Guest: Episode #33 has no guest, but is co-hosted by Meb’s co-worker, Jeff Remsburg.
Date Recorded: 12/13/16
Topics: It’s another Q&A episode before everyone gets too busy with the holiday swirl.
Per usual, Meb has just come back from more travel, this time to Todos Santos, Mexico. He gives us a quick update before we hop into listener questions. A few you’ll hear tackled are:
- I don’t really understand Trend. In order to maximize return, wouldn’t it make more sense to buy below the simple moving average, then hold or sell when above it? I’m just applying common sense – buy when cheaper than average. What am I missing?
- If you were building an investment strategy for the next 30-40 years, would it more resemble the one found in your QTAA paper, an absolute value strategy (similar to what Porter discussed in that podcast), or your Trinity approach, which is more buy/hold with rebalancing?
- Have you ever considered a strategy that buys put option protection for equity portfolios when valuations are historically high? You could buy long puts or long puts/short calls to offset some of the option premium.
- Are recent bond yield increases causing you to tweak your bond allocations in the Trinity portfolios?
- How does your use of momentum differ from Gary Antonacci’s dual momentum system?
- I’m a banker, and can’t tell you how many times I’ve heard a variation of “Rates are so low at the moment, what a great time to borrow.” What are your thoughts on the long-term debt cycle, and how would you “time” leverage?
There’s plenty more, as several of these questions send Meb into deep, labyrinthine rabbit holes – one of which involves his thoughts on how to educate children about investing. He believes most parents today do it entirely wrong. So what’s the right way to raise a world-class investor? Find out in Episode 33.
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Transcript of Episode 33:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: Hola amigos. Welcome to a podcast episode Q&A with Jeff.
Jeff: What’s up?
Meb: Jeff, welcome. I just got back from Mexico so I’ve been practicing my Spanish a little bit.
Jeff: How was the tequila?
Meb: The tequila was great. You know, one of the benefits of the U.S. dollar surging is that it’s really cheap to go a lot of places, Mexico, Canada, etc. Baja California is one of my favorite places on the planet. I’ve been many times. You can drive down from LA pretty easy. So what some people actually don’t know, that there’s a pretty amazing wine country in Northern Baja. Have you ever been?
Jeff: No, but it sounds to me like you weren’t doing much investing research down there right now. I don’t think your listeners appreciate that.
Meb: Well, I wasn’t in wine country anyway. I was down in Todos Santos, which is northwest of Cabo by about an hour. But the amazing thing is that you can take a plane from LA, very low cost, Southwest flies there. And I figure if Southwest flies there, it’s an easy weekend trip. You could go Friday, back Sunday, takes two hours. If you have global entry, you get in and out, it’s… And by the way, the Cabo airport is nicer than the LA airport, by the way, which is…describes most airports in the country. But, beautiful, warm water, lot of tacos, great trip.
Jeff: Sounds nice. I was sick while you were gone, so I’m extra jealous of you.
Meb: Yeah? Well, next time, come on down.
Jeff: By the way, congratulations to you. Wall Street Journal rated the Meb Faber Show one of the top five investing podcasts around, so, kudos.
Meb: Great. Well, thank you. Thanks to the listeners. By the way, you guys, we’re starting to run down on the questions, so fire ’em in. We’ve had a lot of good guests recently. The two most recent episodes with Yusko and the PeerStreet boys were a lot of fun, got a lot of great feedback. But for the Q&A ones, which we do about once a month or so, send in some more questions. We’d like to update them and answer any y’all have.
Jeff: All right, well, why don’t we hop in? We’ve got a handful to go through today. Won’t keep this for too long, though. We’ve got a couple questions that are more 30,000-foot nature about momentum and trend in general, so I figured we’d start there. Sounds like a couple of them come from some people who may not be as familiar with trends.
So, it says, “I really don’t get trend following as a concept. Provided, I don’t really care about volatility as I’m 40 and I won’t need my savings for another 15 to 20 years. In order to maximize return, wouldn’t it make more sense to buy below the SMA and hold or sell when above it? I’m just applying common sense, buy when cheaper than average, but I must be missing something.”
Meb: That would be a horrible investing system. And if you look at almost any market, when the market is above…the higher returns, and the market’s below, it’s much worse returns, and in many cases negative returns. And one of the reasons that it’s not just a magical system is, the market goes up… Most markets go up about two-thirds of the time, and so the other third, when you’re out, you need to sit in cash or something, which is a lower vol…a lower returning asset so it reduces the total return.
So, even if you have a higher return, so let’s say, stocks do 10%. And when above the long-term moving average they do 15. Well, the reason you don’t get 15 is you have to put that money somewhere else when it’s under the moving average. So, T-bills, which maybe is two or three or five. So that reduces the return. So overall, you end up with the same return, lower volatility, lower draw-down. But when it’s below the moving average, and all of our research has shown this, including the paper on “Where the Black Swans Hide” is it shows that there’s vastly more volatility and vastly higher draw-downs. The return is often very low to even negative. So that is a surefire system of having negative compounding.
But look, trend following, I mean, you get a long-term horizon, valuation doesn’t matter as much over very long periods. You know, in the mean reversion matters, but only at real big extremes. But trend following is meant to make the path be smoother. It’s not gonna increase your returns. So, if you got a 20-year time horizon and you’re totally rational, hey, just buy it and park it and forget about it. The problem is, most people can’t handle very large draw-downs.
So the mental fortitude it requires to sit through 20, 50, down 90, which is what a lot of investments have done in the past, U.S. stocks have been down over 80, it’s very difficult for people to sit through, and they say they’re rational and then all of sudden that million bucks you got is only worth 150 grand, you may not be so rational.
Jeff: So if you truly could not be affected at all by any sort of draw-downs, then trend following wouldn’t be a useful strategy for you?
Meb: No. Well, because, let’s say, if you’re just optimizing on return, for example, you could do a managed future-style, lever it up, target 20% returns and ensure that you will probably have 80% draw-downs at numerous points. I mean, look at Dunn Capital, one of my favorite trend followers, has been around forever, does not give too blanks about draw-downs. I mean, they regularly have 50% draw-downs and could care less, but they compound at a very high rate.
So, someone who says, “You know what, Meb, I don’t care about draw-downs, I wanna press the accelerator, I wanna go fast. I want big returns.” There’s other ideas that you can target that will target higher returns, I think, that are superior to simply a long-only [SP] investment. And this is what a lot of the risk parity guys do, remember? They equalize volatility and then lever the whole portfolio. So leverage isn’t bad by itself.
Jeff: But leverage right there seems to be the differentiator. If you’re looking purely at trend, and we’re going back to the idea of, this is to prevent you from these sort of behavioral bad mistakes, and you didn’t have leverage as a tool, you’re only looking at trend, would it be helpful?
Meb: Trend on one market, on any one market, is meant to be a return neutral… I think, in many markets, it does improve return, but it’s vol reduction and draw-down reduction. And then you apply it to 50 markets around the world, you get an added bump from the diversification, and then you can leverage it any way you want. But, you know, most of the real big out performance strategies are concentrated by nature. Whether it’s Buffett, whether it’s John Henry, whether it’s Bill Gates owning and operating his own company, the real big wealth-building comes from concentration.
But when you think about trend following in general too, I mean, there’s a lot of areas that are trend following, that people don’t associate… S&P is a trend following system. It’s market cap based, which means the price going up, that is a trend following system already, okay? It’s a momentum and trend system. Venture Capital, the most trend following system on the planet, where you invest in 50 companies, 30 go broke or do nothing, 10 may have okay returns, 5 maybe have good returns, and 5 are the next Facebooks and Googles of the world, and those dominate the portfolio.
That is a trend following system. You cut your losses short, meaning the ones that went to zero, went to zero, and that’s your max loss position size. But you let your winners run, and so the winners were the ones that were the 10, 50, 100 baggers. That is a trend following system. It’s always interesting to me, though, that the VC guys don’t have much crossover with the trend following guys.
And what I’m talking about is, if someone says, “Meb, I want big returns, what should I do?” I would say, you focus on private companies. If you have value add to do it, VC style to where you can invest concentrated, and it can be micro-caps too, it could be public companies, but in general, where you’re gonna be hugely concentrated. And then pair that with a managed futures. Then on top of that…
Jeff: But the concentration, when you’re in VC, that seems like a recipe for disaster.
Meb: No, I mean, they are concentrated. I don’t mean concentrated, like one or two companies. I mean, concentrated in your number of bets. But on top of that, I don’t understand why VCs and leverage buyout funds or the end-owners, the real money guys, don’t hedge with trend following. Because if you think about it, VC, they do mini vintages, right? Where they’ll do a fund in 2005, they’ll do another fund in 2007, and they kind of ladder them, right?
But the big… What are the biggest risks to a VC? The biggest risks are high-equity valuations, which then, in turn, you have a long bear market. So all of a sudden, the companies that are private can’t access the capital markets anymore, they can’t IPO, so there’s no exits. The valuations go down and get cratered. So you have all these simultaneous indicators. What helps with that? Trend following does. And if you really believe you’re a kickass VC manager, or you’re hiring them, you can also even do it market neutral, where you’re saying the whole point of VC is you’re gonna outperform 5, 10, 15% over these traditional benchmarks.
You could use broad equity beta to hedge that out or do a trend following approach, and that’s a killer. Man, we wrote an article about this back in like 2007 about trend following on private equity ETFs, which are horrible ideas in the first place. They’re never gonna outperform. Because in VC and private equity, you have to be in the best firms, the broad betas, basically the S&P, but worse, with fees. But we said a trend following approach actually works great, and it does.
Jeff: What’s your line in the sand, there?
Meb: For what?
Jeff: The trend following, I mean, what…
Meb: If you overlaid like a long-term moving average on a trend following portfolio, on a VC portfolio, you have the return enhancement style, aggressive VC portfolio, which, by the way, there’s been a number of papers that say that’s basically small cap value leverage, if you go back to the Medina podcast, among others, have written a lot about this. So you can actually do what the public markets. We’ve considered launching a PEVC replicator ETF that just buys leverage, small cap value stocks, for example.
Jeff: How levered do you have to be to replicate that?
Meb: You don’t actually have to leverage… There’s two ways to do leverage. So one is, you leverage the entire portfolio. So something like Buffett does with his float. Or two, you buy companies that are already leveraged, meaning they have a lot of debt. And so, then you wanna target the companies that are reducing that debt, that have low valuations. So, the traditional LBO, the metric is enterprise value to EBITDA or similar to those.
But that does a very good job of replicating VC and LBO returns. But my point being is that… I mean, those stocks in ’08 declined 80%. You know, a lot of financials had these massive declines. So you overlay a trend following methodology on that and you have the simultaneous goal of shooting for the big returns but also coupling it with a trend following hedge, reduced volatility and draw-down. And where does trend following work best? It works best in the markets that are hugely volatile and have those massive draw-downs over time.
Jeff: All right. So, excellent rabbit hole there, from where we’ve started.
Meb: A tangent, there you go. Well, you know, there was a study we did the other day, where we said… I looked at all the podcasts, and by the way, listeners, “We are doing summaries on the blog, you should check out. They’re gonna be a lot of fun.” I asked all my favorite investing podcast friends, I said, “What are you five most downloaded podcasts for the past year?” And we’re gonna post them all to the blog this week, so you can check them out, and it’s an awesome, awesome list of guests. Highly recommend to listen to over Christmas while we’re taking a week or two vacation from the Meb Faber Show.
And then we’re also gonna do that with blog posts. And, the problem is that, you know, as we’ve mentioned many times on this podcast, is that there’s not really any good apps to curate podcasts, or many things. So asking our friends, “What are the most downloaded or popular podcasts?” It’s an incredible list. There’s some real… I’ve already started listening last night. I woke up at 4 in the morning to start listening to these.
Jeff: By podcast, you’re saying specific episodes as well, right?
Meb: Yes, episodes. So, Ritholtz, it’ll be, you know, his guest will be Tetlock, or someone else, it’ll be Bill Sharp. And it’s some really incredible podcast. But out of the hundreds if not thousands that have come out in the past year, this curates it down into the top five. I’m doing the same thing with investing blog posts. And then readers, I have a survey on my blog, that also let’s you input either your favorite article, so specific article, blog, or paper, or book from the past year, and your single favorite podcast episode. So you can type them in, it’s on the blog. Let me know and we’ll publish the curated list.
Jeff: I’d be curious, do you have one that stands out in your mind as one of your favorites from us?
Meb: From ours?
Meb: I like all the ones where I monotone read, just by myself, where no one else is on there, it’s just me and the mic. No, those are the least fun. Do you know what the…?
Jeff: Amazing hate mail for those.
Meb: Yeah, yeah. The least popular was our special announcement, which is surprising, because I feel like if you read the word special announcement, like why would you not want to click on that? But the quant study was that for our podcast, the most popular episodes are the longest ones, which is counterintuitive to me. I wouldn’t have thought that to be true, and people give various reasons. They say, “Well, maybe it’s because you guys do go down a rabbit hole, or the guest is interesting, so you just continue chatting. Or, you and Patrick have a bunch of beers and it just goes downhill from there.” I don’t know. But so, we may start to… I may not start putting a hard stop and just say, “You know what? We’ll talk until we run out of stuff to talk about it. And if this thing goes two hours, how about it?”
Jeff: I’ll have to make sure to keep the fridge stocked with beer.
Meb: Yeah, seriously. All right, all right. Moving on.
Jeff: You know that I love options myself, so this was near and dear to me. All right. Research has shown that we can expect lower than average future returns if we buy equities when they are highly priced and outsize returns when equities are historically cheap. Have you ever considered a strategy that simply buys put option protection for equity portfolios at the start of years when valuations are historically high? Let’s see here. This hedge might be just long puts, or long puts short calls, to offset some of the option premium.
Meb: You know, there’s not a whole heck of a lot of option data. Even if you bought up the best option data, it only goes back 20, 30 years. So that’s a pretty small subset. I think naturally it makes sense. The challenge, of course, is options…the price of them, and puts in general are expensive in insurance. And depending on what’s going on in the markets, it can be very expensive. And so, let’s say you just bought, every year, puts that would hedge your equity portfolio totally, so no loss, like right at the money strikes.
I mean, that’s gonna cost basically the entire return of the portfolio. That’s gonna cost you 5 to 10% a year, or 8 to 10% a year. So it just destroys the entire… Because what it’s doing, I mean, obviously it’s an efficient market for the most part, where there’s no magical orb, otherwise, everyone would do it and they would be risk-less stocks.
Jeff: What if you were selective and only did it when volatility was, call it, the VIX was lower than 12 or 13?
Meb: Well, so one of the examples that people give… It was a question, it says, “Meb, instead of a trend following approach where I buy and sell U.S. stocks when they go above and below the long-term trend, what about when stocks cross below the long-term trend? What if I buy puts instead?” And I think that’s reasonable. The challenge, because what happens is, you’re entering an environment where returns are lower, so you’ll get a benefit from the put, getting a tailwind from being in an environment where returns aren’t gonna be as high as they would when above.
And, you’re gonna get an added benefit of volatility going up. Because when markets are below long-term average, volatility is higher in every case. And I think it’s by like 30%. So it’s a dual benefit. The challenge comes, and if you’re just hedging that position, how long do you give it? So, there’s times when you’re under the moving average for a month and that’s it. There’s times when it could well over a year. So if you buy a year put, and then it expires, or at six months it’s totally in out of the money, you have to keep adjusting it. Well, what happens if VIX goes from 15 to 40 in the meantime?
All of a sudden you have an uncovered position. So I think it’s reasonable in that there’s option traders, I’m sure listening to this, that probably could come up with a much better methodology. There’s much more complicated things you could do with spreads and collars and everything else. And you know, there’s an interesting part about the tail risk hedging too, is that…and trend following in general, is that paying a cost isn’t always bad. You know, so many people optimize on cager or compounded returns but ignore the paths to get there.
And I think this is a problem with a lot of portfolios we see, is they’re far too risky, they have way too much in equities. You know, so many advisers and software say, “All right, 20-year-old comes into my office, you got 50 years until retirement, boom, you’re portfolio’s 100% in global stocks.” And the math probably says that’s a reasonable algorithm output. That 20-year-old probably can’t handle a 20, 50, 80% decline.
And what happens, they’re gonna fire that adviser, you know, ya-da-ya-da. We talked about this many times. And so, something like tail risk insurance, or buying puts, on a consistent basis, you know, it’s like having car insurance. It’s like having an insurance on our farm when it burned down this summer. You know, is that it’s a traditional cost, but it acts in a beneficial way when times are bad, so it may be behavior corrective.
Jeff: Well, that’s something you said awhile ago, which I always thought was pretty insightful, was that, we buy car insurance, we buy home insurance, and we have no problem doing it because it’s positioned as insurance. You’re protecting a valuable asset. When it comes to your portfolio, people are so hesitant, and it’s potentially an issue of framing. If you frame this as you’re simply buying insurance for this highly valuable asset that you want to maintain, then people would probably be more willing to do it. But everybody sees it as a cost center rather than a protective device.
Meb: Yeah, I mean, it’s hard, too. I mean, look, it’s gonna lose 5, 10% a year. So who wants that investment? And then, of course, in the bad years, it goes up multiples of that. But as I’ve gotten older and thought more about markets, I’ve…two things have happened. One is, I’ve become much more on board with those sorts of insurance payments. And two, I have no problem with people having a large chunk of their portfolio in cash or cash-like investments. You know, I think that having a huge exposure to risk-type of investments, that historically have large draw-downs, the more people I see and the more investors we talk to, the more and more I’m like, “Man, half the population should be in CDs and just move on.” You know? I think it’s just…
Jeff: Do you think that’s a reflection of being more mature as an investor or simply having a greater net worth that you want to protect?
Meb: Me or the people?
Jeff: You. You said you changed.
Meb: I’m the most mature thousander [SP], you know. No, I mean, it’s just…it’s more of a perspective on talking to clients and watching them. And not just individuals, institutions as well, watch them behave so poorly over and over again. And it’s getting better, I think. I mean, the internet is such a disinfectant, sheds so much light on the dumb things. And hopefully, we start to learn from them. But in general, I don’t…if someone came up to me and is like, “Meb, I got a portfolio that’s 100% in munies and CDs and bank accounts.” I’d say, “I’m okay with that.” Or it’s 80% in cash. I would say, that’s, you know, “You sleep at night? Great.”
Then we talked about this on prior episodes, where, you know, the Bernstein quote of, “Once people get wealthy,” you know, “you’ve won the game.” Right? And I actually just like 10 minutes ago, on Twitter, I saw one of our favorite researchers, Dan Egan, over at Betterment, was talking about an experience he’d had chatting with a wealth manager friend, and someone came in to his office and said, “Hey, you know, they have 250 million, and they said, you know, “My goal is to get to a billion, and I’m very risk-averse.” Whatever that means, you know. “And so I wanna quadruple my money but I wanna be risk-averse.” And a lot of people like that… The behavioral traits it takes to get rich by running a country…a company or being an entrepreneur are totally different than the traits it takes to maintain that wealth.
Jeff: Well, as you guys said in the past podcast, the portfolio that gets you wealthy is vastly different than the portfolio that maintains your wealth.
Meb: Well, I mean, like, the Battistas, the great example, the Brazilian guy, top five richest people in the world, had like 35 billion, hugely concentrated, hugely leveraged. And so that’s what got him there, but that’s also what brought him down to bankruptcy, is that you don’t… Like, you don’t need the same exposures and concentrations as you do if you’re trying to really hit the grand slam.
Jeff: Next question, moving on. If someone were to ask you for general portfolio ideas and building the strategy for the next 30 to 40 years, would you be more inclined to point them towards the QTAA paper methods and absolute value strategy based on the long-term value metrics, kind of like Porter discussed in the podcast, or the trinity-style paper portfolio where there’s more buy-hold rebalance?
Meb: I probably wouldn’t point them to any of those. I would say, first, you need to start to read some more introductory texts. And for a lot of people, it’s finding their, you know, their personal song. I don’t know if that’s the right word. But finding the approach that speaks to them. I mean, some people value investing, and Seth Korman talks about this, it’s like, they take to it immediately. It’s like an inoculation. You know, other people, only until they do three or four or five dumb things, do they then arrive at their, you know, risk tolerance and investing strategy. There’s other people like you that just don’t know better, and continue to trade options and, you know, do dumb things, until… It’s like…
Jeff: I’ll be retiring from this job in another year.
Meb: Is it sadism or masochism, which is it, you like your own pain?
Meb: Sadism. You’re just a sadist, where… Ed Seykota’s got a great quote, where he’s like, “Everyone gets what they want out of the markets.”
Jeff: Well, it actually might be masochism.
Meb: Okay, well, you’re probably both. And so, you know, some people like to gamble, they want the hope of the long shot or… You know, whatever it may be. I mean, we’ve talked a lot about… There’s a book I’d love to write that I just… A lot of the books that I’ve written are kind of easy to write, if that makes sense. It’s research we’ve done, it’s things we’ve talked about. There’s a book that I would love to write called, essentially, “Learn to Invest” or… The way that I framed it was, years ago when we wrote about it on the blog, it says, “How to Teach Your Child to Invest.” Because what most people do and most parents do, and they have good intentions, is they teach all the wrong lessons with all the wrong incentives.
So classic example is a father will be talking to his son or daughter and say, “You know what? Let’s start talking about stocks,” or, “Let’s start to talk about investing.” And, you know, maybe they get to college, or even after college, and say, you know, “I’m gonna give you a $10,000 account,” or whatever, and say, “We’re gonna invest it together. Or, you invest half and I’ll invest half, and you pick some stocks and I’ll pick stuff,” or whatever, and it creates all these mal-incentives.
So, for example, most of the children will, one, look for the home runs, the long shots. They may not, they may just buy stuff they know. But two things can happen. One is that their picks do great, in which case, they were probably lucky, you know, to be honest. And they then think investing is easy, they become over-confident, they wanna go start their own hedge fund, they say, “Oh my god, it’s so easy to make… The stock I bought, it went up 15%. What do you mean stocks only go up 5 to 10% a year? I just bought this one that goes… I can clearly make 25% a year in stocks.” So they’re learning the wrong message.
Or, they pick a bunch of stocks, it goes to a bear market, or they do poorly, or they chase a bunch performance. They lose a bunch of money and then they’re embarrassed, they don’t wanna talk to their father, they don’t like investing, they’re mad at their father, they don’t wanna open the accounts, and it creates a rift. So in either case, it’s a lose-lose.
Jeff: Well, are you forgetting a potentially different strategy where there’s far more communication and discussion between the parents and the child and a little bit more of an actual learning tutorial setup?
Meb: Well, no, no. Because there’s a good chance the parent doesn’t know anything about investing either. And so they’re…
Jeff: That’s a big assumption.
Meb: No, I don’t think so. And so, what… My whole point is, I said, “Look, let’s design it as a curriculum,” and say, “You know what? Here’s what we’re gonna do. We’re gonna treat this like a child going through college.” And so there’s gonna be four-year college, maybe eight semesters.
Jeff: Your child’s gonna hate you.
Meb: And each semester is a lesson and something to learn, but they have to do something. So, like lesson one would be, you have to go read the essays of Warren Buffett, which is a great, great… Have you read that? I think it’s by Cunningham.
Jeff: [crosstalk 00:27:39]
Meb: But it basically is just all Buffett’s old essays [SP]. It’s phenomenal, phenomenal. Yeah, phenomenal reading. And then you would say to the kid, “Hey, look, you know, I want you to think about Buffett’s approach and pick three or four stocks. Once you’ve read the book, I’ll put 10 grand in the account, and you follow the lessons and then we’ll…you know, we’ll check in every six months.” Semester two.
Jeff: Well, that’s predicated by a pretty in-depth understanding the financial statements, and balance sheets, and…
Meb: No, no. No, it’s not. All right, so maybe that’s year three. Semester one can be, “You read John Bogle’s ‘Common Sense on Mutual Funds.’ And so you learn to buy…that paying high active fees is usually a loser game, and you buy…you learn the art of indexing, and you go pick an index or two.”
Jeff: Here’s an interesting question for you. Okay. You know, your kid becomes of age investing, what’s the very first thing you’re gonna point them toward to them?
Meb: That’s what I’m trying to describe to you right now, is… I don’t know the answer, but I’m saying, is you build this curriculum and you say, “All right, you now, next semester is… You know what? Fine. You wanna trade penny stocks, we’re gonna trade penny stocks, and you read the literature on penny stocks and we’re gonna go follow these promoters and you’re gonna implode this 10 grand. The next semester, or summer school for you, Jeff’s gonna teach it, is how to lose all your money trading options.”
Jeff: You just described like a decade of learning.
Meb: Yeah. And so, and maybe we design it as undergrad and grad school. And each kind of part is an interesting lesson, because… So, this is more about the art of investing and it being a lifelong skill, rather than, “I’m giving you money, how much… I’m giving you a check.” So one, you had no skin in the game either. So, in general, the kid needs to work for that. So whether it’s reading the books or completing the lessons, or mowing the lawn, I don’t care.
But just giving them a check and saying, “We’re gonna do this together and we’re gonna make a lot of money,” is a horrible incentive system. It doesn’t check any of the boxes. That’s how 90% of the people I know that I talk to do it. They’re the parents and friends, and they say, “Yeah, we got an account, we do it together.” But this book would be, I think, a lot of fun to write. But I’ve sworn off writing books, one, and two, it’s…I think it would be a hard one to write.
Jeff: Well, clearly, it sounds like you gotta sort of figure out your ideas first, for a lot of things thrown out with a lot of things.
Meb: Well, there’s a lot of different semesters. And in some, there may be some extra credit, etc. But there’s a lot of great investing books that, you know… And some would even go into behavioral investing and finance, say, “All right, you know, read Montiay’s [SP] book and these other two books. And by the way, you need to write down examples of these biases you’ve had and have had the last in three years in doing your trading, etc.”
Jeff: All right, well, listeners, if you like this idea for Meb, send us what you think would be good modules for this learning course. Because we gotta put some parameters around Meb’s idea here.
Meb: And what should we name it? What should we call it?
Jeff: The Jeff Remsburg School of How to Crush It with Options.
Meb: Yeah. That’s…yeah, okay.
Jeff: All right, moving on, come on.
Meb: Rabbit holes.
Jeff: All right. Are the recent bond yield increases causing you to tweak your trinity bond allocations?
Meb: We did some posts on the blog over the years on bond draw-downs that I think are fairly interesting and instructive. And bonds, you need to look at both on a nominal and a real basis. So historically, 10-year bonds don’t have that large of draw-downs, but on a real basis, they’re like 50%. So after inflation, bonds are just as risky as stocks, they’re just… It’s a different risk, which is a long erosion of an inflation. But you gotta remember, what role do bonds play in your portfolio?
So there’s a role that treasuries play, I think, and there’s a role that T-bills play. And we wrote a paper on this, and I think we may have done a monologue on it, about…thinking about foreign bonds. I mean, foreign bonds are the largest asset class in the world. Most people have nothing allocated to them. And we said, “Look, you should move away from a GDP or bond issuance weight to GDP or high-yield or carry weight,” which we talk about in this… What was it called? What was the name of that paper, the sovereign bond paper?
Jeff: Global Yield?
Meb: Global Yield or such? We’ll link to it in the show notes. But historically a value approach to bonds adds a couple percentage points. So, my belief has always been that you should have some U.S. treasuries, you should have some exposure to foreign bonds as well. I mean, and again, you have to look at the… I was having…chatting in a meeting today, we were talking about bonds and where interest rates can go. And everyone always assume interest rates are just gonna go up.
But in the case of Japan, interest rates didn’t go anywhere for…haven’t gone anywhere for 20 years. In the U.S., you know, they have gone up since the summer, but I could easily envision a scenario when they go back down and sit at 1% or half a percent, like the rest of the world, where some of these sovereigns are negative yielding. So, there is still a place for bonds. Now, I mean, again, going back to the old 5-2-1 rule, on a real return basis, U.S….global stocks have done 5%, 10-year bonds have done about 2, and bills have done about 1.
Now that premium of bonds over bills, for the better part of the 20th century, was zero. So from 1900 to 1980, 10-year bonds didn’t outperform T-bills at all. Only until the big bull market of the ’80s and ’90s on did bonds earn that premium of whatever couple of percentage points over bills. So, the challenge is…for people is…
Jeff: Which one’s the outlier though? How do you know…?
Meb: Neither. I don’t think either. I think, is there a premium for bonds over bills? Yes, there should be. Historically, it’s been about a percent, globally, but it’s not guaranteed. And in different environments, one will do better than the other. Same thing with bonds versus stocks. You know, it’s not a guaranteed premium, but over time that there is one.
Meb: What was the original question about? Rethought the bond exposure?
Meb: I think it’s seductive to write off bonds at low rates. And I think it makes total sense to write off negative yielding bonds, I mean, that just seems preposterous to me, why you would ever want those. So we do tilt towards foreign, I mean, and the high yielders yield 5, 6, 7%. So versus a global market cap weight of… It was like half a percent, maybe it’s one now. And the U.S. is better, which is one of the reasons the dollar has been appreciating. So it’s up around, what, two now?
Jeff: I don’t know.
Meb: Over two. It’s quite clear I don’t pay that much attention to the bond yields, but historically, so like, if you look at the timing models of moving to… So in the old white paper, we showed the effect of moving to cash when out of the market, or T-bills. And a lot of people said, “Well, what if you then put it in bonds?” And so, 10-year bond… So instead of moving to cash, you’re put in 10-year bonds. That actually adds another hundred basis points of returns since the ’70s. And it actually didn’t hurt in the ’70s, which is interesting.
So even in a rising interest rate environment, by moving to cash, it didn’t hurt the return, partially because the other asset classes you were invested in when they were going up, such as commodities, real estate, stocks, covered that. But it’s an uncomfortable feeling for me to be in a low interest rate environment and go all in on long-term bonds. As you’ve seen with 30-year bonds, zero coupons are the most volatile of them all, they can be extremely volatile. But we don’t…I don’t have a strong opinion on it.
Jeff: Well, a related question. You might’ve…you might feel you’ve already answered as much as you want. But, a peripheral question here. “I work as a private banker in Australia and can’t tell you how many times I’ve heard a variation of, ‘Rates are so low at the moment, what a great time to borrow,” from clients. What are your thoughts about the long-term debt cycle and how would you go about timing leverage?”
Meb: I think people get a couple things wrong. I think they get wrong that… People always think of nominal returns, so, interest rates are at 10, or interest rates are at 1. And so we’re in a low-yield environment, we’re in a high-yield environment. But that’s not really the way the world works. It’s almost always a spread to inflation. And so, you have a slight spread to inflation, so it’s really the real yields is what matters over time. And historically, investing in markets with higher real yields is the best place to be doing it.
And there’s certain macro regimes such as when real yields are negative, meaning bonds are yielding less than inflation, that are great for some asset classes like gold, Which makes sense. And why is gold sold off this year? It’s because bond yields have come up and real yields have increased, As an example. Another class that’s…and asset classes do well or worse, depending on the macro environment. We have an old blog post on that somewhere, if you can find it. We’ll add it to the show notes.
So, it’s… The real underlying force is real yields, in my mind. Nominal creates behavioral differences, I think. We’ve seen a lot of rush into higher yielding, riskier assets over the last 15 years because yields are low and artificially, you know, low. And what was the second part of the question?
Jeff: Where are we in the long-term debt cycle? And then, how would you time leverage?
Meb: I’ve always been a big fan of Ken Fisher’s writing. You know, his marketing direct mail that I get once a week, less so. Although I like getting it, because it’s a masterful look into behavioral psychology and how you can write a sales pitch to hit all the neurons that make you wanna sign up for an account. But I’ve loved his writing and read all of his books, and I think he’s actually a great writer. He, you know, talks a lot about debt. And I think the thing that people always…the people that pull their hair out about government debt, in general, is they always forget that there’s the opposite side of that coin, is that someone owns that debt, and so that’s an asset for someone.
So that liability is grandma’s pension fund, it’s someone’s bank account that’s earning yield. So a lot of people freak out about debt because they think about it in terms of individual. You know, most people think debt’s bad on an individual basis, and in general, it is. And it causes people to go bankrupt and do dumb things, and leverage, etc. It’s just a little different on a government basis because the bonds end up being an asset for people to hold. And I don’t sweat it as much as most people do. I used to a lot more, but I really don’t, so I would recommend reading some of Ken’s articles about it.
And then looking at… I mean, there’s a million different ways to look at debt. You could look at a corporate balance sheets, you could look at individuals, how levered are they, you know, at different points in the cycle. Where are we now? I don’t know. I’ve always been bad at the kind of the macro fundamentals, but I don’t know that anyone’s good at it either, so… I’m not so sure.
Jeff: I can’t help you there.
Meb: Maybe Soros. AQR just put out a paper that we sent out to the Idea Farm that looked at the factors of famous investors. So the exposures of Peter Lynch, Warren Buffett, Soros, and Bill Gross.
Jeff: Is that the…Soros is a trend follower?
Meb: Yeah, Soros is… Soros loaded a lot on momentum and trend, and I… You know, currency valuation and other things you would expect. Buffett, of course, value and quality, and each of those had some alpha exposure. But it’s basically how could you replicate these guys based on common factors? And we’ve talked a lot about in the past, about Buffett’s exposures actually not that complicated, value and quality, but rather, it’s the fact that he sticks with it through thick and thin.
And you’ve seen… This year is such a good example, because you got two environments this year. You got the environment for the first six months of the year, which…very different asset classes had great performance than the next few months, including post-election. And the dividends were a great example, because a lot of people… We’ve been ranting against dividends for forever. They’re expensive companies, they’re highly levered, they’re junk, and they do poorly in a rising rate environment. Most people don’t understand that.
So what’s happened since June, these dividend funds have… I wouldn’t go so far as to say they’ve gotten crushed, but they’ve done very poorly. And lots of other strategies and styles, like shareholder yield, are having monster years and a lot of value strategies, particularly post-election, have gone straight through the roof. But this is a good example of a strategy where first… You know, value, what’d Wes say, “It’s the value pain train of the past few years, where value’s been an under-performing factor.”
And all of a sudden, you light a match, something happens, and, you know, it explodes. And this is a great year, where you look back and say, “Oh jeez, Cape has done incredible this year. The value styles have had a monster year.” But, what has changed, you know, part of it is interest rates coming up, part of it is things we’ll look back on and say, “Oh, that’s what happened.”
Jeff: Do you see factors as sort of existing in a certain sequential chronology? Where, like, you can look at next year and sort of say, “All right, well, you know dividends are gonna…”
Meb: I think that’s a story people like to tell, you know. One of the first things you read as a young student is that economic cycle, right? There’s like this perfect sine wave of, “This is what happens early in the cycle, and then companies de-lever, and this and that.” And like, as if you could predict them at each point. And even Bridgewater talks about, they have like a framework for the business cycle, and it makes sense. You read it and you’re like, “Oh, this is a perfect cookbook. All I have to do now is figure out where we are and then I can invest and make billions of dollars.” And…
Jeff: Trillions if you use options.
Meb: Oh, god. And so, I think it’s much more complicated than that. I think that’s a reasonable framework, and people often say, “Well, here’s the sectors you do in the cycle.” The problem, of course, is that you never really know, and what the future’s gonna look like. So, could I have said, “Hey, this is a world where interest rates are actually gonna go down or something else is gonna happen.” And you look back and say, “Well, of course, dividend stocks did poorly, interest rates went up.” And that’s what we thought would happen, but you know, who knows? It’s… The macro economics has been evidence by the fact that economists are routinely incorrect on most of their predictions that you see. It’s so challenging to predict that side.
Jeff: Okay. Jumping around here. Over the last few months we’ve had more than a few questions come in, curious about your thoughts on momentum versus Gary Antonacci. Do you mind giving us just maybe a quick 10-second review about what Antonacci does and then what are the similarities between you and him?
Meb: Ten seconds. Gary Antonacci does dual momentum. Is that under 10 seconds? Gary is a chill dude. We gave a speech together in Vancouver, we’ve corresponded over the years. There’s a lot of strategies that have a very similar feel and flavor. I mean, look, we wrote about a cousin of dual momentum in our first white paper.
Jeff: What is dual momentum?
Meb: Dual momentum, the way that Gary does it, and I may… I read this book years ago and listened to Gary’s, we’ll get him on the podcast one day, is that it looks at an investment set, so momentum again being relative strength to what assets are doing best, so he’ll look at various assets and say, “What’s doing best? U.S. stocks or foreign? What’s doing better? Gold or rates?” Or whatever it may be. And so it’s ranking those assets the same way we’ve talked about in our old global tactical aggressive portfolios.
So, you’re ranking assets based on intermediate term performance. And then he says, “Are they going up?” And the way that he does it, if I remember correctly, is looks at it like a one-year look back, is the asset up or down? Which is a simple way. And, you know, we talk about trend following with simple moving averages, other people talk about, you know, three-year highs, channel breakouts, dunkins [SP], all these things, they all are cousins in the same family. They’re all like first and second cousins. So they do the same thing but they have different flavors.
And so, Gary’s looks similar to what ours does. In a given year, they’ll probably have vastly different performance. But they get this…they should get the big ones right. So any trend following system should get a really long bull market, they should be long, and a really long bear market, they should be out. Now they may get the turning points different, but they should all get the meat of the move, which is the whole point. They may not enter the same…
If you pull up all the managed futures funds, type them into stock charts, they have a feature that lets you compare performance. They all have the same ebb and flow. You know, one may do better because they trade more currencies, and the other may do worse because they don’t short energy, and the other, like our buds at Longboard Trade, carbon emissions, or whatever they do.
So there’s little differences, but the big designs are the ones that cause them to look fairly similar. So Gary’s approach, I think, is a totally valid approach, you know, looks very similar to the funds we run, some funds we run and strategies. So we’re on board with it. It has a lot of the same characteristics.
Jeff: So nothing major in terms of the differential there. Probably just a few tweaks that affect…
Meb: And I don’t remember the exact rules, but, you know, in general, the big decisions are, do you use a trend following metric at all? And then two, what markets do you target? So a lot of people may only target four markets and other people may target… Listen to Winton or any of these guys, and they’ll say, “Yeah, we trade 120 markets around the world.” So that’s gonna look different than someone who trades… And then, how much leverage do you use? So yes, there’s a lot of subtle differences that make them sound a lot different, but you pull the performance and they often look pretty darn [SP]. So, for example, most managed futures funds are having a poor year.
But because most of the global momentum strategies we use don’t short and have pretty heavy exposure to equities, they’re having a great year. So it’s just different colors, but same general concept. So ’08 and ’09 are kind of great examples. Any trend following fund should’ve had a banner year in ’08, either being flat, or not losing much, or making a ton of money. If they didn’t, then they’re doing something else weird.
Jeff: Okay. We had a listener apparently hear you talk about your farm a fair amount. And he writes in, “As a small investor, is it possible to invest directly in farmland with, say, $100,000 or less? If so, where’s a good place to start?”
Meb: You can buy a small plot somewhere for 100 grand, I’m sure, have a garden in your backyard.
Jeff: How would you invest…?
Meb: In LA that buys you like a closet. You can grow some farm… Now, in California, you can grow some farmland agriculture in your basement and probably make a lot of money that would’ve gotten you arrested a few years ago.
Jeff: I mean, what about, like, a Plum Creek, like REIT type thing?
Meb: So you’re not talking about cannabis anymore? I still think we should do a cannabis ETF.
Jeff: Focus, man, focus.
Meb: Yeah. Farmland is an example of a great asset class that is… I would love to access to, in a liquid format, much like catastrophe bonds. I can name about three or four others that don’t really exist as liquid asset classes. And farmland is one that institutions have really become familiar with and started investing in, but it’s something that happens at scale, you know, where they’re buying huge tracts of land in various places. So there’s private funds that do it, there’s a couple REITs, now and I’m surprised there’s actually not more REITs that do farmland, because it seems to me to be a perfect structure.
Jeff: Is Plum Creek timber or is that farm?
Meb: Yeah, it’s timber. I just ignored that comment. And so, it’s the same problem with timber, because a lot of the timber companies are amalgamations of wood product and they do paper processing, and they do like 10 other things, and on top of that… So it’s not pure timber exposure, and then they have a ton of stock beta.
So they’ll move with the stock market, when in reality, a timber private fund, if you just bought a bunch of timber, you know, they… It’s a totally different exposure than if you bought a stock that’s a wood processing company. So the same thing. So there’s a couple REITs that have come out. I remember looking at their prospectuses and I wasn’t that impressed because I feel like there’s a bunch of embedded cost structures. But a lot of ideas like that, so…
I was talking to a guy the other day who’s running a private fund that invests in mobile…what do you call it? Mobile parks. Like, trailer parks. So, invests in a bunch of trailer parks, and the same thing with people used to invest in taxi medallions, or invest in, you know, private timber. There’s a lot of these asset classes that aren’t particularly correlated to other things that would be awesome to be able to get exposure to but you just can’t, really. Like, I don’t know how you do.
Jeff: It’d also be interesting to look the actual farmland. I mean, if you go on sort of a plot by plot basis, there’s potentially discrepancies in whether or not you’re veering more towards land banking versus an active farm that’s producing significant amounts…
Meb: So, there’s two parts, right? So there’s…same as real estate. So you have, for like a REIT, you have the building value appreciation and then you have the yield for renting it out. Farmland, same thing. You have the farmland appreciation or depreciation, and they go through some pretty crazy cycles over the years. And we’ve seen them go up for like 15 years straight, they’ve come off the peak of…the last few years. And there’s also the factor of crop prices, which are, for most part, agriculture’s very depressed on the prices, but the government’s made it a scenario where they’ve taken a lot of the risk out of production.
So it’s almost like a utility yield, you know, where I’ll just get checks in the mail from the government. I still cash them. I would rather not get them if they would get rid of some of these, because it creates a kind of, you know, distorted market. You know, people talk… Tim Rogers always rants about the sugar growers in Florida, where he says, “We’d be better off just buying all the farmers a Lamborghini each year and just telling them not to produce.” Because it’s an absurd amount of incentives that the government pays out.
But, yes, I would love to see more farmland REITs. I wish more people would do it because… And not only that, you could do, you know, say, “Hey, we’re gonna have farmland REITs in the midwest or the northwest.” Or, “We’re gonna do vineyards.” I mean, you could do… The sky’s the limit. So someone listening to this, hey, great idea. I need to…
Jeff: PeerStreet, PeerStreet, tell them to expand.
Meb: Yeah. They got all that money, I don’t know what they’re gonna spend it on. We should update our $5 million ideas in fintech and investing for 2017. I got a few new ones. Although a lot of the old ones haven’t been done. That’s a great episode.
Jeff: Options is gonna be number six.
Meb: No. We’re gonna spin you out as a separate podcast and have you have your own show. Penny Stock Option Trading with Jeff “Jefe” Remsburg. All right, everybody, we’re winding down here. We may have a light posting schedule over the holidays. We’ll come up with a few ideas to record, but in general, we have some awesome guests coming up, we’ve already got planned.
In the meantime, check out some of the posts on the blog coming up. We have the top investing podcasts of 2016, as well as the top investing blog posts, articles, books that people have submitted. If you haven’t put in your answer, put the answer in on the blog, and we’ll curate and publish it. And look for, too, some really cool stuff coming out in 2017. We got, I think, the 10-year anniversary of my original white paper.
Jeff: Let’s update it.
Meb: So we may have to do… Yeah, we may have to do an update with some new magical twists. Look, anyway, everyone have a great holidays, if this is the last one pre-Christmas and New Year’s. Again, you can always go find the show notes at mebfaber.com/podcasts. We’ll add the transcript for this later. And please, it’s holiday season. Go leave us a review on iTunes, we really appreciate it. Thanks for listening, friends. Good investing.
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