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Leveraged or Unleveraged ETFs — How to Choose?

In today's episode of the Market Foolery podcast, Chris Hill talks with Motley Fool Asset Management's Bill Barker about earnings, ETFs, and the virtues of coffee. KB Home (NYSE: KBH) rose 11% on a better-than-expected fourth quarter, but don't get too worried that this is a portent of 2008-style doom. Delta Air Lines (NYSE: DAL) had a solid fourth quarter with some raised guidance and joins the ranks of companies that are happy about their new tax break. And the guys explain the merits of unleveraged index funds, as opposed to their leveraged counterparts, and give a sneak preview of this week's upcoming Motley Fool Money radio show.

A full transcript follows the video.

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This video was recorded on Jan. 11, 2018.

Chris Hill: It's Thursday, Jan. 11. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, from Motley Fool Asset Management, Bill Barker. Happy Thursday!

Bill Barker: Thank you!

Hill: We have a lot to get to. We have earnings. We're going to dip into the Fool mailbag to talk ETFs. We have a preview of the Motley Fool Money radio show this weekend. But we're going to start today with housing. KB Home, shares up 11% this morning. Fourth-quarter profit and revenue came in higher than expected. Stock hitting a 10-year high.

Barker: Yes. Getting it all the way back to a little less than half of its pre-recession high.

Hill: If you got into KB Home in the year 2000, you're pleased with the 10-year run the stock has had from the last 10 years. But as you pointed out, it's nowhere near where it was in '04 or '05.

Barker: Yeah. Wild ride. If you were to open up a 20-year chart of KB Homes, you would see a huge peak there at '05, I've talked about this before, where it's going to go straight up and straight down. This is referred to, at least by Bill Mann, as "the middle-finger chart." One of the more interesting things about it, and we'll get to the present earnings in a moment, but in '05, that's when it peaked. Two, three years before the real maximum pain was suffered in the economy. So, there were indications well ahead of time that the stock had gotten ahead of itself. In '05, it was doing $8 billion a year in revenue, $9 billion in '06. And it was down to less than $2 billion in '09. And that level held for about five or six years. And now it's getting back to the mid threes, as of '16 and last year, a little above $4 billion. So it's still less than half. Just like the stock, the actual business is about less than half of where it was at the peak.

Hill: Is there anything that you look at in housing, whether it's KB Home or D.R. Horton, anything in the housing industry, is there anything that you see that makes you think, boy, we're getting close to bubble territory here?

Barker: No. I think it may turn out to be the case that, if interest rates go back to anything approaching levels that they lived at comfortably for long periods of time, that housing is going to look tougher then than it does today. But no. I think, certainly, the lessons of '08 and '09, regarding extension of credit being the biggest problem that led to everybody buying six or seven houses at the time, that's not present.

Hill: Let's move on to Delta. Fourth-quarter profits came in higher than expected. Delta also raised guidance for 2018 and seemed to be pretty clear about the fact that the raise in guidance was due to the cut in corporate taxes.

Barker: Yeah. I think the raise is about 20%. A number of other airlines have been coming out recently with, the tax guidance is going to be a consistent theme for this earnings season for every company. "Hey, what do your taxes look like now that you have the bill and you've done the numbers, and you can tell us what the answer is?" And they're in the realm -- this is not going to be for everybody -- where they see their tax rate go from 35% maximum federal right to 21%. But Delta was in that group that was paying an effective tax rate of 38%, maybe something like that, because there are other credits and state taxes. But they're going to keep $0.14 of every dollar of profit more next year than they kept last year.

Hill: Am I the only one who's having trouble adjusting to a world where airlines are a profitable and good investment?

Barker: You're not the only one, but you keep pointing out that you're having trouble adjusting.

Hill: [laughs] I really am.

Barker: Let's go back to comparing your old experience on airlines and your current experience on airlines. You get on a plane, and it's full.

Hill: Yes.

Barker: They just seem to be running an unpleasant, oftentimes, for their customers, business, although they're trying. But the consequence of filling up the planes and having multiple people waiting on standby to make sure that every seat is filled is a full plane. I loved getting on a plane and having it to myself in the old days, or having a row, or having something like that. That doesn't happen. That's too bad, from our experience. But the airlines, you can visibly see they're busier, and they're running all the planes full. I don't think that going forward you should think this is some weird period of time where airlines actually made a profit. Really, we should look back on the old days as the weird period of time where, because --

Hill: And say, what were they doing running those planes?

Barker: What were they doing? There was a lot of money that would constantly go to new airlines. I think a lot of people thought, I'll start an airline, that'll be fun. Not individually, it takes a little bit of money to do that. But there were just too many airlines, too much competition from the perspective of owners of airline stock. It was great when there were too many airlines and you could do things like, in our market, get on Independence Air. Did you ever do that?

Hill: No. I don't even remember Independence Air.

Barker: It was up for about three years, something like that. My memory is, they paid you to fly them.

Hill: "Please, we're lonely. Get on the plane."

Barker: So I got a couple of $29 flights to Albany. Granted, that's not the most competitive route, D.C. to Albany. But, $29 and the plane would be virtually empty.

Hill: I remember things like Eastern Airlines and Trump Airlines, where there will be tickets for $20.

Barker: Did you ever fly Trump Airlines?

Hill: I think I did fly Trump one time. I think I did Boston to New York.

Barker: The shuttle route, Boston, D.C., New York.

Hill: And to your point, there were so many options. They were just so many options in terms of airlines and times. Would you like to go at 10 a.m.? How about 10:15? How about 10:30?

Barker: For whatever you think of Donald Trump, he was fairly consistently an inept businessman. So his presence in the airlines guaranteed that you would have this inefficiently run -- you should really be able to make a killing on the D.C.-Boston-New York route, because you have a lot of people doing last-minute travel --

Hill: A lot of business travel.

Barker: A lot of business travel. And his ability to lose as much money as quickly as he did on that was characteristic of his other business operations. That was part of the problem, that people like Trump were involved in running airlines, because they thought it would be fun or a marquee thing for them to do. He wasn't the only one. He might have been one of the least competent doing it, but there were plenty of others as well that thought along the same lines.

Hill: You have to believe that at least part of the interest in putting up a building or starting an airline is slapping a name on it. I'm going to put my name on this plane. I'm going to put my name on this building. Do you ever think about a Barker Airlines? If you had all the money in the world?

Barker: No. [laughs]

Hill: Because now it's a profitable business!

Barker: All the money in the world, running an airline? No. Nobody likes airlines anymore. It doesn't seem glamorous to fly, does it?

Hill: Not really, no.

Barker: Not like in the old days. You ever put the coat and tie on to fly when you were a kid?

Hill: I remember that happening when I was a kid, the idea that, I think we were flying first to Boston and then to New York, and the whole idea of...

Barker: It's like going to church.

Hill: You're going to the big city. Get dressed up!

Barker: Get dressed up so they let you on the plane.

Hill: Exactly.

Barker: They're not going to let you on without a tie.

Hill: If only I had the foresight to say to my parents, "I've seen the future, and it involves a lot of people getting on planes in their pajamas and flip-flops. Trust me on this."

Our email address is marketfoolery@fool.com. From Brian Deidrick, who writes, "If you believe the U.S. stock market will end up higher than lower over the long term," and let's just go ahead and stipulate that, at least in this room, we do, "and go up in more years than it will go down, why not invest in leveraged index funds? Normal unleveraged index funds are always recommended as safe and steady investment options due to the high level of confidence in the S&P 500. So, why not throw some leverage in for increased returns?" What do you think about that idea?

Barker: It's an idea that would have worked out in the recent past, when the stock market was consistently going up.

Hill: You're saying the next nine years are not going to be like the last nine, in terms of the market going up?

Barker: [laughs] What I'm saying is, you're not buying and owning parts of the business. You're buying an ETF, which holds various options contracts which are betting on short terms in the market, and the cost of that erodes your returns in many other situations other than the market going up 25%. Now, if you could go back in time and invest in a 3X levered ETF rather than an S&P 500 index fund last year, that might be one of the things you would do with the power to go back in time. There might be even more interesting things to do with that power, but that's one of the things you could have done.

But you're not an owner and investor in the business; you're a speculator on movements in stock prices, because you don't own a piece of the business. That's not what you own when you own ETFs. They're not buying three times as many stocks with one time the money. It's a function -- interesting that they're able to achieve this -- with the levers that they have. But you're betting on prices. You're not betting on the rewards of ownership over long periods of time. And the erosion of those instruments oftentimes gives you less than 3X, one way or the other. Of course, the other reason not to own 3X of it is that it could go down 3 times as fast.

Hill: Nobody likes to think about that part, though.

Barker: Not many people are thinking about it right now, and the day will come when 3 times the direction of the market is really painful. And if you're a long-term shareholder, you can just own your stock, and as the stock returns to its old levels, you have the same thing you've always had, which is a share of that stock. With these instruments, you're paying and you're getting little bits of your original dollar taken away from you all the time. So on a round trip of the stock market prices, you're going to lose money in a 3X vehicle, whereas in a round trip of stock ownership, you're going to return to your original investment.

Hill: Got to give a quick shout-out to long time listener Matt Holzman from Denver, Colo., who's in town for business and visiting us here at Fool HQ, and brought a little something from the good people at Stranahan's, which is a Colorado whiskey company. I haven't opened it up, but I think there are little glasses, which I'm very excited about. Thank you, Matt, for coming in! Really appreciate it.

Barker: This is not going to be one of those shows where we're drinking whiskey during the show.

Hill: No. We save that for the now-twice apropos-of-nothing episodes.

Barker: We'll use those glasses for the next apropos-of-nothing.

Hill: You know what? We talked about that the other day, that there might be a third apropos-of-nothing episode coming sometime, maybe at the end of the month. We'll see. We're still working on it.

Barker: It's a trilogy.

Hill: [laughs] It's the worst -- if we're rank-ordering trilogies, we have The Godfather, we have Star Wars, Lord of the Rings, and way down at the bottom of the list is the apropos-of-nothing podcast trilogy.

Barker: But on the positive side, whereas people are probably still reeling from the disappointment of No. 2, because the middle part of the trilogy is usually a weak bridge -- you establish the premise in one, and in three you wrap up the story. In two, it's like, I don't know what we're doing here; we're going to leave you with a cliffhanger.

Hill: Maybe.

Barker: The Godfather was not supposed to go three rounds.

Hill: Yes. That was a situation where Francis Ford Coppola needed money, where he was investing in his vineyard, because he's a winemaker, and he needed money, and someone came to him and said, "You know what you could do to make some money? Make a third Godfather." That's how that worked out.

Barker: Yeah. So it really wasn't a pure trilogy.

Hill: It was. I will defend The Godfather Part III, just because there are very few of us who will actually do that. It still got nominated for Best Picture. It just doesn't hold up to the other two. The other two are two of the greatest films of all time. The Godfather Part III has its flaws; it's still a good movie in my mind.

Barker: I side with the masses. I'm thinking, as I recall it, the weakness was Sofia Coppola, whose obvious talent as a director didn't translate as well to her on-screen performance in that movie.

Hill: That's true. Which is a little odd only in this sense -- she's such a talented writer and director of film, so it's slightly odd to me that she wouldn't be almost as good at acting.

Barker: Let's give her another chance. Has she done other acting that we recall?

Hill: I don't know. But she's so good at writing and directing that she's probably like, I don't need to do this.

Barker: Write something for yourself.

Hill: Isn't that what she does every time she writes? Isn't that what every writer does? Ultimately, they're writing it for themselves.

Barker: But she's not writing it for herself to then perform it. That's what I mean.

Hill: Yeah. I want to say, because it was a week ago this time that I announced the launch of the Motley Fool podcast shop, which you can find at shop.fool.com, and I wanted to share a couple of early takeaways from the shop. First, thank you to the dozens of listeners for the enthusiastic response, because people bought stuff. Even people who are just like, "I just love that you're doing this," that's fantastic. I appreciate that. The most popular items in the shop early on appear to be the Invest Better items -- the Invest Better mug, the T-shirt, that sort of thing.

Although I will say, the No. 1 selling item right now is the mug that I have here in the studio, which is the Motley Fool Money mug, the mug that says the opening line of Motley Fool Money, which is, everybody needs money; that's why they call it money. I mention that only because, that was the last item added. We had seven items for the shop, and at the last minute I was like, "I'm just going to throw this in here. I don't know if it's going to sell, but I'll just throw it in there." And early on, it's the No. 1-selling item. Proving once again that I really don't know much of anything.

Barker: Have you ever thought about going with, do you have your own catch phrase? Because really, that's part of it.

Hill: I don't know that I do. Nothing that would be slapped on a mug.

Barker: Have you thought about developing one?

Hill: I really haven't. But let me just add one more comment on the shop, early takeaway, because there was some feedback about the shipping fees. I'll just simply say we're working on that. Here's what I learned about shipping in the last week or so: Part of it depends on distance and part of it depends on weight. So if you're buying a baseball cap or a T-shirt, you're really not going to pay a lot in shipping at all. If you're buying a single mug and you live on the East Coast of the United States of America, you're going to be paying more in shipping. So we're working on that.

Barker: And the fragility involved.

Hill: There's a lot more involved in the packaging of shipping a ceramic mug than a T-shirt, because no one's worried about a T-shirt breaking.

Barker: Right. And if they are, they need help.

Hill: Right. You don't understand how T-shirts work.

Barker: Right. Try wearing a few more. They won't break. It's not just ours. You're not advertising, like, we have the unbreakable T-shirts.

Hill: Maybe we should try that, though, see if that works. This weekend on Motley Fool Money, our guest is Dan Pink, best-selling author who's out with a brand-new book. Dan was in the office yesterday, and I got to interview him in front of a live audience. Dan Pink is, I said this at the beginning of our talk yesterday, he's one of the most intellectually curious people I've ever encountered in my life. I'm not finished with his book. I'm about halfway through. But I'm really enjoying it. That interview is this weekend.

And what I learned about Dan that I did not know is that Dan -- and you can follow him on Twitter -- big coffee guy. Big coffee guy, big coffee drinker, big fan of coffee, and just like even me, Dan is looking to use Twitter not just to share ideas and share information about his books and writings and appearances, because he's about to go on a 30-city book tour, but he also uses Twitter to just knock down the haters out there that are saying caffeine is bad for you, that coffee is bad for you.

Barker: You referred to him as intellectually curious, and therefore educated, right?

Hill: Yes.

Barker: To be educated is to be a big coffee drinker, isn't it?

Hill: I think so. You could just take someone's word for it, like, "Oh, coffee is bad for you." No. There's an increasing amount of scientific research backing coffee as -- is "cure-all" too strong a phrase?

Barker: We don't know yet.

Hill: It's too strong a phrase right now, but 10 years from now, 20 years from now, maybe.

Barker: He's part of, and we are as well, the coffee generation.

Hill: That's true. If you are of a certain age, and I think we'll put this out on the Market Foolery feed, if you are of a certain age, and by that, I mean, you were growing up in the '80s, you may remember a television commercial that was produced by the National Coffee Association, and it was about the new coffee generation and being part of the coffee achievers. It's a commercial that's so wonderfully emblematic of the 1980s. It is, if you want to know what the 1980s were like, just go on YouTube and find the "coffee achievers" commercial.

Barker: It's hard to remember now, but there was a time when coffee was worried that it was losing out. There was a generation coming along that did not adopt the habit of drinking coffee. And certainly, there were health risks involved with a whole generation skipping coffee. I think it was more of a public service announcement.

Hill: In hindsight, it looks like a public service announcement. At the time, let's be clear, it was the Coffee Association of America going, "Holy cow, coffee is seen as boring and old, and we have to make drinking coffee exciting."

Barker: "What eclectic group of people can we get and put into a commercial?" And they came up with Ann and Nancy Wilson from Heart, Jane Curtin from Saturday Night Live, Kurt Vonnegut for some reason.

Hill: Yeah. I'm not sure why Kurt Vonnegut is in that --

Barker: But he's great in it. He rocks that ad.

Hill: -- but I love that he's in it. Isn't Bowie, isn't David Bowie in that ad?

Barker: Not the one that I was rewatching. But there are a lot of great talents of the era, all of whom appreciated coffee.

Hill: And it worked. It planted the seeds that laid the groundwork for the explosion of coffee in the '90s with Starbucks (NASDAQ: SBUX).

Barker: Speaking of Starbucks, have you seen these new ads? One of the very few times in my life where I've ever seen a Starbucks ad on TV was last night.

Hill: Was it for this blonde espresso thing they're pushing?

Barker: Exactly. It's working. They got us talking about it here.

Hill: They don't have us buying it, though. So yes, we're talking about it. It's sort of noteworthy that Starbucks is buying television ads, because throughout the company's history, they really haven't done that very often. Do you have any sense of why they're doing this?

Barker: It's the launch of this blonde espresso, and looking to get attention. I don't know if it's a sign of a difference in management philosophy, now that Schultz is not making those calls, or I guess he's not --

Hill: I would hope not. I would hope the chairman of the board is not making decisions about television commercials.

Barker: Right, I would hope not. But I don't know what the dynamic is there, now that he's still very much involved in the company, focusing on the Reserves --

Hill: The Roasteries.

Barker: But it was surprising, we agree, to see any Starbucks ad on TV.

Hill: Here's what I like about the blonde espresso drink. It seems like an adult drink, and it seems like it's not a one-time fad, like the Unicorn Frappuccino nonsense that they pulled last year.

Barker: No. Apparently, this is the first time in 40 years that they've added a new espresso blend. Not a form of espresso, but a different bean, I guess.

Hill: I think we're at the end of this episode, aren't we?

Barker: Yeah.

Hill: We were probably 10 minutes ago. If you want to read more, not necessarily about coffee, but about actual investments, about actual asset management from Bill Barker and his colleagues at Motley Fool Asset Management, here's how you fix that. You go to foolfunds.com and check out their latest writings. It's some great stuff about the world of investing. Bill Barker, thanks for being here!

Barker: Thank you!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Austin Morgan, pulling double-duty once again. I'm Chris Hill. Thanks for listening! We'll see you next week!

Bill Barker is an employee of Motley Fool Asset Management, a separate, sister company of The Motley Fool, LLC. The views of Bill Barker and Motley Fool Asset Management are not the views of The Motley Fool, LLC and should not be taken as such. Bill Barker has no position in any of the stocks mentioned. Chris Hill owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks and Twitter. The Motley Fool has a disclosure policy.

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