Episode #46: “We’ve Got to Expect a Recession This Year or Next Year, or if We’re at the Wild Extremes, the Year After That”
Guest: Raoul Pal. Raoul’s early career was at Goldman Sachs where he co-managed the hedge fund sales business in Equities and Equity Derivatives in Europe. Other stop-off points on the way were Natwest Markets and HSBC, although he began his career by training traders in technical analysis. Raoul retired from managing client money in 2004 at the age of 36 and now lives on the Valencian coast of Spain, from where he writes for The Global Macro Investor. His is also the co-founder of Real Vision TV.
Date Recorded: 3/24/17
Topics: In Episode 46, we welcome Real Vision TV co-founder, Raoul Pal. The guys start by going over a bit of Raoul’s background.
Raoul started his career by running equity and equity derivatives at Goldman Sachs. Through this, he learned the macro investing world. He then joined a hedge fund, managing its global macro fund before retiring at 36 on the coast of Spain. But it was then that Raoul decided to start a research service, the Global Macro Investor, aimed at large, institutional players.
However, in 2008, Raoul realized the ordinary investor had been let down by the system and financial media. So, in an effort to help, Raoul founded Real Vision TV with Grant Williams. Real Vision features the smartest guys in the world teaching you how to invest, what their best ideas are, and so on…
After this background, the guys jump in, with Meb asking Raoul about his overall investing framework. Raoul tells us this whole game is about probabilities. To invest successfully, we look for times when the odds are in our favor. So, to look for these times, Raoul developed a system based on the business cycle – with a focus on GDP, as asset prices are moved by economic growth. The model relies heavily on findings from ISM reports (Institute for Supply Management). Raoul tells us that when looking at ISM numbers, it’s not just the level that counts, but also the rate of change of those levels. Overall, this model helps forecast S&P levels, bond yields, inflation, world trade… basically everything!
So, what is it saying now?
“We’ve got to expect a recession this year or next year, or if we’re at the wild extremes, the year after that.”
Meb brings up stats from Ned Davis, tying ISM levels to market returns. He says how last year, it appeared that ISM levels were rolling over, but then they steadied and now are a bit high. He asks Raoul what it means for us now.
You’ll want to hear Raoul’s response, which includes the possibility that asset prices may weaken soon – while bond yields may suffer significantly.
Meb then points to Raoul’s call of a potential short trade in oil. Raoul tell us that this is the largest speculation in oil – ever. Way too many people went long, and this speculative positioning is too far ahead of the actual business cycle. He says oil is maybe $10-$15 too high right now. It’s coming close to being a perfect trade setup. Oil could hit as low as $30.
Next, the guys discuss great opportunities around the globe. Raoul points to Cypress. Greek stocks are still hammered too. He says the upside could be huge – potentially 10x your money. Meb agrees, mentioning his own study about markets that have gone down big, or stayed down for many years. The upside is often spectacular.
The conversation then steers toward one the biggest emerging macro story in the world – India. You’re going to want to hear this one. It’s a fascinating story, and Raoul gives us actionable investment ideas.
Next up – Bitcoin. Raoul gives us a quick primer on Bitcoin and blockchain technology. He tells us that many people are confused as to what, exactly, it is – currency? Investment? Raoul gives us his thoughts.
There’s way more, as this episode is packed with great content. The guys talk about Google’s and IBM’s prospects as investments… artificial intelligence… making money entrepreneurially rather than through investing… and Raoul’s most memorable trade – it’s fascinating story involving the South African Rand that you don’t want to miss.
What are the details? Find out in Episode 46.
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Comments or suggestions? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- Real Vision TV
- Raoul’s business cycle video which can be viewed for free: realvision.com/businesscycle
- Raoul’s Twitter handle: @RaoulGM
Transcript of Episode 46:
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 cofounder 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: Hello podcast listeners. I am super excited today to have a fellow macro guy on the show. Raoul Pal, welcome to the show.
Raoul: Thanks, Meb. Great…
Meb: You’re calling in from the Caymans today?
Raoul: Yeah, our office is right near the beach, so it’s not like the end of the world. What about you in L.A., so you don’t have the worst weather either.
Meb: Not so bad here. You know, we…So I met Raoul at the Cayman Investment Forum. We had some sushi and sake, and the next morning I did a sit-down video for Real Vision. And the interview went great, we had a great time, but it’s probably the sweatiest interview I ever did, because I went running right before the show. And so I’m almost too embarrassed to show it to anyone but had a lot of fun. So I’m excited to turn the tables on Raoul today and get to ask him lots of questions, so…
Raoul: I just thought you were nervous, Meb, that’s why you were sweating.
Meb: I don’t really get nervous, and I also don’t really run, so it was just the combination…just being sweaty. Anyway, so a lot of the listeners have heard us mention one of your new ventures, Real Vision, but why don’t…for most of the people that aren’t familiar with you, give us a super-quick background on how…career trajectory that landed you in the Caymans today.
Raoul: Sure. My background was equity derivatives, that’s where I started my career in London. I happened to, early in my career, get involved with some of the world’s largest hedge funds. You know, at that stage, there weren’t that many hedge funds, but they were massive and really important, the Titus [SP], Sources [SP], Tudor [SP], Steinhardt [SP], Moore Capital, all of those guys. My kind of sales side of the career finished when I was running equities and equity derivatives at Goldman Sachs, dealing in four hedge funds. So, I had the big hedge fund team, huge team of us, and I was just lucky enough to get to learn the trade from the greatest people in the history of investing. So, you know, I’ve always been a macro junkie, and I, you know, incredibly fortuitous in my career, and getting to know the other guys who shared my same macro junkie mentality.
The obvious happened, is I moved over to the dark side, back in 2000 and moved across to a hedge fund, which was GLG Partners. I ran an internal book there to start with, and then launched and managed the global macro funds. GLG is probably, well it was at the time, the largest hedge fund group in Europe. They then took over Man Group and they’re now absolutely enormous. So I did that for a few years and had the fun of the global macro game, investing. I’ve always been investing myself, but back in 2005 I decided to opt out of the rat race and kind of semi-retire at the age of 36 and move to the sunny Valencian coast of Spain, where…scratching my head, thinking, “Well, what am I gonna do now?” I realized I’d learned so much and my framework within global macro was different from so many people, I tend to approach things in different ways, that people might be interested in reading stuff I’d have to write. So I started a research service called the Global Macro Investor, which is very high end, it’s very institutional, it’s aimed at the largest hedge funds in the world, big family offices, pension funds, sovereign wealth funds. But starting, you know, writing for a few people and before you know it, it resonated and people loved what I did. And I built a business from there, just quietly from Spain, writing away and traveling around the world meeting these incredible investors, advising them on their portfolios and the best trade ideas in the world.
And then 2008 came along, and I got increasingly awkward with the dichotomy that people like myself knew exactly what was going on and had been predicting that this was gonna happen, but the ordinary guy had been let down, both by financial media and by the banks. Nobody wants to acknowledge the risks that were there. And people were getting destroyed, whether it was in the housing market, whether it was their savings, or in Spain when the banks started shutting down. And I thought, you know, it’s really not right that the media’s let people down. So I had this idea that I had a duty to do something about it. I’ve had a great career in finance, and I think that finance should not be an elitist industry. It’s basically everybody’s savings and what to do with it. And you can’t treat it as entertainment, as many of the media networks have, you have to take it seriously.
So yeah, I parked that for a while and carried on writing and doing my thing. And then I ended up having a dinner in Spain one day with a guy called Grant Williams, who writes a newsletter called “Things That Make You Go Hmmm”. And Grant… I’d never met Grant before but he’d been a big fan of my work and happened to be in Spain. So we had a few glasses of riacca [SP] over dinner, as you do, before you know it, he was talking about some of the videos he’d made. And I’d seen some and was very impressed, and then the light bulb moment came, was the fact that we were probably stupid enough to go and take on the entire financial television industry and start a whole new media business. So that’s what we decided to do. And Real Vision was born a few years later, four of us in a small office in the Cayman Islands. We’re now 50 people, we’ve got customers in over 100 countries worldwide, some of the world’s greatest investors on a weekly basis appearing on the platform, telling us the best trade ideas, what they do, how they invest, some of the world’s best analysts, strategists. We’ve broken some of the world’s biggest investment stories, it’s incredible journey.
Meb: And it’s good, it’s interesting and we’ll come back to some ideas on the business side a little later in the podcast, because you and I see the world pretty similar there. We used to write a handful of articles about some of the needs there, on the content side and the frustrations, of course, with going on CNBC for 15 seconds in the octagon. But let’s talk about investment ideas first because, you know, you are a little bit different and saying, “macro” is kinda like saying, “dog,” right? A Great Dane is different than a poodle or is different than a Beagle and so you have the Rentechs [SP] of the world that are systematic macro, and then you have other guys that are discretionary. Maybe talk a little bit about your framework for how you view the world. And I know you talk a lot about the business cycle as well, and then we’ll touch on a few specific kinda ideas and the way the world looks to you. So maybe let’s start with your general investing framework.
Raoul: I saw the opportunity when I was running a macro fund and having monthly P&L [SP] reporting. So even though you have a time horizon of your idea, let’s say your idea is, “What’s happening to the U.S. economy over the next year?” You can’t treat that on a month by month view because the data only comes out month by month. And meanwhile, for reporting purposes and risk management purposes, you have to look at this on a monthly basis, it kind of was ludicrous. And I realized the great investment arbitrage, the biggest source of [inaudible 00:08:01] of all, was time horizon. The longer term time horizon you have, the more probability you’ll have of success, if you have a framework that is true and robust and realistic. Those two things married together just shift the balance of probabilities in your favor. And this whole game is about probabilities. None of us are right all the time. All we try and do is look for the time when probability’s on our side and the risk/reward is in our favor.
So, what I did is I developed, when I was at Goldman, and then through to GLG particularly, I started developing a framework based on the business cycle. What that means is, I looked to the ISM survey, and the ISM survey is what I use as the basis of the business cycle. And the ISM is the Institute of Supply Managers survey where they survey a load of purchasing managers and ask them about their intentions and what’s happening to prices and purchasing pieces [SP]. But regardless of that, it’s an index, goes up and down. But it happens to go up and down perfectly with GDP. So it’s a monthly index that basically forecasts or tracks GDP. Okay, so that’s pretty useful. But why is it useful is because asset prices are moved by economic growth.
Now, this is where people get lost. People think, “Well, if the economy’s growing at a certain pace, then asset prices should be fine.” It doesn’t work as simplistically as that. It’s the rate of change that counts. So, when the ISM’s at 50, which is considered neutral, i.e. the economy’s not expanding or contracting, then the return versus [inaudible 00:09:40] the last year, the S&P should be about zero. If the ISM goes high, as it is now, then the return over the previous year should be higher, 10%, 15%, whatever the number is. And if the ISM signals a recession, which is roughly 46 or lower, then we’ll see the yearly rate of change of the S&P contracted. But it’s not only the S&P, but it allows us to forecast the S&P. But it’s not just the S&P, because the year on year changing bond yields is driven by the ISM. The year on year change in inflation is driven by that, the year on year change in world trade is driven by that, the year on year change in the KOSPI index in Korea is driven by the same thing. In fact, almost all asset classes, copper, oil, everything, are driven by the U.S. business cycle, which is the main driver of the global business cycle.
So, basically, understand one thing and you can pretty much understand the relative pricing of all assets, and it also allows you to forecast. The forecast ability of the business cycle is based on a simple thing. Even a child can understand this, but for some reason economists can’t…is economies go up and down, they’re cyclical, it’s just a fact. Look at any chart of GDP over the last 200 years, it goes up and down. So what we know from that is we can get probabilities from that. So we know, for example, that every economic expansion lasts, on balance, seven to nine years. So currently, we’re in year eight, so we’ve got to expect a recession this year, next year, or if we’re at the wild extremes, the year after that. So we know the probabilities of recession coming are rising. If it was year three, the probability of a recession’s extremely low. So that kind of thing makes you understand therefore that we should be cautious in stock markets and more positive in bond markets. And so, all of the things flow out, it also means we’d be less optimistic in the oil markets and the commodity markets.
And so, that’s how I look at the world. It’s a simple framework, but it’s worked over time. The ISM survey goes back to 1948, and it’s worked ever since. And there’s the Treasury survey that preceded it that went back to 1870 and that worked too. So we’ve got a huge set of data that’s forecastable, understandable. Nothing gives you a 100% chance and nothing ever will, but what it gives you is a very easy way to understand the world. So that’s how I do it.
Meb: You don’t have to just believe Raoul straight off, but we pulled off a chart off Ned Davis and they do a lot of quantification. And there’s some pretty good stats on showing that, you know, when ISM is above 50, you know, and future stock market returns are fairly strongly positive and vice versa below 50. So what you’re saying has merit and, by the way, there’s a great video we’ll link to in the show notes of Raoul talking about the business cycle at realvision.com/businesscycle. So, okay, so the ISM kinda ripped back up after the depths of the crisis and was strong for a few years, kind of bounced along a few times, maybe touching 50, and then last year, I believe, in 2016, there was a couple of times when it looked like it might roll over and then really kinda ripped back up. So, what does that kinda mean right now? It’s at a fairly high number now and then what does that kinda say about markets, to you, as far as your takeaways in the main markets as a starting point?
Raoul: Yeah. So just going back a little bit historically, as you said, the business cycle started weakening badly in 2015. In early 2016, the ISM was below 50 and GDP was below 0. So I had been forecasting a recession, looking for that. That didn’t stick around. And the reason it didn’t really stick around is a number of elements, but one of the key elements was that the rate of change, the fall in commodity prices and various other things had been so extreme that the rebound meant that the economic data started coming out much more positive. It’s the year on year comparison of economic data that makes a big difference. And the ISM has rebounded strongly as had the year on year change in oil and all sorts of other indices and commodities. To explain is, everything looks stronger than it is and that’s because of this translation effect to January, February last year when everything was puking. So now it looks very strong. The reality is, is that translation effect comes off all of this data from next month onward. So the data should weaken significantly, and we’ll see, yet again, the true trend rate of growth of the U.S. And I think GDP will come back down to kind of 1.5%, 1%, that kind of level, where trend rate of growth appears to be now.
So that sets me up. So, again, we know that the asset prices have followed the business cycle. We have a vague prediction here that the business cycle should weaken because of one of the reasons why it’s so strong now, we understand why it could weaken. And therefore, that should tell us that some of these asset prices are pricing on the wrong thing. It means that equities are likely to struggle a bit, I don’t think there’s anything major to worry about. Bond prices, however, bond yields, should significantly fall because bond yields are basically just GDP plus inflation. So if GDP’s lower, and inflation’s gonna be lower, all by this form of translation effect, then bonds should be a home run trade. So that’s kind of how I’m looking at it. Oil is the other one that’s involved in this whole mix, and I think oil is also likely to become weaker due to the business cycle and a whole number of other things that I think we’ll probably talk about later.
Meb: And oil, you know, is interesting, I mean, you kinda went out on a limb on the oil side, where you say, potentially, at some point, and you don’t have a position yet to my knowledge, but you just said, potentially could set up as a home run short trade. And part of the thesis, I believe, has to do something with speculative positioning. Maybe you talk a little bit what you mean by that?
Raoul: Oil is also very cyclical. What has happened recently is that the oil price kind of rebounded after the big sell-off [inaudible 00:15:42] 30 bucks in Jan-Feb last year. That brought speculative positioning into it. But not only some speculative positioning, it’s the largest ever speculative positioning in the history of oil. In fact, if I look over the 30-year history of oil, it was the seven standard deviation or eight standard deviation event. Basically, too many people got involved on the long side in oil. So that is the kind of thing…that’s a brilliant example of where I will suddenly start to look at something and say, “Okay, oil is following the business cycle, it’s kind of doing what it’s supposed to be doing” but suddenly speculative positioning is way ahead of where the business cycle should be going. We then look at the U.S. dollar, the U.S. dollar’s been strengthening. It has an inverse relationship with oil and this kind of alligator jaws of where the two charts have separated, suggesting that oil is probably 10 or 15 bucks too high here, at around 50.
So all of these things start to get me interested in, what’s going on? So then, that’s when I start digging into the story and I started talking to people about what’s really going on in oil. And it seems that Saudi Arabia is behind this because of the Aramco deal. Aramco, if you remember, is the Saudi Arabian state oil company that is purported to be the largest company in the world and has a potential market capital of a trillion or $2 trillion, nobody’s really sure. They were talking about IPO-ing Aramco. Now, there’s a whole number of reasons I don’t think that will ever happen, but there’s also a bond coming because Saudi Arabia’s desperate for cash. I have a feeling that they are in cahoots with some of the larger hedge funds to try and support the price of oil at a higher level before this bond comes out. So we’ve got a whole series of things that make it very interesting to me, a number of reasons why the market is unsustainable.
I then spoke to the oil producing guys, got a hold of the oil traders that I know and they’re like, “We’re selling as much oil as we possibly can. We see how much is in our ships, how much is in the tankers, how much is in the ground, how much is in storage, we know how much is being used, and nothing adds up.” So it’s coming close to being a perfect trade. So the last part of what I do is that I use technical analysis for timing. So I’m now waiting for a technical set-up. I’ve got the first part of the move, I’m now really waiting, potentially, for a bit of a bounce-around, a bit of a [inaudible 00:18:05] of that move from the recent high, and then if oil breaks kind of the 45 to 43 level, then the trade is on and oil could hit as low as 30.
Meb: That’s interesting. You know, one of the parts that I do enjoy about reading through your pieces is a lot of the use of the charting is packed, in many, many charts involving some technical analysis, which you’ve been using for years. So there’s another quote that I saw, you know, in the piece, and this is an area that we certainly overlap on. I remember when we sat down for our chat, and you said, “Meb, what’s your best idea now, if I had to ask,” and I think my response at the time was, “Emerging markets”. But one of the comments you have in paper says, “I continue to believe that the source of biggest returns over the long-term are not developed markets, but markets that were smashed over the financial crisis and are beginning to recover.” And you give some examples in the piece, but maybe you wanna talk about what you meant there, and a few possible ideas on where you think there’s some opportunity.
Raoul: Yeah. I mean, if you understand what an index is it’s very different from a stock, and not a lot of people understand the subtle difference, the fact that an index, unless they close down the stock market, will never go to zero. And what you’ve got is some extraordinary things that I have never seen in my entire lifetime, in my entire study of financial markets, and I’m a big economic and financial market historian, are markets that are down 95% and have never recovered. So what you get is basically a self-funding option. So whether the market is Greece or Cyprus, Cyprus is down than more than any market I’ve ever witnessed in history, which is 99.5% percent, so it’s basically worthless.
Now, you could buy Cyprian stocks, add them up…you know, it’s an EU country so you can buy them through a brokerage. That’s not the easiest thing to do, but no good trades are easy to do, if not, everybody would be rich. And so, Cyprian stocks, Greek stocks, these things act like an option, but they’re self-funding because they pay dividends. So you can get paid dividends to sit on something that is an option. So, you trade a small size, but the upside is tenfold. So, yes, you can lose, you know, “another 50% from here” as the classic quote goes, but the point is, the upside is ten times your money. So risk/reward bets over an extended period of time are great, and unlike an option trade, where you lose money over time because of the time decay, you actually gain money over time because of dividends.
Meb: And the nice part about a lot of these bombed-out markets is, you know, we talk a lot about it on the podcast at my favorite intersection, which is, you know, something that’s really cheap or value or in many cases, something that’s just simply bombed out but is starting to enter an up-trend. And you’re really starting to see, for the first time over the past nine months or so, a lot of these countries that are really really cheap start to outperform and really see some moves. But going back to your comment, you know, we did a study that has been pretty popular, where we took the French Fama database back to the 1920s on sectors and industries, and just a really fun one where we said, you know, number of down years in a row. And it’s very similar to another study we did looking at the same thing, sectors and industries, once they were down 60, 70, 80, 90%, and found exactly what you’re talking about, which was, you have to have a long time horizon so meaning in terms of years, rather than months or quarters. But, basically, the more something has gone down, the more down years in a row the future of the expected returns are.
We’ll put a link in the show notes, but certainly spits out a lot of names, like you even mentioned uranium stocks in one of your pieces and we’ve talked a little bit about that as well. And it was also interesting to see you mentioned a couple of names in the piece where you said, you may be more bullish on Morocco as one of your favorite countries. And I was laughing because we did a survey, being an ETF issuer and said, “I’m curious what the largest GDP countries are that don’t have ETFs” and I think Morocco is in the top three and then, of course, you also said Iran. So, ETF issuers listening to my podcast, feel free to steal my ideas and launch a Moroccan ETF.
Raoul: You can buy every single company in Greece, the entire lot, the entire stock market, for less than the price of Bed Bath & Beyond in the U.S. just so you know how cheap it is.
Meb: Well, we have a fund that owns a bunch of Greek stocks, and have for the past few years, so I can sympathize and I understand. And Greece is one that’s interesting, you’ve seen a lot of big moves out of countries, whether it’s Brazil or Russia, a lot of these super cheap valuation countries, and even a lot of Europe and Eastern Europe start to really recover stock markets over the past few months. And Greece is one that’s been kinda quiet, maybe everyone’s forgot about it. So, you know, hopefully we might see some big returns there. I think we will.
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Meb: I wanna save some time for a really, really interesting article in this month’s GMI that you wrote, and it was followed up by… I think you had tweeted about it and basically asked your audience, “Has anyone ever heard about this topic that we’re gonna talk about?” And basically everyone said, “No.” And the lead-in from your piece, you said, “I think this is the biggest emerging market macro story in the world”, you were talking about India. So, you wanna talk a little bit about what you found in your study?
Raoul: Yeah. I mean, I only just came to this recently, I’m half Indian, I didn’t know anything about this. But what I discovered, after writing a small GMI article, I then discovered the whole story. I was shocked, you know, it’s an extraordinary thing. So what happened was, India banned cash. We all saw that, you know, everybody was like, you know, “This is the government stealing your money, isn’t this terrible” because everyone looks through Western eyes, you know. If that happened in the West, it’s a much more potentially concerning thing, not necessarily concerning. But anyway, so everybody’s screaming and shouting, what a terrible thing. And I thought about it and I listened to what they were actually saying, and I realized that what they wanted to do was basically stop the petty corruption within India. Okay, that’s a good thing. Would it stop all the corruption? No. But it’s a good thing, it’s a good idea, it also would recapitalize the banks because everyone had to take the money from their mattresses, put it into the banking system.
So I kinda stopped at that and thought, “Well, that’s interesting”. And then I started doing a little more reading, and I realized something had happened in India that had never happened anywhere else in the world, is they have, in the background, without kind of letting anybody know, 1.1 billion people have gone into a database called Aadhaar. Aadhaar allows…is a retina scan or a fingerprint system that essentially carries all of your information. So, as opposed to having an ID card, you have a retina scan or a fingerprint. Okay, that’s pretty straightforward. However, India, cleverly, once they got 1.1 billion people onto this system, because people in India, many people didn’t have birth certificates, weren’t in banks, they couldn’t get into the system because they couldn’t prove who they were or what they were, this was a way of doing a number of things. It brings people in the system because everybody has to get registered.
Once they got registered, it means they could use their fingerprint or their retina scan for transfer of payments. So they created an application called UPI that allows instant transfer without a bank in the middle between one party and the other over a mobile phone. The confirmation process is your retina scan, which they’ve got a camera on your phone or just a fingerprint. Okay, that’s pretty revolutionary. It’s a bit like when people were expecting Bitcoin to go, on a different level. It’s a payment system and its processing ability is enormous and it works over a 2G phone network. So you basically need no technology to do it. Okay, that’s a revolution to start with.
But the revolution went beyond that, because the Indians then decided, “Well, what we should do is use this verification system, this digital verification system or biometric system, to secure everybody’s documents.” So your birth certificate, your utility bills, your bank statements, your medical records, anything, goes into something called IndiaStack. IndiaStack is a secure drop box or lock box digital, that you only access with your retina or fingerprint, so it’s difficult to hack. Now, point being, is, again, India went one stage further and did some incredible things. You are now able to go into a medical clinic anywhere in India with just your fingerprint. Let’s say you’ve been run over and you’ve got amnesia. They can put your fingerprint down and they will know your full medical record. So you don’t need to transfer medical files around. Now, that system is being developed…it’s developed, but getting all of the doctors and everybody on it is in the process of being developed.
Not only that, but a farmer in the middle of nowhere, can now easily open a bank account, which he couldn’t before, because farmers are poor and farmers weren’t often in the financial system, they can now do that. They can get loans. It’s a digital know-your-client, so use your fingerprint, it’ll give all the data in your IndiaStack to the bank, and they can review it instantaneously and give you a loan there and then. It also shows the records of all the other loans and everything in the financial system so that you can just leverage that off. So that’s another whole thing. So you’re bringing everybody into the system that couldn’t ever get into the system. They can get insurance, they can get banking, they can open a mobile phone account with a fingerprint. And, to top it all off, they go one stage further, you can now go to a local store and buy a carton of milk by just using your fingerprint, no wallet, no telephone, no nothing. So, basically, they just revolutionized the entire financial infrastructure of one of the largest countries on Earth, and it is a massive change.
Meb: And what’s the sort of investment implication? Is it such that, you know, this is kind of releasing the animal spirits of capitalism by allowing a lot of people that weren’t in the system to now participate, or what’s the thesis? Is there any sort of actionable thoughts there?
Raoul: So there’s three levels of the thesis. At the very top down, it’s somebody taking the foot off the brake. If you imagine the friction caused by a 90% cash system where people are disparate, they couldn’t communicate easily, you’ve then thrown in this incredible mobile phone network that’s building, and I’ll come on to it in a sec, and allowed them to exchange money and everything else without middlemen taking a share, so you’re basically lowering your personal tax rate. Not only that, for the average guy, it makes it easier to do business. The farmer can hedge himself, he can buy insurance, he can get banking, he can get a loan, he can do all of the things that wasn’t available. So, it’s somebody taking the foot off the brake of India. Then, the mobile phone industry. That is gonna explode because all of this is based on mobile phones. So, there’s only 28% smartphone penetration in India, that’s gonna explode. So the data usage within India is going to dwarf that of any other country in the world, just by what they’ve done. So it’s gonna become the mobile phone data center of the world, that means it’ll attract capital, people, and technologies.
All of this IndiaStack is open API, which means anybody can build products around it to interact with it, which is gonna bring a whole load of FinTech revolutionary stuff to India, potentially to get exported to the world. Additionally, the banking system that was stocked with capital from a load of bad loans in the past and hindered by corruption, that all gets cleaned up in one go, because everyone’s had to put their money back in the banking system, and it’s a banking system that functions purely and simply and easily. So, on a number of levels, you’ve just massively stimulated an economy. The government can obviously raise more taxes, because most people didn’t pay taxes in India, in fact, the tax uptake in India was like 10%, it’s ridiculously low. Nobody paid tax, now people will pay tax. Okay, so what that means is that the government can finally spend money on infrastructure because India’s got terrible, terrible infrastructure. So the government can stimulate that too. So you’ve got a multi-stage approach, all of which are positive for the Indian economy. It will play out over years, but it’s one of the biggest opportunities with a country with a demographics of…you know, the average person is aged about 30 years old. You’ve got this enormous demographic wave of people looking for opportunity and who have spending power. So I can’t think of a better story.
Meb: I like it. Jeff, I think that means we need to start thinking about some Indian FinTech ETFs. What do you think?
Jeff: Raoul, you mentioned a brief reference to Bitcoin. And so, by the way, there’s a website you can go and sort people’s tweets by most popular, favorited retweets. And I think about…well, one of your most popular was a quote you made earlier, which was, “Longer time horizon is the greatest edge in investing” but I think three or four of the other most popular had to do with Bitcoin. And you’ve been talking about Bitcoin a long time, I know you recommended it in 2013, I know you even wrote an article that talked about the possibility that Bitcoin could eventually reach a million. Our listeners…we don’t spend a lot of time talking about Bitcoin on this podcast. Maybe give us just sorta kinda your quick thoughts on Bitcoin, as either an investment or kinda how you view it and what you learned about it in the last few years.
Raoul: Yeah. I mean, if you had asked me this question six months ago, I would have had a different answer, so it’s not that clear. So people new to Bitcoin, it’s a cryptocurrency, so it’s a currency based on a mathematical formula that only issues up to 21,000,000 of these Bitcoins. It’s basically computing power, because you need an enormous amount of computing power to solve the mathematical equation to the coin for doing it. It’s basically you get paid to lend out your computing power to the network. What it does is essentially, it’s called the blockchain, it’s the infrastructure behind Bitcoin, which basically is a three-party or multi-party ledger system, meaning that, as opposed to having a buy and a sell being put down in a ledger, you have a buy, a sell, and a validation by somebody else. Which sounds simplistic, but actually it’s revolutionary. It’s revolutionary because it gives proof. You know, as opposed to just one person’s word against another, it’s a much stronger system of proof. So it creates a whole number of things. And as the technology’s developing, people are realizing you can attach contracts to it. So your proof of purchase with your house or whatever it may be, derivative contracts, anything can go onto the blockchain. So it becomes incredibly powerful and basically, Bitcoin is a share of that blockchain.
Now, Bitcoin is also a number of things to a number of people. Many people think it’s a currency, others think of it as a commodity, and others think of it as a share of the blockchain. So, it’s like getting a share in the internet, you know, the blockchain, potentially, is the financial internet. So that’s the great story about it. The bad story is, it’s volatile. I still think probably goes a lot higher because its uses are very high. But many many people bought into it thinking it was a currency and you couldn’t touch it, like governments can touch other fiat currencies because of this formula. However, in recent weeks it’s become apparently clear that there is a group of Bitcoin developers who want to try and move towards changing the formula for Bitcoin to allow it to conduct more transactions in each block, basically, make it faster. Now, that’s an innocuous statement, of course, it’s a good thing for blockchain, and you know, if they decide to have one version versus another or both of them running against each other, who cares? But what I do care about, it means it can’t be a currency, because what you’ve done is just proven that it’s not sacrosanct.
So it’s changed the format of what it is, so I think it’s gonna get a bit more volatile for a while. But what I do know is some of the world’s smartest minds are working on blockchain technology right now to create payment systems, to create storage systems, and create a whole number of things that we have no understanding what can come out of it. It’s basically like having the internet back in kinda 1996, you had no idea what’s gonna come from it. So I think it’s the same thing, I think the India story also added a bit of confusion, because suddenly India developed a payment system that was faster, as effective on lower technology than Bitcoin. So, okay, it’s not a cryptocurrency, it’s still to do with the Indian rupee, but as a payment system, it’s bloody good. So that kind of says that maybe Bitcoin is not gonna be the world’s most efficient payment system. But what it’s gonna be, I don’t know. But as a tri-party ledger, that’s the backbone of the world’s financial system, I think it’s certain to happen. So, I think there’s some downside, there’s some volatility, there’s some unknowns to come out of Bitcoin, but over time, if you wanna own a share of that financial system, then you have to own Bitcoin.
Jeff: You know, it’s funny, I’ve been kind of a pleasant spectator on Bitcoin, we even set up on the Idea Farm that people could pay in Bitcoins, and so far no-one took me up on it. And I was sad, because I wanted to own some without actually having to buy any. And so, there’s a lot of other cryptocurrencies, Ethereum, etc. Is that sort of like Betamax versus VHS? Do you even spend any time looking at some of these other cryptocurrencies as well?
Raoul: Yes. I mean, I don’t look at most of them, you know, as a macro guy, I look at a lot of things, I’m a master of none of them, almost. But, you know, with the cryptocurrency world, yes, there’s several cryptocurrencies, you can’t have different blockchains. Many of them are positioning themselves with different uses. So, Ethereum may have a different use and Ripple may have a different use to Bitcoin. I think, in the end, the space is large enough for them all to be valuable, which ones are the right ones? So it’s not like VHS and Betamax, it’s a multi-system, it’s more like Windows versus other operating systems is how I look at it. So, the internet still exists i.e. blockchain technology, and there’ll be different ways of accessing it.
Meb: We can talk about investments for an hour, and we’ll probably just have to have you back on again, but I wanna touch on two more investing questions and then pivot to talk a little bit about some content and media ideas. First, you know, you talk a lot about, your audience is obviously very institutional. You know, a lot of our listeners are IRAs or brokers or individuals as well as opposed to large pension fund CIOs, so given that, would your kind of market commentary, things we’ve talked about so far today, investment recs, would it change significantly? Or are the opportunities similar, just slightly different in implementation due to scale etc.?
Raoul: In which area, sorry?
Meb: Oh, well, just so like everything we’ve talked about today on investment ideas and approach, is that something that you think that a lot of the…it’s bits targeted towards CIOs and big institutions, but, you know, is this equally applicable to the smaller investor etc.?
Raoul: More so, I think, Meb. Snd the reason being is I think small investors suffer from lack of framework, because they don’t get the tools that the bigger guys get. And to get the right framework where you’re not just punting, and you really understand what drives the global economy and what drives asset prices, I think is really important. So even if you’re just an investor who buys themselves S&P 500 ETFs, to understand what the business cycle does, if you were just to sell out your exposure and go flat every time the ISM crossed 47, you get whipped sore a couple of times, but over the last 30 years, and you’ve re-bought it when it cost 50 on the upside, you’d have a fantastic return. So just simple things, taking from other people’s frameworks is important. So, you know, yes, we might be getting quite complex in areas that people can’t buy… People can’t buy India. As an ETF, it’s not the most liquid but it’s doable. The S&P 500, as I said, you know, it probably is fine for the time being, but it’s not gonna go up a great deal unless the ISM continues to go higher. Oil, that’s a tradeable thing, oil’s stocks are tradeable. Maybe people don’t like to short them, but many people are over weakened [SP], so I think that’s interesting. But if we wanna bring it down to a single company level, you know, there are interesting things, even within the U.S. [inaudible 00:39:58], for example, about Google.
Google is the company that everybody believes to be something amazing, you know, it’s this great technology giant that’s so clever and so smart. Google is basically actually a media company, and media companies trade on a much smaller valuation than Google does. Google just happens to own 70% of the entire…between Google and Facebook, 70% of the entire digital media space. So, you know, perceptions like that give you an edge because you understand that they should not be trading like technology stocks and they’re relatively expensive. However, for technology companies that people don’t believe are technology companies, they’re ridiculously cheap. IBM, IBM is an amazing example of a company that nobody seems to understand anymore, because everyone just thinks it’s the boring stock of your dad. But really, IBM Watson is one of the biggest revolutions to be brought to the general public in terms of artificial intelligence. They’re also trying to launch quantitative computing power for the general public. So, IBM are doing some incredible stuff, trades over P of 12, it’s ludicrous. So, you know, there are opportunities just for the average guy. Some of them are business cycle frameworks, others are macro themes, the rise of artificial intelligence and how to play that theme, you know. Everybody likes to play the theme meaning we’re all gonna be out of jobs. Yeah, well, you can be out of a job and rich if you buy the right companies that produce artificial intelligence.
Meb: Your Google, Facebook sort of a long piece, will have to be a topic for another podcast, but I found it, one, highly interesting, and two, had very similar experiences. So we’ll have to talk about that next time you’re in L.A. So, let’s pivot a little bit because there’s a lot of interesting going on at your shop. And you had a great quote, I can’t remember where I found this, but it says basically, “The highest return on capital right now is not necessarily in investing, it’s building a business. You can can make 20% a year owning a coffee shop, but you can’t make 20% easily. You’d have to beat all the best hedge fund managers in the world in the stock market. Start businesses and that will make you money.” And so, maybe talk a little bit about that and then kind of the origins of what you’ve done with Real Vision, because I think a lot of people in our audience, in particular, are interested, because we talk a lot about financial media education as well as curation of ideas and the challenges of really finding the signal in the noise out of so much of what’s out there. So why don’t you tell us a little bit about the origins there and what you all got going on?
Raoul: Yeah. I mean, look, I think of everything as a macro opportunity, I mean, macro is in my blood. So what is the best asset allocation of my time? My time is the only thing I’ve got that I can’t get more of, so I need to optimize my time versus anything else that I own or could own in the future. So the maximum use of my time is, “How much money can I spend in the time that I’ve got allotted and what’s the best use of using my time to get that?” i.e. your quality, [inaudible 00:42:52] into quality of life. It’s not always necessarily time over money, it’s the other things you do with your time. So that’s how I look at things in a framework. And so, for me, you can sweat it out in financial markets and right now, even the world’s greatest hedge funds barely make 10%. Okay, so if the smartest people in the world who’ve been doing this for 30 or 40 years can barely make 10%, the very best in the world are kind of averaging at 17, but right now so few people want to start a business. It’s one of the lowest levels of new business startups in history, still, even with the startup revolution going on, you’ve got very little competition for a lot of things. And the technological changes in the world have made building businesses much cheaper.
So, let’s go to Real Vision. What was the real macro opportunity in Real Vision? Forget the micro of how we could better serve the public with better information. But what was the macro decision behind it? It was simple. A friend of mine ran one of the largest independent television companies in the UK. Him and I were having dinner and he’s like, “I don’t know what the hell to do about this, because the internet has now allowed people to stream video and our business is dead. And I don’t know how to charge, because I have to pay £100 million a year for a broadcasting license in the UK.” And I was thinking about that, I’m thinking, “This is such an arbitrage. They’re stuck in a business model they can’t get out of, they have to pay £100 million a year for the broadcasting license but they’ve got this incredible cost of infrastructure, you know, camera shoots, and studios, and people, and blah blah blah. And I can do it on a handheld camera, digital HD camera, and compete and publish on the internet”. That was the macro opportunity. So I realized that there was a need, which was the market need, the market was desperate for high quality, better information where people don’t treat people’s finances as entertainment but take it seriously. Serious financial discussion is a serious matter. But I wanna make it engaging too, so people actually wanna watch this stuff and want to get involved and understand better how the world works. So I can do that and I could disrupt an incumbent bid, CNBC or Bluebird Television, who are providing the old school method of doing things at the old school costs. The opportunity is enormous. So that’s basically why I started a startup.
Meb: And so, those who are unfamiliar listening, Real Vision is an online video platform where Raoul and the team will chat with various money managers. We mentioned we did one but like, John Burbank, we’ve had Mark Hues [SP] go on the podcast, so a lot of these guys. The best part about it is it’s long form, and so, you know, CNBC and Bloomberg… We have a TV at the office, it comes on only during NCA tournament and other sporting events, really, because it’s of absolutely no value. And I have lots of friends that are journalists at CNBC and I love them to death, but the short, 15-second video clips, it’s of no use to your general process and really all it does is cause people to stress out, etc. And so, Raoul kinda came to this realization as well, and so we used to talk about, I said, “Man, I would love to see someone do this Charlie Rose style” what used to be the old school listeners of the podcast would recognize Louis Rukeyser, these long form conversations of some of the brightest minds in the world. So I love it, it’s a great concept. So you then went a step further, tell us a little bit about the publication side which launched, I think, within the last year.
Raoul: Yeah. I mean, you know, there’s a few fun bits that people want to know about startup life. I mean, we’ve failed many many many many times, we blew up our first million dollars in having to write off the entire first platform that we did, you know. So we’ve made lots of failures, lots of mistakes, and worked lots and lots of hours, but we’re starting to really get things right. I mean, we’ve got subscribers in over 100 countries now and people are absolutely fanatical about what we do, which is, you know, an extraordinary thing. I’ve been in finance for 27 years now and nobody’s ever thanked me until I started Real Vision, and people thank me all the time, so I’m doing something right. But yes, we’re launching, our vision is not just for television, we’re launching a number of products. The first one that launched was Real Vision Publications, where we get a selection of the world’s best newsletter writers. We’ve got 30 of these incredible newsletter writers, put them on one platform, show examples of their research, and you’ll never get that breadth of quality research, this has never been accessible to the average guy. And again, this is like $300 a year, this is nothing for the kind of information you get. Again, our ideas disrupt the level of quality first. It is on a beautiful product, but the quality of information… The average man, the average investor does not deserve average information, he deserves something good. So we did that. We launched a podcast which is called Adventures in Finance, which is a fabulous journey through the world of finance. We’ve launched that and then we’ve got probably another five or six launches of products, on whole new business areas coming out this year, all equally disruptive and very new to the space.
Meb: Exciting to look forward to those. You know, I mean, I think it’s a part of a bigger transition from, you know, so many of the old school media properties, and don’t even get me started on the seeking alphas of the world that have, it’s something like 10,000 contributors. And we did an article a couple years ago, where many many years, we pulled all of our content from all the aggregators in like ’08, and we did an article because this is the value of content, essentially seeking alphas receive for free. And I forget what it was, it was like 50 or 100 million or something. And the beauty of the internet and where we are now is that, the people that are creating the content, doesn’t matter if you’re talking about microbreweries in Portland or…we mentioned on the podcast another other day, this podcast where it was an author, and this is the Lore podcast, where the author had been doing a ton of research for his science fiction books. And he said, “Well, I did all this research and it’s interesting, historical. I have nothing to really do with it” and then he tossed it into the dustbin on his Apple laptop. And he said, “You know what, I’m gonna share it with a friend.” And then shared it with his friend who was like, “Hey, you should just turn this into a podcast.” And now that podcast gets 5 million downloads a month. And, in addition, he’s got a new Amazon show that is based on his research, and, of course, he was able to quit his job and focus on writing.
So the cool part is that there’s all these amazing business ideas that come up and in this very niche sort of world. So the owners and creators of the content now have the ability to have a platform. And then one more comment I wanted to make, and it’s interesting that you’re doing it across multiple channels, is that, you know, Jeff and I get emails all the time from listeners and feedback at themebfabershow.com. And it’s funny because people will say, “Meb, look, you know, I would never read a single one of your books or white papers but I listen to the podcast every day.” And so, you hit different types of people that consume in different ways. So I think it’ll be fun for you guys to see on the podcast you’re just getting started, the different responses from different people, but really looking forward to see the new launches. All right. So we’re getting close to an hour, so I don’t wanna keep you too long, I know it’s probably a beautiful day out in the Caymans and Jeff’s itching because Carolina… who are y’all playing today? Carolina is on it.
Meb: Butler? You guys should cruise on that. All right. Carolina-Butler comes on in about a couple hours. So, Raoul, I’m gonna ask you a couple more questions and we’ll let you go. First, and this is a question we ask everyone, and this is gonna be particularly interesting for you because you have a long and varied career. Most memorable trade that you’ve ever been a part of? And this is good or bad, memorable where you made money or lost money, doesn’t matter but the first one you think of that comes to mind.
Raoul: I think I learnt back in 2001 how incredible it is to trade fixed income, which most people in America, people are not really good fixed income investors. In Europe, people trade a lot more fixed income. And as the economy started slowing down in 2000, the risk adjust return of owning Eurodollar futures, which are the interest rate futures, not the currency futures, was so staggering and it was such a beautiful trade that you could buy and hold, that it made our entire hedge fund, basically for one trade. It was an extraordinary period because interest rates got absolutely slashed and you had to just ride that tide. So that was the most exciting trade I’ve ever been involved in myself. I’ll give you a screwup and I’ll give you somebody else’s most exciting trade. I was really lucky in the Asian crisis to be involved with everything that was going on, when I was still at Goldman on behalf of some of the big hedge funds. Seeing how people like Stan Druckenmiller put trades together was astonishing to me. I mean, these guys are legends for a reason, and it’s not because, necessarily, that they’re the world’s best market timers, it’s the trade construction. It’s so superior that it just blew my mind. Seeing [bleep] trade intricacies of the South African rand devaluation back in 1998 was astonishing. So I was very lucky to just be part of that.
Jeff: And what part of it, just real quick, what part of it stood out to you? Was it in the, you know, spending months on a thesis and preparing for the trade, was it how they positioned size and managed their money management when it came on and doubled down when they were winning? What was the main kinda takeaways that…?
Raoul: It’s a little bit technical, but I’ll talk you through the trade because it was astonishing. I still think it was the best trade I’ve ever seen in my life. So, I got a phone call from the head of trade [bleep], which was Shell South Africa. I’m like, “What kind of board is that?” He said, “I don’t care, pick any stock, sell it.” I’m like, “Wow, okay.” So we start offloading South African trades. Not that liquid, and it’s the Asian crisis, so everything’s all over the place. And the guy calls back again, and said, “Whatever you do, don’t sell futures.” I said, “But they’re by far the most liquid thing.” He goes, “I don’t want futures. Keep selling as many stocks as you can.” I said, “Does it even need to look like the index?” He goes, “I just don’t care, sell them.” I’m like, “Okay.” So this went on for five whole days. I mean, I can’t remember what the position size was. It was like a billion dollars, it was ludicrous. Then, nothing happened, the Asian stock market fell in South Africa and everything was quiet, and they came back and covered their position into a rallying market. And, again, it was equally messy when they covered their position.
And I calculated the total returns and it was like 7% or something. I was like, “Why would you do this for 7% return? You know, a billion dollars in capital in this messy way in a highly liquid market that’s very risky…” He said, “Raoul, you’ve no idea what you’re talking about. We make 57%.” I’m like, “What? How?” He said, “Oh, this was not equity trade, this was a currency trade. We couldn’t borrow the short [SP] the currency because the market rates were too high.” South Africa had two currencies. A commercial rand and a financial rand, one was for foreigners and one was for domestics. Basically, to short the currency, the ones all the foreigners were speculating, the rates were like 25%, so it was impossible to short the currency. But by shorting stocks, they were basically borrowing rand for half a percent or whatever it cost to stock borrow. So they basically arbitraged the entire global borrowing markets, managed to get a huge position shorting the rand against the U.S. dollar and absolutely cleaned up.
Meb: I love that. I think most of the podcast listeners are gonna hit pause here and hit the rewind button, listen to that two or three times because that’s a great one. Did I interrupt you, were you gonna say one more, I think you were gonna mention a loser as well?
Raoul: Well, there’s been plenty of those, right? There’s been plenty of those. I found the biggest losers have been when you overcomplicate something. And often you got yourself involved in trade then you figured the smartest way in the world to do something. And I remember, again, it was actually fixed income futures in Eurdollar futures back in, again, 2003 or 2, I think it was, where we had amassed an enormous option, call option position. Because the calls were super cheap and basically there were some funky ways that we could do things, and this was a great opportunity if the fed didn’t raise rates for 2003. So, what we would write was dead right on our outcome, what they didn’t do which was raise rates. We should have had a home run. What we didn’t understand was that volatility could get absolutely crushed. So the volatility’s the largest part of the pricing of an option, it got so crushed, and people knew the position that we had on and were trading against us, that basically we lost money in a trade that should’ve made a fortune. If we had just bought futures, we would’ve done extremely well indeed. But we overcomplicated the trade and actually ended up losing money on a winning idea.
Meb: I think that’s great. Raoul, well, not great that you lost money, but great from an instructional standpoint. We have a lot of common examples we talk about here and that’s one of my favorite part of y’all’s news podcast, is you talk a lot about losing trades in humble pie, where, by the way, listeners, almost every trader, if you listen to them talk about their history, the best ones certainly will talk about their losers, whether it’s Paul Tudor Jones or etc. And that, in many cases, the foundations for what created their career, in my case, it’s what caused me to be a quant and etc. etc. Raoul, look, this has been a blast. People wanna follow you, where can they find more information? What’s the best place?
Raoul: The easiest place to find me is on Twitter, @raoul, R-A-O-U-L, GMI, so @raoulGMI.
Meb: And we also mentioned, but we’ll give it a link in the podcast, for realvision.com, is a great hub for everything, and if you go to /business, you’ll get the longer video of Raoul talking about the business cycle as well.
Raoul: Yes, sorry, it’s realvision.com/businesscycle. There’s a whole free video there to show exactly how I use all of my financial framework, how I use the business cycle, and real world examples. So people find it really useful if they’re looking for a way to understand some of the concepts that I’ve introduced today.
Meb: Awesome. Well, we’ll have you back on when the ISM crosses below 50 again, at some point in the future. And Jeff wanted me to mention, go Heels, everyone. Everyone, look, thanks for taking the time to listen today. We always welcome feedback and questions through the mailbag at firstname.lastname@example.org. As a reminder, you can always find the show notes and other episodes at mebfaber.com/podcast. Subscribe to the show on iTunes or use Castro or Stitcher. And if you’re enjoying the podcast, please leave a review. Thanks for listening, friends, and good investing.
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