So, I’m, you know, I’m prepared to see higher marginal tax rates, but we have to agree as a nation. What should the maximum tax rate be? And I think working half time for the government, half for yourself is reasonable. Trouble with it is if you include the state you live in; you’re already past 50%.

David: And so when you look at the, the subject and even apart from tax policy, the overall issue of class envy, class warfare, that I think was really driving her animosity towards you personally, even in the face of such a compelling biography that you shared in your letter. Are you worried that that story of class envy even divorced from legitimate policy conversations like tax rates, that that will become a more prominent theme in our national politics?

Leon: Unequivocally, actually I should say unquestionably, it will. And it really results in large part from income disparity. And I’m very sympathetic to that, but you have to deal with it.

• You know, I don’t want to take too often quote Winston Churchill. He said you don’t make poor people rich, by making rich people poor.
• My approach is through education. My family and I have [the Cooperman College Scholars] that we’ve sent 500 kids from Newark, New Jersey to college. We pay their tuition. We give them up to six years to get college degree. It’s life changing because you know, the average lifetime earnings of a college graduate exceeds by well over a million dollars, more than a non-college graduate plus you’re giving them more self respect and the, the tools to be competitive in our society.
• I think through education is a way of dealing with it, not through just taxation. I mean, the government has not done intelligent things with the tax money they already gotten from us.

David: Is the message of an opportunity society one that can sell to millennials, Lee?

Leon: Not easy.

• I think the way we have to deal with it is we have to bring more people into economic prosperity. And as I said, not to be redundant, I’m doing it through education. Yes, I think that we have to educate the millennials.
• Look, I would tell Bernie Sanders, you know, he talked so favorably about Cuba. I went to Cuba three years ago. Okay. The Cubans are industrious, hardworking people. They’re doing extremely well in Miami. You go to Cuba; they get a quarter of a chicken once a month for their protein rationing. It takes two hours to get from the suburbs to downtown Havana, just to have no organized transportation system. Its $3 and 85 cents a minute for cell phone service. They can’t afford cell phone service. They have no satellite service, no newspapers, and they live in dilapidated conditions and that socialism or communism versus capitalism. So it’s very clear you know which system works better, very clear.
• And I’d suggest someone in doubt have Kenneth Langone, fly on his plane to Venezuela to see what communism/socialism is all about.

David: Ken’s a great example of another high-profile successful Wall Streeter for lack of a better word who has been an ideological advocate of free market capitalism as, as you have now been. Is your sense that a lot of Wall Streeters who have benefited from free market capitalism are also willing to be publicly ideological about this subject?

Leon: It varies, but I would say yes. I mean, Ken is one of the most fabulous human beings I ever met. I have the highest regard for him.

• Frankly, you have to start from the basic question. How do you get to be wealthy? And how do you get to be a billionaire? You develop a product or service that somebody needs and is willing to pay for it, is the world better off or worse off because of a Jeff Bezos, because of Bill Gates, because of Bernie Marcus who co-founded Home Depot?
• Unequivocally, the world is better off… the consumer is better off.
• And these people are doing wonderful things with their wealth, particularly Bill Gates and what he’s done with the Gates Foundation, so the world is better off.
• The whole American dream is work hard, be successful, and share that success with others who are less fortunate. That’s the American dream.
• And most people I know that are wealthy, basically are doing that. Ken Langone has done enormous things for NYU and is sharing his wealth very generously.

David: David asked Leon about COVID.

Leon: COVID has created numerous issues.

• Let me just say this. I’m optimistic on solving the virus problem. I’m optimistic that the economy will start opening up in May (this month).
• But I believe there are long-term, serious long-term implications.
• Number one capitalism, as we’ve known, it is likely to be changed forever.
• When the government protects you on the downside, they have the right to regulate the upside. And we’re seeing some examples of that already very quickly. I believe there was some congressman or senator that proposed that airlines not be allowed to fly with an occupancy or load factor in excess of 67%. And he said we bailed you out. We have the right to say that. Well, there’s no airline in the world that can make money at 67% load factor.

Leon:  That’s just one example. Other factors that weigh on my thinking, which is really more long-term, not today or tomorrow, it’s clear that the Fed has created an environment of free money and people are feasting off of that.

• But I think long-term beyond this short-term, number one is the change in the outlook for capitalism.
• Second, I think the country is moving to the left and taxes have to go up, quickly if Biden wins much slowly if Trump wins.
• Third, everybody, and I’ve been saying this now for three years, but everybody seems to be bullish on low interest rates, but low interest rates to me are indicative of the troubled economy and that is not bullish. We have negative interest rates in Japan and Europe yet their price-to-earnings ratios are lower than ours. Debt is growing much more rapidly than the economy is growing.

Leon: And more of our national income will have to be devoted to debt service.

• Just think of it this way. We were founded in 1776 from 1776 to 2020. The debt has gone from, I guess, from zero to $23 trillion.
• That number is going up $4 trillion a year, which is much more rapid increase in debt than the economy is growing in real terms.
• That’s another restraining factor on growth.
• Fourth, I think demand is likely to come back slowly. When you think about certain industries, like sporting events and concerts, in my opinion, I could be dead wrong, but you’re not going to get access to a concert or a sporting event without having had a vaccination and a card to show you been vaccinated to get access to that sporting event. That’s probably at least a year away.
• Fifth, business will have substantial compliance costs with the new regime.
• Sixth, there’s going to be substantial equity issuance to replace lost capital. For example, I had a decent sized position, United Airlines as did Warren Buffett. The company brought back 35% of their stock at an average price of $65 and recently sold a billion dollars’ worth of stock at $25 to finance the hole that they’re in. And so there’ll be a lot of equity issuance coming to market.
• Seventh, I think stock repurchases lifted earnings a lot in the last half dozen years. And stock repurchases are largely over.
• Eighth, profit margins tend to be mean reverting. And when this down cycle began, profit margins were a record level as they tend to be at cycle peaks. I expect them to mean revert. We’ll have to deal with that factor (reduced earnings).
• Ninth, I look very much at the credit markets as an alternative to the equity markets and the credit markets, high yield ex energy yields around 7%. That equates to about a 15 P/E multiple in the S&P 500 Index, but it is now closer to something between 19 and 20 times earnings (SB here: On May 31 forward P/E was 22.4). So, expense relative to credit.
• And finally, I said this a month ago, now it’s become commonplace knowledge. I’m a watcher of Buffett and Munger for good reason, uncharacteristically Buffett’s sold airline stocks into weakness recently and he sold his Goldman Sachs stock. And he is sitting on his pile of liquidity, which is uncharacteristic. If the greatest investor of my generation is having difficulty figuring it out, there is no reason for me to be bold. And you can add on other people I spoken with about their views: Stan Druckenmiller and Sam Zell and a bunch of other people. But you know, my own view is the market is fully valued, not dramatically overvalued.

Leon: I’m less convinced about the market being overvalued because of the compositional change in the market. 25% of the index today is high tech, which is very different than it was a decade ago. And so if I put a premium multiple on high tech, say 25% of the market at a 30 multiple and take the other 75% and put a generous 16 multiple that puts a fair valuation at somewhere between 19 and 20. (SB here: what he is saying is the May forward P/E of 22.4 and fair value is a P/E of call it 19.5, that’s not as far a drop vs. a drop to 15. I think he makes good sense. So if earnings can recover from COVID to levels Wall Street analysts expect, which I have my doubts, a 19.5 forward P/E puts the market at approximately 2,700).

• Leon said (he spoke in mid-May 2020) he thinks I think the market is fully valued.
• And the one thing your conference participants should be aware of the whole change in the market structure makes the market a more dangerous place. You know, the machines run the market. (Algorithmic and machine trading.)
• We’re in an environment now where the machines buy strength, they sell weakness, it exaggerates the up moves and the down moves — makes the market very dangerous.
• When I came to Wall Street over 50 years ago, the Volcker Rule didn’t exist and commissions were 25 to 50 cents a share. So, the brokerage industry provided some amount of liquidity and stability to the market.
• The brokerage industry is no longer a stabilizing force in the market. They can’t be – there’s no reason for them to be. They don’t get compensated for it.
• Secondly, 50 years ago, 80% of the volume was done on the New York Stock Exchange. Today, 80% of the volume is done off the NYSE. So, the specialist system doesn’t stabilize anymore.
• And finally, I’ve been fighting a battle, a losing battle, but you know, in 1938, the SEC enacted the uptick rule, which was in response to the abuses of 1929. And that rule worked effectively until 2000. When they eliminated it, it gave rise to these high frequency trader types, which are ruling the markets. They buy strength, they sell weakness. They create unnecessary volatility.
• And I think that’s going to scare the public. It’s going to raise the cost of capital to business. And it makes it very difficult for professionals to act in a rational way.
• And these are all things that affect my thinking. I’m so happy I retired and now I just run my own money, but it’s very difficult dealing with this thing if you’re in a short-term performance game.
• I’m in the long-term performance game, very different.

David: So if you don’t mind, I think it might be interesting for listeners. You mentioned being on Wall Street for 50 years, and these really substantive changes that you’ve seen take place, but we talked a little bit in our prep call about how you had sell side (SB – selling research and stock ideas) experience and, of course, you spent a significant part of your career on the buy side (managing money). Maybe you could tell people your story throughout your career on Wall Street.

Leon: Yeah, well, I, I, I’ve been blessed. I’ve lived the American dream, you know, I’m the first generation in my family born in America, first generation to go to college. All my education was largely public school based, went to public school in the South Bronx High School in the South Bronx. I followed the advice of Horace Greeley. And I went west to college in the West Bronx. To Hunter College, which is now called Lehman College. And then I had a short stint at Columbia Business School, which opened the door to Goldman Sachs for me. And I started my career at Goldman Sachs after I got my degree, January 31st of 1967. I started my career at Goldman February 1st ‘67. The next day, I had no money in the bank, had a six-month-old kid. And I had a student loan to repay.

• I went to Goldman and I had a great run at Goldman and the combination of hard work intuition, a lot of luck, I did extremely well. I spent about 25 years at Goldman. And then I retired from Goldman to start a hedge fund.
• And I got in at the right time and I ran a hedge fund for 26 years. And then at the end of 2018, I decided to hang it up. And I tell my friends who asked me about that decision. And they asked me, how was my life going to change? I said, well, number one, I’m not going to get up at five o’clock in the morning anymore to run to New York, I’ll sleep an hour later in the morning.
• Second, I’m a bit of a beefy guy. I said I’m going to get to a gym three times a week to try and take care of my health. I’ve been doing the first two. No problem.
• The next thing I set out to do was to pay no attention to the S&P 500 and be absolute return oriented, and also tax efficient. And since the bulk of my fortune is in marketable securities, I try to diversify into some more private deals, which are less marketable securities, but that’s really a function of finding the right people to do that.

Leon: And I’m very happy with my decision. I tell everybody with a big smile on my face and I’m like Hyman Roth in Godfather 2. He was at the airport right before they shot him. He said I’m a retired executive living on a pension. I tell people I’m retired money manager living on investment income. The bad news is I have no active income. All my income is passive dividends, interest, capital gains-losses, the good news is I have no pressure. At age 77, swapping pressure for income was a worthwhile trade off. So I’m very happy with my decision and I look to the future with great optimism.

David asked Leon about the risk parity trade…

Leon: Yeah. I think the amount of leverage being used by these risk parity traders, that’s not my game. I’m not the most knowledgeable of it, but I believe they operate them with 10 times leveraged. And when they have got to unwind, they have to unwind in a very aggressive fashion. I really wouldn’t even use the COVID period as an example. Let’s go back to the fourth quarter of 2018.

• That was the worst quarter since the great depression. And there was nothing going on in the economy that would account for it.
• And this is really the result of a lot of leverage in the system and the machines. The machines know everything about price, they know nothing about value. So there are certain things that are triggered and they buy, and there are certain things that trigger and they sell.
• Also, I think one of the things that we have to start worrying about again now is China.

Leon: You know, the President apparently sees himself behind in the polls and it looks like in the last few days, they want to come up with China as a whipping boy to blame all the problems on China. And they’re not going to sit by and just highly accept it.

• So I think that’s another element of risk for the markets to deal with and when the machines see the word China, depending upon what context they’ll buy or sell.
• But, you know, the truth of the matter is I just have to be in a position to capitalize on it. When something is irrationally priced, I want to be able to do something with it.
• And the good thing about my business now is since it’s all my own money; I don’t worry about quarter to quarter performance. I just have to worry that I’m on the right situation and that ultimately the clock will come around to me and prove me, right. And it’s very difficult if you’re running a hedge fund and you are offering quarterly liquidity to be a long-term investor with short-term, short-term capital.

David: So to the extent that your hedge fund was more long-term oriented and you have a value bias, and right now there’s such a focus on short-term gains machine activity. And you mentioned the higher leverage in the financial system. I believe a lot of that increased leverage as a result of there being so many more players that are finding less, opportunities. So leverage becomes an easier way to try to goose returns. Is there enough alpha to go around in today’s hedge fund industry?

Leon: I always think there’s going to be a role for intermediary. It’s not going to be easy.

• Everybody knows how to swing a golf club. Some people do it better than others. I’ve often told the story. You know, one of the most distinguished writers at Fortune magazine is Carol Loomis. She’s very, very distinguished writer, a very capable lady. She wrote an article with the title “Hard Times Come to Hedge Funds.” And that article appeared in Fortune magazine in January of 1970.
• At that time, the industry was probably under a billion dollars and today it’s $3 trillion. So secretly she probably made a good call that lasted for six months, but then ultimately, as performance improved, money went in that direction. So I think if you provide a good value proposition to the investor you’ll grow as a hedge fund.
• It’s becoming more difficult because, you know, in the last decade; the number of publicly traded companies, I think in the United States had dropped by about 40%. The number of hedge funds competing has gone up by four-fold.
• So, four times more players are looking for 40% less the opportunity. So, you have to be more global and multi-asset category approach, et cetera.
• But the opportunity to outperform exists and those hedge funds that outperform will do well. And those that don’t will fall by the wayside. You cannot expect your client to pay you a premium fee for subpar performance. So, you know, one of the interviewing techniques I had when I ran my business, I told them about the parable of the gazelle and a lion. And I explained that every morning in Africa, a gazelle wakes up it knows it must run faster than the fastest lion or it will be killed. Every morning a lion wakes up, it knows it must outrun the slowest gazelle, or it will starve to death. It doesn’t matter whether you were a lion or a gazelle. When the sun comes up, you better be running. And everyone I interviewed, I would go through that parable and so you asked me why this is very simple? Roundly, allowed me the luxury of rounding off 10,000 mutual funds that will manage your money for 1% or less. And you have 10,000 hedge funds. They have the audacity to ask for some type of fee approaching 2% management, 20% of the profits. And if your client is not a mullet and he’s an intelligent guy, and most people looking at hedge funds are intelligent people, basically, even though they’ve been wrong in the last 10 years. Basically, you know they are not going to pay you a premium fee for subpar performance. So if you want a premium fee you better deliver superior performance. And that means when the market, the United States is not working, figure out what is working and getting yourself positioned, whether it be credit currency, foreign stocks, US stocks, et cetera. And you’ve constantly got to be on the balls of your feet. You know, looking for opportunity, that’s not easy, but it can be done.

David: But you made the comment, Lee, in our prep call that people’s disappointment with hedge funds in the last 10 years was largely related to expecting them to be relative return vehicles instead of absolute return vehicles. So, with that, how would you relate that to the comment that hedge funds have been wrong a lot over the last 10 years?

Leon: No, no, I, I, what I would say the following if 10 years ago you came to me and said, if I I’m trying to phrase it the right way, if 10 years ago you, I told you, you don’t want to be in an absolute return vehicle. You want to be in a relative return vehicle. That we would be getting a 10-year economic growth run, no recession, and a 10- or 11-year bull market. After the 2008 experience, you would have locked me up in a nut house. Okay.

• But that’s exactly what’s happened. So the idea of being in a hedge fund in the last 10 years has penalized you because you’re in a vehicle with a manager who has a lot of his own capital tied up. He doesn’t want to be fully invested, wants to be hedged and anything you hedge by and large you’d be hedging prosperity.
• So now we go through this 10-year bull market where the S&P has outperformed the average hedge and people are saying I’m not going to pay you a premium fee for subpar performance.
• And the question each one of us has to ask, including myself because I have money with outside people, is now the time to be a long only without a hedge fund.
• And I would submit probably it isn’t, and this is going to be more of a two-way market so hedge funds make more sense now than they did 10 years ago.

David: Well, and, and that, that makes a lot of sense. Could you share your long-term perspective and maybe share some of the investment ideas you like right now?

Leon: Alright, let me just say this. We are in a two-tier market presently.

• Tier one is no longer cheap. I own Amazon. I own Google and a little Facebook. I own a lot of company called Fiserv. You know, that part of the market is not a giveaway.
• It’s the other part of the market is very cheap, but these are the things that have a lot of hair on them, I mean the cyclical-oriented businesses are very weak. You wait and you have to bet on a big turn the economy.
• Tier one, I’m just looking at my list now – we have Amazon, we have Cigna, we have Facebook, we have Fiserv, we have Google, JP Morgan, Microsoft. Those would be a big tier one positions.
• And then tier two, I have 6% energy, which has worked very nicely last couple of months, where I basically feel the solution to low energy prices is low energy prices is going to drive a lot of capacity. Any industry can’t lose 30% of its demand and not have a big problem. That’s what we saw. We went from daily consumption of a hundred million barrels a day down to 70 million barrels a day and the world’s got to adjust. We can take out the high cost production. There’ll be a turnaround. We think that the price of oil could be getting close to $50 a barrel sometime next year, which, and the ones that we own like Parsley, WPX Energy and Magnolia make money at $25 oil.
• We don’t own the high cost producers. Some other companies, Special Situations, Ashland Global Holdings, chemical company Kemira in the mortgage finance business, Energy Transfer. The CEO owns 10% of the company, which I think is like $4 billion worth of stock… Kelcy Warren, who’s an achiever, a good man we like him we respect him. We own Trinity Industries.
• Overall, I do believe the stock market is adequately priced. I wouldn’t be running after things now.

David: Do you like anything on the short side, Lee?

Leon: We’ve tended not to publicize the shorts…

David: Okay.

Leon: In the past. So I’ll stay away from that. We’re not a particularly productive short shop. So I would say frankly, short-selling is not been a particularly good rewarding thing over a very long period of time.

David: Yes.

Leon: And you can be short something and have the position for 20 years. It’s a short-term gain. So, you know, you can’t go long-term and try to be tax efficient.

David: Well, you you’ve quoted Mr. Buffett a couple of times today. And one of my favorite lines from Buffett is the only thing he likes too short is pessimism. That seems to be consistent in a lot of your portfolio approach. Leon, as we get ready to wrap up, what are some of the things that have been the biggest surprise to you going specifically from running money for other investors to just running your family office? Maybe tell us a little bit about that dynamic.

Leon: You know, when you’re running money competitively, you’re probably quicker to cut losses than running your own money. If you have a belief in what you’re doing, you have a willingness to hold on. And so, you could rack up a larger loss, hopefully temporarily, but no surprises.

• I missed the revenue and the profits from the hedge fund business, but I don’t miss the pressure and believe me, I had fabulous investors. My investors were extremely supportive of me. And I really was very grateful for the historical support and one of the more gratifying things, when I announced my decision to retire. A bunch of my investors asked me if I could find a way of keeping their money and you can’t, you know, once you’re a family office, you can’t have any, any investors other than the family.
• So, I’ve been very lucky, I live the American dream. I said that before and have no regrets, no regrets. You know my older brother sitting here in the background, he’s 84 and I hope to follow in his footsteps. Our dad died at 70. I’m, 77, he’s 84. And I hope that he’s around at a hundred and I’ll be around at 90, 93.

David: Well, hopefully between now and then we’ll, we’ll get to hear a bit more from you, either CNBC or at John Mauldin’s conference in the future. Lee, it’s, it’s a real privilege for me to have had this opportunity, not only to work with you on the, on the book deal. To spend this time together today (know) I hold you in the highest regard and believe very much that Wall Street needs more people who’ve lived the American dream like you, and who are willing to come defend the American dream.

• And I thank you not only for all your investment expertise, but for your evangelism for capitalism, it’s really greatly appreciated.

Leon: Yeah, my pleasure. Let me just say, I’m a capitalist with a heart, you know, in the last month, my family and I sat around and we sent some more money to Amazon to Robin Hood South Ward in Newark, New Jersey, New Jersey Performing Arts Center, where I used to be on the board.

• Here’s is a typical situation. You have monthly overhead is $4 million a month to run the business, no revenues for hospitals when they eliminate elective surgeries. It’s coming back now but they have lost tremendous amounts of money.
• So all of us that have the financial resources should do what we can do to help those that don’t.

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Mauldin Economic’s Ed D’Agostino led the Q&A session:

Ed: Thank you, David, Leon. We do have some audience questions we’ve got about 13 minutes left. Leon, if you’re up for it, we’ve got a few.

Leon: Yeah. Call me Lee, but I’m up for, yeah, I hope I have the answers as good as the questions.

Ed: Okay. Thank you, Lee. So first question is just kind of general, how do we deal with income inequality in this country? What would your recommended path be?

Leon: Well, I think we need faster economic growth to absorb the labor force to present economic opportunity. And I think we have to provide more education.

• The labor force, as I said before, the average lifetime earnings of a college graduate is well in excess of a million dollars, more than non-college graduate.
• Plus you give them skills to be more competitive in society.
• So my family and I, you know, we put $25 million into a fund and created something called the Cooperman College Scholars. We have a board of a dozen people that interview these kids to get into the program, you have to be showing initiative. Franklin & Marshall developed a program with a two-week orientation session where they explained to kids what to expect in college. You have to show the initiative to enroll in that program. You have to basically be academically qualified.
• I’m big on teaching people to fish and not giving them fish. You have to have a financial need unmet by government and have to be a resident of Essex County, New Jersey; because I can’t do everything all over the world. And if you qualify, we put $25 million into a fund, which should create the opportunity for 500 kids to go to college. We have a about 350 in the program now, most gratifying thing, which I take zero credit for, zero credit for, historically 35% of Newark High School kids went to college, only 5% managed to stay in the program and graduate. And our program, we have a retention rate now of close at 90%, which is due to Twinkle Morgan and her whole team that works with the kids every day after school to keep them focused and motivated.
• So I think it’s faster growth and education.

Ed: Okay. Next question from the audience, several questions, actually asking about your thoughts on stock buybacks and the talk about how you know, should they be outlawed?

Leon: They should absolutely not be outlawed. I think they make a great deal of sense. I’m going to get away from the screen for a second. I want to get a letter that Warren Buffett wrote me and I want to read it to you…

Ed: Perfect.

Leon: One second.

Ed: I think this is the first time that we’ve had a speaker who in the middle of speaking was just, you know, grabbing a letter that Warren Buffett wrote them.

Leon: In 2007, I gave a speech at the Value Investing Conference and I spoke on two subjects, Henry Singleton, who is the brightest man I ever dealt with, who unfortunately is deceased and on the subject of stock repurchase programs, which I was negative on the way it was being practiced. And Warren got a hold of them. And on November 23rd of 2007, he wrote me the following letter. And I’m going to read you.

Dear Lee,

I don’t think you could have picked two better subjects. Henry is a manager that all investors, CEOs would be CEOs and MBA students should study. In the end, he was 100% rational, and there are very few CEOs about whom I could make that statement. That’s Henry Singleton, the founder of Teledyne.

The stock repurchase situation is fascinating to me. That’s because the answer is so simple. You do it when you are buying dollar bills, at clear cut, significant discount, and only then. As a general observation, I would say that most companies that repurchased shares 30 years ago were doing it for the right reasons and most companies doing it now are wrong when doing so. Time after time, I see managers who are attempting to be fashionable, or perhaps subconsciously hoping to support their stock. I gave him my speech in 2007 at Loews as an example of a company that did it the right way.

And he said, Loews is a great example of a company that has always repurchased shares the right reason. I love this last sentence. I could give examples of the reverse but I try to follow the dictum, praise by name, criticize by category.

Best regards, Warren

• So in response to your question, I think stock repurchase is a good tool to be used by management when they’re using their tool intelligently. In other words, buying back stock is another use of cash flow and corporate assets like mergers and acquisitions, plant and equipment expenditures, dividends.
• And basically, you expect the management to do right things.
• Now, the airlines, nobody could have foreseen this situation that evolved, so I don’t want to be critical the airlines. But a lot of repurchase programs are not well intentioned, and the ones I hate the most are repurchase programs that managements announced 10b5 programs and they sell into the repurchase program.
• Now, when you repurchasing stock, you’re basically saying your stock is undervalued. It’s contraindicated to be selling stock back to the corporation, when you think it’s undervalued. So you got to — you know, there’s no sure way of figuring it all out, but I would say that I’m absolutely not ruling it out except for those companies taking government assistance. If you take government assistance, you get paid by the government rules.
• But if you’re not taking government assistance, you ought to be able to manage your capital as you see fit and let the market determine whether you turn out to be right or wrong.
• You know, Henry Singleton was brilliant. He did eight self-tender offers and bought back 90 percent of his stock before anybody figured out stock repurchase, never sold a share into his own buybacks. Okay!
• And on three of the eight occasions he offered fixed income securities in exchange for stock. If you go back and check the record he bought his stock back at the low end of his stock and issued bonds at the high bond prices, the low of interest rates. Nothing to do with the credit of the company, he just was a brilliant guy and he distinguished himself because he was one of the few people that understood how to move between financial assets and the real economy.
• You know, most industrialists, understand the real economy, they don’t understand financial assets. He understood both. You know he was an exception. And he was, like Warren said, 100 percent rational.

Leon: Probably a longer answer that you bargained for.

Ed: It was a fantastic answer. Thank you and thank Warren. Do you have any thoughts on, several people are asking, do you have any thoughts on gold?

Leon: I don’t. I see the case for gold. I have a very bright son. He runs his own family office now and he’s long gold. I had a little bit but not enough to make a difference, and I sold it about $100 under the current price. I could see the role of gold in a portfolio.

• I’d rather buy cheap stocks. I’d rather own Energy Transfer where the CEO owns or has a $4 billion position. The stock yields 16 percent, you know, and I’d rather go that direction than gold.
• But I understand the case for gold.

Ed: Okay, next question from the audience has to do with the so-called zombie apocalypse, right?

• It’s the companies who have been kept alive for years and years by being able to access capital markets, borrowing at extremely low rates and are susceptible to a rate increase.
• How do you feel about the Fed potentially moving in and buying high yield, certain investment grade? Is the market functioning? Where do we go from here?

Leon: Look, the Fed and Congress have done a yeoman’s job here. They did what they had to do. It’s a damn shame that they had to do it.

• But I’m a believer in free markets and I’m not so sure what the President believes in, to be honest with you. Six months ago, he was talking down the price of oil. Now he’s trying to talk up the price of oil.
• You know, he’s talking about negative interest rates. I think negative interest rates would be a disaster for the economy. Look at negative interest rates in Japan and Europe. They have lower price earnings ratios than we have. And in capitalism there’s got to be return for risk taking. And if interest rates belong –
• I’ll make this one point, which is very critical. If interest rates belong where they’re trading, that tells you only make two, three or four percent a year in the stock market. You don’t make double digits returns which is a capital market line.
• What you earn in cash, what you earn in a fixed income should determine what you earn in equities.
• And so for three or four years now, every time David mentioned my CNBC appearances, any time I’ve been on TV, I said we’re in an abnormal world. Why are we in an abnormal world? Because there was $14 trillion of sovereign debt that carried negative interest rates.
• The idea of lending money to Japan and Germany and some other countries and getting back less in 10 years than you lent them makes absolutely no sense whatsoever.

Leon: So, my job was to figure out what is normal. So, this is my definition of normal.

• Labor force growth in America at a half of one percent. Per activity in the labor force growing about one and a half percent. That defines real growth.
• If you take labor force growth and productivity growth, that determines real growth. That’s two percent.
• Add another two percent for inflation. That’s four percent nominal.
• In a four percent nominal world, one day the Fed funds rate ought to be three percent and the ten year government ought to be four percent.
• Because of global interest rates and what’s going on globally, I’d say it may take several years to get there, but we’ll get there.
• In that world, I would’ve thought a 17 multiple in the market would’ve been fair. I have to adjust that market multiple for the greater role of technology, which carries with it a higher multiple asset light in business models.
• But I would say, you know, 18, 19 times earnings is all that she wrote and if I apply that to normalized earnings of 150, that’s where the market is, the market is reasonably fully valued. But I hope we don’t go into negative interest rates, and I think interest rates are too low.
• But I think the administration is doing the right thing and Congress is doing the right thing, and it’s a shame that they had to do it.
• You know, we were running a trillion-dollar deficit in January in a fully employed economy. We were heading to a problem of some kind. You know, when the economy is fully employed, you’re supposed to be in balance. The deficit was a trillion dollars.
• We have a President who is an inflationist. Sometime this is going to catch up with us, you know.
• I’m watching very carefully two things. I’m watching gold, which is signaling some concern, and I’m watching the dollar exchange rate, because the dollar is king right now. As long as the dollar is king, this caper can be pulled off by the Fed.
• But if the dollar starts to weaken and inflation starts to pick up, I think the game is going to change. And with a $24 or $25 trillion debt level, every hundred basis point increase in interest rates is a $250 billion increase in cost.
• So the bulls say the interest rates have to stay low because the government can’t afford to let them rise.
• If interest rates stay low, the economy grows very, very slowly and returns on stocks are a few percent. Still better than bonds.
• I think the high-risk assets in the economy are basically bonds, not stocks.

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