Guest: Episode #50 has no guest, but is co-hosted by Jeff Remsburg.
Date Recorded: 5/1/17 | Run-Time: 1:09:46
Summary: We discuss current market news, Tweets Meb finds interesting, various research papers of note, and anything else on Meb’s mind.
But first things first: A huge congratulations to new father, Meb Faber. His “spin-off” came in the early morning hours just a few days ago. In fact, this episode was recorded with Meb calling in from a spare room at the hospital.
The Meb Faber Show also just passed the one-million downloads mark. So a huge thank-you to everyone who has tuned in, listened, and recommended us to your friends. We’re genuinely grateful to everyone for giving us their time each week.
Diving into the financial content, we start with Meb discussing the need for investment literacy with kids and new investors. The problem is that most of us learn to invest incorrectly – generally, we learn about single stock valuation. As Meb tells us, the problem is that far more historical context is needed before even getting to this point. What have equity and bond investments averaged over the years? How cyclical are the markets? What does a bubble look like and how to you avoid one? In essence, there’s so much to learn in order to be an informed investor before diving into the details of, say, a cash flow statement or a price-to-earnings ratio.
This ties into a conversation about expected returns going forward. Turns out, a recent source indicated that some investors are still expecting to make 8.5% per year going forward. Is this realistic? Not if you go by Bogle’s formula. Meb explains in detail.
Next, Meb made a recent change to his personal investment portfolio. Since he believes it to be important to be transparent about how he invests, he publishes this online. Meb tells us about his recent change, in which he added a tail risk hedging component. He expects it to be a drag on portfolio returns under normal circumstances, but it should provide him some protection if the U.S. equity market spikes lower. This bleeds into a discussion on bonds, and where they might going, since roughly 90% of Meb’s new hedge investment actually is invested in 10-year Treasuries.
Next up is a quote from John Bogle which Meb recently Tweeted. It’s about risk, valuations, and indexing. It leads into a discussion about whether there’s a valuation at which the risk of owning stocks outweighs the potential reward of remaining invested. We discuss market timing, and the possibility of exiting stocks due to absurd valuations – and potentially missing great gains as the market climbs higher, indifferent to your opinion that it was too overvalued.
The conversation takes another shift, gravitating toward active versus passive funds, the toxic effect of fees when buying active funds, and the problem of “active share.” Active share references the degree to which a fund in which you’re invested differs from its benchmark. If you want to invest in a smart beta fund, typically you want to see high active share (lots of difference) compared to a vanilla index fund – especially if the fund fees are high. Unfortunately, there are lots of funds out there claiming to be different, but they’re actually “closet indexing.” All you’re doing is paying through the teeth for something you could buy much more cheaply. Meb discusses in detail.
There’s lots more in this episode, including a “coffee can” portfolio… the challenges of “looking different” when the market and/or your neighbors are doing better (even though over a longer investing horizon, you’re positioned to be in better shape)… “over-rebalancing” toward global markets these days… why Europe has been a horrible investment for a decade and what its prospects might be going forward…
Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159
Interested in sponsoring an episode? Email Jeff at email@example.com
Links from the Episode:
15:05 – “Trinity Portfolio” Whitepaper
18:32 – Trinity Portfolio
25:26 – “Finding Yield in a 2% World”
49:50 – “Paying For A Filet, And Getting Bologna”
01:03:10 – “Investing In Europe: Where’s The Return?”
Transcript of Episode 50:
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.
Sponsor: Support for the Meb Faber Show and the following message come from Wunder Capital, allowing individuals to invest in solar projects. Earn up to 8.5% annually while diversifying your portfolio and combating global climate change. Create an account for free at wundercapital.com/meb. Do well and do good.
Meb: Hello, podcast listeners, welcome to a live remote radio hour with Jeff Remsburg. Jeff, welcome.
Jeff: Hey, what’s up, Meb?
Meb: Not much. I’m calling you from an enclosed room about 10 miles away at Saint John’s Hospital.
Jeff: Yeah? What’s going on over there?
Meb: Well, just executed my first spin-off unexpectedly about three weeks early. Just had my first child.
Meb: Thank you, it’s been very exciting. If I am a little bit dim-witted on today’s podcast is because I’ve slept maybe two hours in the last two days, you know, and despite having seven nieces and nephews, a little harder when you’re on the stinky end of the diaper, than when you can just kind of, you know, pass them back. So it’s wonderful…
Jeff: Have you changed a diaper yet, honestly?
Meb: Like five, and hopefully, that’s where it ends, but, yeah. So everybody’s great, I wouldn’t recommend to the listeners going to a birthday party and drinking some wine and beer before having to go to the hospital at 1:00 in the morning. But other than that, you know, I mean we had a breech baby who was gonna have a C-section, have the dates planned, and I really needed that extra 12 days mentally, you know, I was not mentally ready to have a child, so, you know, it’s kind of…it’s all about expectations.
And so then when my wife kind of threw the wrench into the plan and said, “I think we need to go to the hospital.” I said, “Babe, just go back to sleep.” And 30 minutes later, we had a new baby boy. So let that be a lesson to you, Meb.
Jeff: Right. So when do you think you’ll have a name?
Meb: Well, yeah, his initials are TBD because she’s scratching off names as we speak, by the way, in the room, so we’re probably down to about seven candidates. So, hopefully by the time podcast airs.
Jeff: How many viewers are still on the…in the contention?
Meb: Very few. Thirties here, all right.
Jeff: Well, again, congrats, we’ll move on. You’ll have to give us updates later on.
Jeff: A side note, a huge congratulations to you and a big thanks to all of our listeners. Everyone, we are about to pass 1 million downloads of the “Meb Faber Show.” So we have a lot of appreciation for everybody who’s been listening to us. And Meb, kudos, congrats.
Meb: Yeah, you know, and I think, if you were to ask both of us almost a year ago, what has it been nine months and said, “Hey, do we think this is gonna be as much fun or as widely listened to,” all right? I was getting some emails this week when we posted our top 10 countries, and oddly enough, UAE was, like, number 6 and I kind of posted this. I said, “I’m kind of surprised, 6 through 10, we have listeners in China, in Sweden, in Finland, in Norway, we’re all big ones,” and then I got some emails from people in all those countries. So the good news is it’s not just a bunch of bots listening, it’s actually people.
So it’s been a lot of fun. Look, as always, friends, send suggestions, feedback at the mebfabershow.com. We’ll probably have a few fun updates coming…going forward, you know, that we’ll continue to do the interviews, which have been a lot of fun. We’re thinking about adding this format, the Q&A radio style as a weekly offering, so maybe have one of each, each week, but that may be a little too much at Meb Faber Show. We’ll feel it out, we’ll see how it goes in the coming months.
If you have any ideas, please leave us note. And also, by the way, please leave a review, you guys, we love reading them. There has been some really funny, interesting ones, and so we read them all. So it would mean a lot to us as we kind of hit this milestone if y’all leave a review. And with that, unless you got anything else, why don’t we dive right into the episode?
Jeff: All right, so that said, Meb, why won’t you start us off here, you know, in light of the child, one thing you and I had talked about was the role and the importance of educating children on investing that ties in with saving money, and then there’s taxes. There’s a whole list of sort of domino topics here. Why don’t you sort of leap in and sort of tell us what we’ve been talking about offline, which we wanted to talk about here on the show?
Meb: Well, there’s a lot. So one of our good friends, Jason Zweig, “The Wall Street Journal” correspondent, he just had a great article in The Journal last weekend, which we’ll link to in the show notes, where he was talking about surveys with investors and expected returns. And we’ve been talking about this for years where…and it’s not just individuals, we’ve seen surveys with both retail and institutionals where investors almost across the board expect around 10 and a half percent returns for their investment portfolio.
Now this kind of goes along the themes with what we were talking about earlier with expectations about when to have a child, but also with investment portfolio, but also just the general theme of education. So if you look back historically, 10 and a half percent returns means, you know, in today’s environment with about 2% inflation in the U.S., that’s about an 8 and a half percent return real. Real historical return for globally is around 4%. So, remember, our old five to one rule, stocks, 5%, bonds, 2%, bills, 1%, real, that’s after inflation.
So to get 8 and a half percent return today, when bonds yield around 2 and a half, so net of inflation, half a percent, that means the rest of your portfolio needs a return like, what, 14%, 18% or something?
Meb: We did a traditional 60/40, right? So it’s just very, very, very, very unlikely, but it goes back that theme of education. And so obviously, we’ve put out a lot of education, we’ve done 5 books, dozen white papers, about 50 podcasts, 1,500 blog articles, but one of the biggest challenges I have and I struggle with, I get a lot of emails from friends and [inaudible 0:07:06.7] they say, “Hey, Meb, my son or daughter is just starting out investing, just got out of college, really wants to learn about investing and the craft. What do you recommend? What book do you recommend? Where can they go?” And the problem is I don’t really have an answer to that, you know, and I don’t think most advisers or people do. They say something along lines of, “Oh, look, go read the essays of Warren Buffett or maybe read “Security Analysis, or, you know, these other…Charlie Munger.” But there’s really not a curriculum, there’s no Rosetta Stone for investing.
So A, I think that’s a business opportunity for somebody. If you’re listening, we actually wrote about this on the blog a while ago. And we also talked about a theme of a book, which I may turn my attention to, at some point, now that I have a child, but basically, it’s like how to teach someone to invest, how to teach your child to invest. And so many people do it kind of the wrong way, and they go about learning to invest the totally opposite wrong way, and teaching people to invest the exact opposite way they probably should, it kind of teaches all the wrong lessons. So I think it’s a big need out there.
Jeff: Let me interrupt real quick. I’m curious sort of diving into the details, and you can take this as far as you want, what would you say is the right way to learn to invest? And in terms of context, one thing that surprised me when I began to work more with you was you’re focused more on a macro fund level versus the way I had learned to invest, which was more specific stock picking. And, you know, you would try to do that based upon the value…same valuations that you typically use but on a larger scale. So, you know, P/E, press the book, press the cash flow and things of that nature. But, you know, I never hear you talk about valuations of a specific stock, you’re always talking about an index or a market or a sector.
Meb: Here’s the comment is that that’s almost how everyone learns to invest, it’s about stocks, you know. They have a tangible association with Nike or with Facebook, or if you’re a millennial that happens live in LA or use the Robinhood app, you bought Snapchat, it was something like 60% of their investors bought Snapchat the day of the IPO, that’s how you learn, right? You invest through things you understand, and then you quickly learn lots of lessons. You learn a stock is not the same as a business, and you could have the world’s greatest business and the world’s worst stock and vice versa, you can have the world’s worst business but a really great investment. And you learn all these things about investing and things to do in stocks.
But the problem with that, without not understanding the macro environment, is you learn lessons very dependent on your own personal experience and that can last decades. So think, for example, my mom, I love using her example, she’s like our only family member in my extended family that listens to podcasts, so hey, mom. But she taught me a lot about investing, but she grew up in a time, for example, where it was the biggest bull market inequities. And her advice to me every time we talked about, she said, “Meb, you just buys stocks, you put them away and forget about it.” And that’s great advice in general, by the way.
But her experience is colored because she’s owned some of the best performing stocks of all time. She has a cost basis of like one on GE, you know, she owned Reynolds Tobacco, one of the best performing stocks of all time, you know, you can relate from Winston-Salem, and so she had a very specific experience. But if you were to ask someone in Japan, you know, or in Brazil or in U.S. in the ’30s, there’s an amazing investment book, it’s called something along the lines of The Great Depression, like diaries or something, and it’s a guy that found his father’s diaries during The Great Depression.
And the conclusions that anyone that lived through The Depression, and remember, this is an 80% loss in the stock market, anyone who lived through The Depression investing has a totally different investing experience, takeaways, outcome than people that grew up in ’80s bull market and the millennials that have now grown up in this bull market. But that’s usually the way that people learn. But their takeaways are so vastly different from someone who studies market history and understands these different environments and different things that can happen.
So it’s great to have that personal experience, but without the knowledge of what can happen… You know, I think if you were to tell most people and say, “Hey, look, here’s the stats, two-thirds of stocks on informed indexes,” and educate them why that is and what indexing is or what passive investing is, and say, “Almost half the stocks have a 0% rate of return,” and educate them why that is and how 20% of stocks generate all the gains, and so why the odds are stacked against you and talk about Burton Malkiel and the “Random Walk.”
So the whole point is there should almost be this curriculum that touches on all of the various pieces that give you the whole because the problem with the way that you learn, and the way that I learned, and the way that many other people learn, is you end up learning the lessons by making the mistakes. And that’s good because like…
Jeff: It’s very costly tuition.
Meb: Yeah, I guarantee you, I’m not gonna be trading option straddles around biotech drug approvals anymore, you know, I’ve learned that lesson, eight mustard sandwiches for a year, and that was painful. It’s good that I learned it, but also it’s just because I was an idiot and didn’t have, you know, a little more education. So I think there’s a big opportunity. I don’t wanna go on too long about this because the way that most people do is just consume as much information as possible and gravitate towards their style. But I think there’s a big lost opportunity on getting a really holistic education.
Most people essentially get like a, you know, a degree in, you know, painting or mathematics, or something, so it’s this very kind of niche exposure. But without the knowledge of the whole space and history, it’s a huge disservice because what happens is something changes on a macro level and, you know, it totally destroys their worldview. So going kinda back to the expectations, all these people who are expecting 8 and a half percent real returns, so that’s 10 and a half percent nominal, you know, they’re delusional. And this is institutions too, same survey on the institutionals.
So I think it’s a big opportunity. I don’t have the answers. Maybe you and I will turn our attention to writing that book or doing it at some point.
Jeff: Yeah, I think it’d be fun. Well, the challenge of these long-term averages is, you know, it can hide so much short-term anemic growth, and like your mom, you know, talking about she got used to investing because the time period in which she was putting money into the market, you know, this was roaring, so she knew nothing else. But on the flip side, you get into the market at the wrong time, you’re not going to know or you’re not gonna have those same returns, and it’s gonna really dilute your perspective on things.
So what’s the best way to protect yourself then? I mean we go back to the idea of look at CAPE. I mean are you still very bullish on the idea of CAPE is the best way to sort of give you an idea of where you are, and whether or not…
Meb: Well, you just…okay, there’s a couple of things. So one is that, you know, the best way you can educate yourself is to simply read as much as possible, you know, we’ve talked about that a lot, you know, to understand and take a look around what’s going on in the world, and understand that bubbles and busts still regularly happen to me. If you look what’s going on in the Canadian housing market, you know, you start to see similar histories that rhyme, right, where you go back and read these books like “Extraordinary Popular Delusions and the Madness of Crowds” or we’ll link to a couple others that we’ve written a bunch on bubbles and busts.
But if you look at what’s going on in the Canadian real estate and you see Tony Robbins and Pitbull at a huge real estate investing conference, you know, these are signs that…our bubble style signs. But had you not studied, for example, tulip mania and all these other bubbles throughout history, you may not notice that, you may get really excited about Canadian real estate, whatever the “Le Boom Du Jour” is.
And so I won’t spend too much time on investment philosophy, you know, and what our recommendation is there because we’ve talked ad nauseam on how to approach that. And then “The Trinity Portfolio” white paper would be the best single primer for us, you know, all the books are great, you should read them. “The Trinity Portfolio” is kind of the culmination of our holistic view. But we do have the takeaway that there’s a lot of great pass to investing.
This is a mistake that a lot of, I think, listeners feel often as they’ll email me then say, “Hey, Meb, you know, convince me on this strategy or fund, or why should I be investing in the strategy?” I said, “No, no, no. That is not my intention. I have no interest in convincing you to do anything. If you wanna sit in CDs, totally fine. If you wanna put all your money into real estate and another half in, you know, high dividend aristocrats, hey, great, you wanna put all your money in Bitcoin and Theorem, and all these other cryptio…you know, I could care less. Whatever works for you.”
You know, most of the research that we publish is simply, “Look, here’s the historical, how this has worked. Here’s what we think is reasonable and good ideas. Here’s what I do with my money,” you know. So that’s kind of like the way that we approach it. And a lot of people say, “No, no, I can never get on board with being a value investor, this just goes against my constitution.” There’s other people that say, “I can’t possibly be a trend follower, you know, I’m happy to just sit in government bonds,” whatever it may be, but most importantly is find out what works for you with the caveat, understand how it’s worked historically and, of course, what the realistic expectations are and how it would have done over the course of the past century, if not longer.
Jeff: All right, so a little more historical context moving forward for people who are looking to learn for the first time. Moving on a bit here, you just mentioned how you invest your own money and that’s something that a lot of your blog readers are interested and following, you know, they wanna see what you’re doing specifically, and you just sort of reallocated your portfolio recently. You wanna talk a little bit about what you did and why?
Meb: Sure. And again, for disclosure, I find this only really meaningful to myself, you know, I’m not trying to convince anyone here this is how they should invest. Everyone should invest in their own appropriate way. But I do think it’s very important for managers to have one skin in the game, but also to be transparent. So in the skin in the game part, it’s something like of the mutual fund managers, often 50% have nothing invested in their fund. Asset allocation managers, it’s something like 70% have nothing invested in their fund.
So the prospect of trying to say, “Hey, you should buy our fund and invest with me,” and not have anything invested is just…it strikes me really the wrong way. So that’s one, so I invest 100% in my network and our funds and strategies.
Two, I think it’s just really important to be transparent, you know, I think a lot of managers and advisers, you want them, you know, they’ll give you advice for X,Y,Z and then say, “What do you do with your money is something totally different.” So we’ve been transparent for many years. My basic takeaway is the caveats is that, you know, most of my net worth is exposed as a private company, being Cambria of course, as well as a couple other small private companies, you know, I have farmland as, you know, as a real estate sort of investment, some other things like that, but with my entire public investable net worth is invested in Cambria strategies.
And so, specifically, I have a couple of the Trinity accounts and the average ends up being around Trinity is three and a half, I think. So from Trinity 1 to 6, I’m right in the middle, which is a moderate allocation. For those who aren’t familiar, it’s a global allocation. It has securities all around the world, U.S. stocks, foreign stocks, bonds, real estate commodities, expressed through ETFs, you can find more information at cambriainvestments.com. But that’s how I invest all my money. It’s on autopilot, it just whirrs in the background, it’s awesome. I don’t even have to think about it. Tax efficient, very low cost. And it has tilts, the best part is it has tilts towards value and momentum and trend.
So all of this philosophically fits my personality, it works for me. I don’t plan really on ever changing that or rebalancing it for, you know, a decade or two. The caveat is, is that our company recently launched a fund, but it’s along these strategy lines of tail risk. For those listening don’t know what tail risk is, you know, every distribution, if you think of a bell curve, which is not what the U.S. market is like, but it has two tails. The left tail, which is really bad events, as well as the right tail, which most people forget is really good events.
And we did an article on the blog maybe about a month ago that said the stock market’s risky but it’s four times as risky for advisers. And I’ll kind of walk you through the thinking really quick. So I added about 10% allocation of this new fund to my portfolio and the strategy is that it buys, with about 90% of the fund, it’ll buy 10-year U.S. government bonds. And with about 10% of the remaining assets over the course of a year, it invests about 1% each month and puts on the U.S. stock market. So you end up with, basically, a portfolio of puts on the U.S. stock market.
Historically, that is a bad investment. And what I mean by that is, you know, a good investment is something that’s positive expected returns. And this falls on the category of, you know, we expect it to be roughly breakeven over time, but to be conservative, we say, you know, it could lose 5% to 10% a year, but viewed under the lens, and this is the wrong word to use, but an insurance sort of theme, meaning, you know, it should do well when markets do poorly and particularly the U.S. equity market.
And thinking about when U.S. equities do poorly, and thinking about hedging, you know, the best way to hedge an investment, the first way is not to take the risk in the first place, all right? So it’s like, if you have a portfolio 100% in stocks like, “I need to hedge this,” easiest way is not to own 100% stocks, maybe on 80, maybe on 60, okay?
Second is that you can diversify that, of course, so you could buy foreign stocks, you could buy real estate, commodities, whatever else. The best historically…best historical asset classes that, that has been bonds, so U.S. government bonds historically have done a great job of hedging U.S. stocks, but it’s not guaranteed, of course.
And then lastly are some active strategies like trend following, managed futures have usually done a pretty awesome job of hedging these tail events or poor events. But puts, in particular, are one that historically had been a cost but…and you can’t say they’re guaranteed to do well in times they do poor.
But if you think about the environment right now, why I think this matters a lot right now, one, U.S. stocks are expensive. I think there’s no disagreement in my mind there. Almost across any metric you can find, I think U.S. stocks are expensive. I don’t think it’s as crazy as the late ’90s, but they’re expensive. I think that you’re in an environment where there’s very low volatility. I think VIX almost closed today below 10, which would be the lowest level in like a decade. It doesn’t mean it has to revert to 20 or peak at 40, but historically that’s really low. And lastly is that, you know, where you’re a bull market, could it go 9/10? Sure. but it’s a long bull market. So I think it’s a reasonable time to be implementing the strategy.
And second is, in this article, we talked about, and I’m droning on a little bit long here, but we talked about how advisers… So let’s say you’re a financial adviser at Wells Fargo or Morgan Stanley, all right? Your own portfolio has exposure to stocks. So let’s say you do a traditional global portfolio, great. But that’s a pretty levered bet to simply the global risk on markets, particularly with stocks. So maybe you diversified it, but you still have a large stock exposure.
But you also have exposure through your client’s portfolios, meaning, if and when the market goes down, your portfolio goes down, your clients’ portfolios go down, which means your revenue goes down. On top of that, if you go through a long bear market like in ’08 or 2000, 2003, clients often panic at the worst time at the bottom and may or may not redeem their money, so close their accounts often because in many cases, they don’t have a choice. You know, maybe they’re defaulting on their house or just need money to survive, etc., etc., so you’re also levered to that, the general economy.
And lastly, you’re also levered to your company. And so if you work in a Morgan, or Merrill, or Wells Fargo, you don’t own your own business, that says, “Hey, actually we need to cut expenses because our revenue just went down 50%, so we’re gonna clean-house on all these people and you actually can get fired.” So you have a very multiplied effect of one cost. And what we relate this to and many ways to think about, I think it’s interesting is, you know, the same way that Southwest Airlines hedges fuel. So they’ll hedge it out in the futures market for oil, or a cereal company may hedge its need for wheat, etc., etc. So all these other operational companies will hedge their biggest costs, but I don’t know…I know very few investors, financial advisers or financial advice companies, investment companies, get hedged their biggest cost or risk, I should say.
So I thought as a thoughtful idea, it’s not something that I’ve implemented in any of our portfolios because I think it’s a personal decision that should be made. And particularly since it’s not a good long-term investment you could tuck away for 40 years, you know, it’s not something…
Jeff: How old are you thinking about holding this yourself?
Meb: You know, I think it’s a tactical plan. I’m totally comfortable holding it right now, and I’m totally happy if it loses 5% to 10% a year, you know. And I’ve expressed my views very clearly over the last three or four years, and it’s been the U.S. stock market’s expensive but it’s going up, so it’s in an uptrend. So, you know, we’ve stated many times that’s the second best environment for U.S. stocks.
We state that…I mean people often think I’m bearish then but I’m not, you know, we’re a trend-follower at heart. But more importantly, I’m a huge global stock bull. And we’ve been talking about CAPE valuations all the way back to, I don’t even know when, since we’ve put out global value as a book for certain. So I think the rest of the world is much cheaper, so I have a large exposure as to all of our portfolios to foreign equities. And we’ve talked about bonds, you know, where most of the sovereign bonds around the world have very low yields. The top five bond sovereigns, what is it, U.S., Japan, France, Germany, there’s one more, what…Switzerland maybe, no. I have like a 50 basis point yield in Sweden, I’ve written a paper on that on global value investing in bonds.
Yeah, all these things that kind of come into play, but I think hedging out, it’s a part of the potential equity risk, particularly with the U.S., is it goes into the category in my mind of being a reasonable thing to do.
Jeff: We haven’t really talked about this as much but curious, you’d mentioned that this particular fund has 90% or so in 10-year bonds, and then it’s the remaining 10% that’s in puts. You know, people been calling for the end of this, you know, huge bull market and bonds for years. But to what extent do you feel any sort of vulnerability, having 90% of this and bonds right now with, you know, the potential uncertainty of, you know, it…our bonds, in fact, coming to the end of this bull run.
Meb: Well, going back to being a student of history, it’s sort of you don’t know. I mean, if you wanna focus nominal bond returns, you can do it with roughly, you know, 90 plus percent accuracy, it’s just the yield. So 10 years from now, you buy U.S. government bond, and let’s say they’re 2 and a half, you’re gonna get 2 and a half nominal. Now the big leverage is inflation. So is inflation gonna be 0, is inflation gonna be 5%, so it’s actually gonna be 2% because that gives you a very different real outcome. But the path, which you’re talking about, which is where interest rates go over the next 10 years, who knows? And you need to kind of prepare yourself mentally for both.
I could totally see a world where U.S. bond yields go down to half percent or zero, all right? I don’t think that would be a great scenario for the rest of the economy and everything else, but I could foresee that. I could foresee a Japanese-style market where U.S. bonds go nowhere for another decade. And then I, of course, I could see an environment where U.S. bonds creep up or even screech up. So I don’t have a strongly held view to try to forecast bonds and the yields where they’re going.
Jeff: So that’s like you’re covering all your bases there.
Meb: No, I’m just saying…I mean there’s things, you know me, there’s things I have very strongly held opinions about, there’s things I don’t. This is one of those that I don’t. I recognize that I have zero ability to forecast bond yields 10 years from now or even a quarter from now. So kind of prepare the portfolios for a situation where it doesn’t…you know, certain…so this sort of funder strategy, in my mind, is a bond substitute. So you could take part of the bond exposure, use the fund or strategy like this, and you get the bonds already so you get 90% in 10-year treasuries, but you also get this overlay of a bunch of puts.
And one more thing that’s important, you know, there’s a good AQR paper that came out talking about the name of this pathetic puts, and talks about how poor of a job a one-month put strategy does. So it’s very important in my mind to use roughly a 12-month duration, and aligns that much better, and you don’t have the time decay. But a second very important input is to have a money management algorithm to where when volatility is really low, you own more puts, when volatility is very high, you buy less because traditionally, when volatility is very high, it’s when the VIX is up 30 or 40 or 90, you don’t want…it’s a really probably bad idea to be spending that much on puts because that’s usually when everything’s hitting the fan and it correlates pretty highly usually with times are pretty bad already.
Jeff: It’s [inaudible 0:28:44] bang for your buck.
Meb: Yeah. So, you know, we think it’s a good environment right now, and we think it’s probably volatility is pretty cheap. It doesn’t mean the market has to go down, but I think it’s under the category of being reasonable.
Jeff: All right. So you said you’re doing this for yourself, you’re not going to force this upon any Cambria clients by putting it in turning portfolio. But for any listeners out there who are feeling a little nervous and are interested in a tail risk-type protective strategy, how would you…and they’re wondering if it’s right for them, are there any questions or criteria or anything that you would say that somebody could sort of ask themselves to determine if it’s right for them?
Meb: Yeah. I think most people need to get comfortable a couple things. They say, “Well, look, I don’t know how this is done historically and we’ve done all the modeling in-house, we haven’t published a paper on it yet.” But if you’re doing a 12-month put portfolio where you’re spending about 1% a month on options premium, putting the rest in 10-year bonds, you know, we expect that to…you know, we like to be conservative, I think we can get it to the point, depending on the time frame, where it’s roughly just break-even, which isn’t great, but, you know, versus others.
The problems with so many of these products out there is they’re either hugely complicated, so don’t even get me started on all the VIX products, for two, hugely expensive. For some unknown reason, they all charge like 1% a year, and I think that’s probably double what they should. So we look at this and we expect in bad times for it to do basically a one-to-one with the U.S. stock market.
So if it has in ’08 and goes down 30%, we would expect this style strategy to go up in equal amount, so up 30%. Now it’s not guaranteed because it depends on, one, not just what prices did, but also the path they took there with the volatility, but I think that’s a good bogey. We think that, you know, in the really bad years, really bad months, this is a potentially great strategy. But I mean there’s people out there that say, “You know what, I’m a cowboy. I’m a short-ball type of guy,” which is like one of the all-time best Sharpe ratio strategies because you make like a percent a month shorting volatilities or shorting the puts or whatnot but, of course, you have a 1987 style month or a really bad bear market and you, you know, you get your face ripped off.
So there’s people out there that are gonna listen, they say, “All right, I’m just gonna go short Meb’s fund,” and more power to him. I’m happy if you guys do that, that’s what it was designed for. You can take both sides but, you know, historically, that’s been a graveyard. Option writing, you know, we have some old posts going back to 2007. I think I just probably gave Jeff some remote anxiety thinking about that. But, you know, it’s literally…
Jeff: I bought VXX years ago without knowing enough about it, you know, it’s gonna get a time volatility. And then, you know, contango kicked in and I just got crushed on it. How to get out of that losing a hefty amount?
Meb: We’ll add that…
Jeff: [Inaudible 0:31:32] buyer beware.
Meb: We’ll add that chapter to our “Teach Your Child to Invest” book.
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Jeff: Let’s switch gears here, let’s run to a quote that you recently tweeted about. Do you have it in front of you or do you want me to read it…
Meb: I don’t have it. I’m staring at a PURELL hand sensitizer in the hospital waiting room so I do not have anything in front of me.
Jeff: All right. Why don’t I read the quote then you can give us a little commentary on it. I think one of your questions was, you know, guess who the author is, so everybody listen in. All right, the quote says, “And I would stick by that, this is the time to really emphasize risk. Valuations are clearly high, dividend yields are low, earnings growth will probably be less than the long-term average, which is around 5%. It could be as low as 4% and inflation will take a little bit out of that now. So it’s a time for some caution. And the index fund is not a panacea. It’s participation in a risky business that eliminates the risk of individual stocks, eliminates the risk of picking managers, eliminates the risk of picking the hot sector of the day and leaves only the risk of the stock market itself. But that risk is not to be disregarded, it’s always been high, it always will be.” What are your thoughts, Meb?
Meb: Oh, I know who it is because I tweeted it. But the funny thing is if you listen…if you read the first paragraph, that sounds like something like a lot of people that are active managers or forecasters would say, so maybe like a Gundlach or a Bill Gross, right, or a strategist like Jeremy Grantham. Then you include the second paragraph, you go, “Oh, okay, huh.” That’s interesting because that seems to be angling a little bit towards indexing as a solution.
And the answer, of course, is John Bogle, but you could very easily could have said Charley Ellis, Howard Marks, lots of…lots of people. But its instant takeaway, and I think a lot about it because we’ve written about Bogle’s stock valuation formula, which goes back 20 years and it’s very simple. He published it and works great. And the interesting thing is you plug in his formula today and it spits out a low single-digit return for the stock market, so not negative, so not in a bubble yet, but not great.
Jeff: So in U.S. market right now or in global?
Meb: U.S. market, right. So it’s in a CAPE valuation of around 29, 30. You know, so the formula is very simple. It is starting dividend yield plus earnings or dividend growth, they’re basically the same historically, but there’s a difference, I’ll talk to you about in a second. And then lastly, change in valuation. That’s it, it’s the simplest formula ever, and it correlates very highly with future 10-year returns. He published this in like the ’90s in Rockford [SP], it’s worked great. The interesting takeaway is I’ve always wanted to ask him, and so maybe I will next time we…I get to meet him, I’ll say, “You know, John, is there a point at which you would say the risks outweigh the benefits of owning stocks?” And I’m sure his answer would be no with some caveats. But, you know, I say, “Look, if CAPE ratio hits 45 again like it did in the ’90s, or hits 50, you know, would you say it makes sense to trim stocks or exit completely?” And I think his answer would be, “Look, no, because the lure of market timing is much worse than the kind of prescription where you start mucking around, you’ll do it the wrong time, you’ll try to do it all the time, so you should just stick with it,” and then that’s my guess.
But, you know, that doesn’t check the common sense box for me because I’d say, “John, what about if U.S. stocks hit 70 times or 60 times like China did, and I think ’07? What if they hit 95 like Japan did in the ’80s, would you still say it’s a reasonable bet?” And I feel like that’s just a hard question to answer. And from just a common sense standpoint, say, “Look, U.S. stocks are training its 50 P/E. I still wanna invest in them, I just…I can’t get on board.” And that’s what, you know, philosophical difference, you know, I…
Jeff: To clarify though, are you talking about allocating new money? You’re talking about letting it alone, the money that you already have in the market?
Meb: Either. I think either. I think if U.S. stocks hit at a CAPE ratio of…first of all, 30 is like a yellow warning light, we’re expecting low single-digit returns. You know, it hits 40, that’s like a red light. Anything above that, I basically see no reason to own stocks. And the good news is, of course, listeners, we talked about this ad nauseam, but foreign stocks are much cheaper, the foreign indices are long-term valuation ratios in the mid-teens, emerging markets are low-teens, and then cheapest bucket is around 10. So we’ve been huge global stock pools using a CAPE approach has…had awesome returns beaten…particularly the high expensive countries, the 2015, 2016, 2017, 2014 was a big stinker for the last two and a half years, it’s absolutely dominated everything else. But going back to…
Jeff: Well, are you falling victim though to your own sort of…let me back up here. I can understand you saying valuations are too high in the CAPE level perspective to invest new dollars. Once you already got money tied up there, and CAPE is a 25, well, yeah, that’s high and you just threw out how Japan, you know, 70, 90, whatever, but if you decided arbitrarily that 25 is too high, or 50 is too high and you pull out, and it does get to the 70 or 90, then, again, you’re falling victim to market timing, why not let the market ride? It’d be as expensive as possible. And then when it does reverse, you know, it’ll, at some point, trigger your moving average. So rather than selling at a 50, you’re gonna sell at a 48 or whatever it’s gonna be. But you’ve banked all of that gain from the CAPE of 25 up to 48 versus trying to outthink the market and decide that it has to, you know, have a drawdown because it’s simply too overvalued.
Meb: There’s a lot in your question. I mean, the first is that it presupposes that the…that it will work, that you’ll be able to time it effectively. And look, I’m a trend follower, and so we’ve written papers on this, you know, the value and momentum off and some defense, all these papers that say, “Look, value works, trend following works, totally sensible approach is all three.” Buy and hold works just great, you just have to sit through 80% drawdowns. Value works great, trend following works great, and a combination of all three works great too, all for different reasons, right?
The biggest risk of, and a lot of other people published on this, is that as valuations increase, it doesn’t matter if you use CAPE, you use price-to-book, price-to-sales, whatever, the chance of you having a much bigger loss increases every time a stair step you go up. So when CAPE’s at 20, your future, you know, whatever, you pick the time frame, 1 to 10 year drawdown, is much lower than when CAPE is at 30, which is lower than when CAPE is at 50, right?
Meb: Are you talking about sort of the violence of that initial sort of drawdown after the peak?
Jeff: No. It’s the what is the biggest loss you’ve experienced over the next X years? So if you look at, and we can put a chart in the show notes, if you look at CAPE and future 10-year drawdowns in any country around the world when CAPES’s at 10, 20, 40, 50, it gets worse and worse the higher you go, which makes sense, right? The more expensive you’re paying for something, the bigger the chance of a big, fat loss is going forward.
Now we’ve kind of derailed and hijacked this entire conversation, which was originally starting with Bogle on indexing. And if you plug in his equation, which by the way, so dividend yield 2 and a half or, sorry, 2% right now, and then you plug in dividend growth and…this is where a lot of people get it wrong is that you can split that into inflation in real dividend growth. And while dividend yield is much lower, so let’s call it 2%, you know, historically, that’s been up around four or five because of buybacks, it’s just simply moved the equation to you had much higher dividend growth. Because that’s what buybacks do, right? They shrink the amount of shares outstanding.
So if you have buybacks occurring, dividend growth as a percentage is higher, so it’s somewhat of an equalizing effect. The problem is inflation is a little bit lower. So without any valuation input at all of the three inputs, right, dividend yield, dividend growth, valuation change, you still have a mid to low single-digit return. Include valuation change, and that makes it even worse.
We’ve done charts on this, I’m happy to include them in the show notes, that shows all the various scenarios where, you know, you plug in, that CAPE goes up to 45. You say it stays, you know, back to a normal mild inflation number of around 21 or goes all the way back down to 5. Here’s the possibilities, the spectrums of where the returns might be. The kind of whole takeaways, that you just wanna have a probabilistic view or outcome of what the potential returns may be and be sensible about it. My whole point with the Bogle conversation is, I don’t think it’s a sensible statement to say, “There’s no point at which I would exit stocks based on valuation,” because at some point, it’s just…it gets insane, it gets crazy.
Jeff: Gotcha, okay. Well, you mentioned indexing, and that made my mind sort of leap to the idea of more of active versus passive, to sort of switching topics here. You recently did a speech on that at UCLA. Any takeaways for our listeners from that?
Meb: There’s a lot. This is actually really funny. And the first takeaway is, Meb should never plan on doing anything on a Monday morning because I’d gone to breakfast with a friend and I was having coffee, I said, “Man, I know that I have something to do today and I can’t remember what it is.” He said, “Well, are you doing a podcast with Jeff? I said, “No.” He said, “You got a meeting? I said, “I don’t think so.” And if I don’t put in my calendar, forget about it. So go to the dentist, come back…which is another thing you should never do on a Monday morning.
My idea was that Monday morning is already terrible, so I couldn’t make it any worse by going to the dentist, which is the exact opposite, it just makes it…it compounds, it makes it even worse. I was coming out the dentist and I was actually taking the Uber to the office because I had parked at the office before. And as usual, just kind of scrolling through Twitter and looking at and see a notification that says, “So excited to hear Meb Faber speak on the next panel, you know, coming up at UCLA Anderson School of Business.”
Jeff: Forgotten your own speech.
Meb: My heart just stopped. I mean, I used to do stuff like this back in college or high school, be kind of forgetful of, you know, classes or tasks or events, but I’ve been pretty good in my adult years. And I was just like, “Oh, no. Oh, no. Oh, no.” And so I Google, you know, my own speech and it’s…this is at 11:50 and the speech is at 12:30, and so I’m on full-on panic mode. I’m in a pretty casual outfit, have a full beard at this point, so I just reroute the Uber direct to UCLA and walk in at 12:28 so no one the wiser, whatsoever, and had a great panel.
And the topic of the panel was active versus passive investing, which is like my least favorite topic on the planet. And the reason being is that I think everything is active. And if you go back…and we run active and passive funds. But if you go back to the ’70s, when that first index funds were created, Bogle as well as Wells Fargo and other groups, you know, that had a very specific meaning. It was a rules-based strategy and an invested market cap-weighted index, which means…so like the S&P 500, it buys the 500 biggest companies by market cap, rebalances once a year, whatever, that’s it. And that’s what an index was.
Sort of like back in the ’70s, when you said hedge fund, it meant one very specific thing, which was typically a long-short manager who bet on stocks to go up, bet on socks to go down and netted out the effects of the overall market, you know, that’s what the original kind of hedge funds strategy was. And then there were the macro funds too, like, Soros, but in general, it’s meant to be a good performance, irrespective of market direction. So they had very specific meanings.
Both of those terms have lost all meaning. So hedge fund, you say hedge fund now, it means could mean anything on the planet. There’s like 10,000 different types of hedge funds. Not only that, what were traditionally hedge fund strategies now show up in ETFs and mutual funds and vice versa, and it’s just so polluted. The same thing with index fund, and I described it in this conference.
And it’s so hard for me to even have this discussion because I have one guy who’s a religious indexer, and most of my index friends fall under that category, right, that they can’t even possibly talk about anything else other than passive indexing. You say anything else and they just like…the brain just…has a total meltdown.
Now on the flip side, there’s an active guy, and I’m…it’s very hard to be talked about because I’m like, “Look, everything’s active.” And I’m like, here’s a good example, S&P 500, totally active index. I mean, I was like, “It has a committee, for God’s sake, that gets to decide what stocks go in, but everyone thinks it’s an index.”
On top of that, we just…quick digression, you know, we did a post on Twitter and on the blog this week talking about fees. And you can get the S&P 500 as an ETF for, like, 5 basis points, so 0.05%. There are mutual funds out there that still charge over a percent. We even found a Ritex fund for the S&P 500 index. So not just some value growth guy who’s trying to beat the market, it literally is tracking the S&P 500. It charges you 2.3% per year, which I’m surprised that this hasn’t generated a bunch of class action lawsuits, I’m sure it will. But it’s basically people that have either been sold them who don’t know better. They’ve been in some 401(k) that’s just dog crap 401(k), or they’ve inherited them and just don’t know better. I hope that’s what’s true because if you’re paying 1 or 1 and a half or 2% for an S&P 500 fund, if your adviser got you in it, it’s an immediate fire and probably should be a lawsuit because you’re paying many, many multiples of what you can get out there for free.
Anyway, now my point. My point being is that like an index fund, the term has totally lost meaning. And let me give you an example. You can buy…I could design an index called the cheeseburger index, and we’ve talked about this, whether CEO eats hamburgers or cheeseburgers. So Pete’s hamburgers is out, Pete’s cheeseburgers is in, the stocks in. Then you weight the stocks in the universe by how many cheeseburgers that CEO eats per year. That’s your index, it rebalances once a year. We’re gonna charge you 2% a year. That’s an index fund. Is it a good investment? No, it’s a horrible investment. Actually it might be a good investment, I have no idea, I’ve never tested it. But charge 2% a year for nothing, horrible idea.
On the flip side, you can have an active fund that could also be rules-based, by the way, that charges 10 basis points per year, and there are ETFs that actually do that. So the terms lost all meaning. But what we say in general is the only thing that matters is total return after all fees and taxes. And one…
Jeff: Do you delineate, just curious, if you think everything is active, do you delineate any difference between what’s considered an index fund, which, even though you might consider it active, the rules are less intrusive or less vigorous or whatever, versus how most people would define more of an actively managed fund with a manager, which is getting in there and has either far more robust rules or is relying on his own instinct, like, how do you divide them if you do, if you believe everything is all active?
Meb: I think you’re seeing people divide them currently with their dollars and all the flows go into rules-based portfolios. And the reason being is they at least know what they’re going to get. So whether it’s an index or an active guy, but whether it’s a kind of objective, rules-based, transparent approach, and that could be an active approach, it doesn’t really matter. But say, “Hey, look, here’s what we do. Here’s what this would have looked like historically. Here’s the general rule.” So you have an idea of what you’re gonna get.
If you go by an active on this traditional guy, “Hey, I’m gonna buy 50 stocks and trade them now, then I’m gonna change my exposure based on what the market’s gonna be,” which is traditional hedge funds’ sort of world, how do you plan for that going forward? It’s really hard, right? You were simply betting on the manager in that…in his ability, and that’s it. And that’s totally reasonable. I mean that…I’m not saying that doesn’t work. I feel like most advisers have found that that’s a lot harder than allocating to something that’s rules-based.
So I think it’s just a…then you’re seeing a lot of the flows come out of the traditional active area, but the biggest takeaway that one of the few things people control is fees. And so most of the research shows this, that in general, the less you pay for a strategy or a manager, the better. It doesn’t mean the people who are charging 1% aren’t worth it, the Renaissance is the world that charge 4%, totally worth it. But it’s just a much higher bar the more you charge.
Meb: Well, you’re talking about fees and you’re tying it to the article or the blog post we put out last week, what you’re not mentioning, which is interesting to me, we’re sort of dancing around the issue right now is the idea of whether or not your manager, your fund is giving you, in fact, what you think you’re buying, you know, talking about active share. Maybe for people who haven’t read the blog post, why don’t you remind them sort of that half of the equation? You know, fees is one thing, what you’re paying, but then what you’re getting, that’s a whole different equation.
Meb: Yeah, we just did a blog post this week that you helped out on. It was called “Paying For A Filet, And Getting Bologna,” which it was talking about this concept of closet indexing, which is…and the Bill Miller podcast with Barry Ritholtz, which is a great one, everyone here should listen to it, where he’s talking about active and passive investing. And he says, “Look, 70%…” Most of the world is still active particularly in equities, indexing maybe only a third. But most of the world, most of these active managers are basically index funds. They basically look exactly like the S&P 500 because the bets they make aren’t big enough to make a difference.
And so what we talk about is if you’re gonna allocate to an active manager, the bets need to be pretty concentrated and different for it to even make a remote difference. And most people, there’s a lot of reasons why most funds don’t do that. There’s a ton of career risk, you know, so they don’t wanna look too different, they have mandates, scalability issues, whatever, but you don’t wanna allocate to those funds because you can buy those index funds, the S&P 500 for example, for 5 basis points, right? Almost free.
So to buy something that looks, for all intents and purposes, exactly like the S&P, it’s a total waste of time. If you’re going to go different, so whether that’s factor investing and say you’re gonna buy a value fund or an active manager, or whatever it may be, at least give yourself a shot. So buy a fund that’s very concentrated and looks very different. There’s a lot of resources, we’ll post it to the show notes. Our good buddy, Wes Gray, at Alpha Architect has an awesome website software where you can type in a fund and it’ll show you the percent active share, meaning…like there’s a lot of funds out there that say, “Hey, we’re smart beta. We charge 50 basis points,” which sounds reasonable, but then you type it in and they basically own the same thing as S&P 500. So you’re not really paying 50 basis points, you’re paying, like, 2 and a half percent for the active bets because the active bets are so small.
And actually, I think it’s a really good idea, I think someone should do this, maybe we’ll go about it. I would love to see someone go through for all the main big factors and say, “You know what, if I want to express Momentum, and I go and put in all the Momentum funds into Wes’ module, what’s the one that has the most momentum-y Momentum fund, or what’s the biggest value-value fund?” and kind of plot it out and then say, “Here’s the spectrum.” I think that’d be really interesting, useful tool for advisers, but…because a lot of people, they buy fund to say, “Oh, this sounds…hey, this is a low vol value fund.” You’re like, “All right, that sounds like what I’m buying.” But then you get under the hood and there’s 10 different types of these funds, and they look very, very different.
So we talked about this, and the even worse example is the S&P funds, which aren’t even closet indexers, those are just out in front of your face saying, “Hey, we’re charging you 2% for the S&P,” that’s the worst offender. Then the closet indexes are the next level down, not as bad but still bad because you’re paying way too much and not getting anything. So there’s a lot of tools you can use to look at that, and we’ll post them all on the show notes.
Jeff: So the takeaway is you wanna find something that’s truly different. But I gotta wonder, most retail investors, well, that sounds good theoretically. I mean, when the rubber hits the road, looking different is terrifying. I mean, I’ve seen you write on this where, you know, we are such…you know, the hurting mentality. If we’re that different, if we’re lagging the market, we’re lagging our neighbors when…you know, hell, you know, the last, you know, eight years, if we were that different, how long are you gonna stick with that strategy? It’s hard.
Meb: I cannot tell you how many times I get emails, and this isn’t just retail, by the way, this is almost every institution and adviser as well, they’ll say, “Hey, Meb, I’m interested in fund X, Y, Z but I noticed it’s underperformed the last,” and it could be a year, three years, three months. I’ve literally had people, “I’ve noticed my fund has underperformed in the last three months, can you tell me why?” you know, or, “Why should I buy this fund if it’s underperforming?” I often write back, and because it’s a hard question to answer, and I say, “Would you be more or less interested if it was outperforming?” Because what you should really care about is process and long-term cycles of performance up from any factor active fund, asset class, anything can go not just months and years but multiple years, even a decade of underperformance. And I often say, “I’m more interested in a fund or a factor of strategy.” We’ve talked about emerging markets a lot the last couple of years, we’ve talked about our famous, you know, ones that we talked about last two Christmases, the down five and six years in a row, coal and uranium, which that monster runs sense, but as I’m most interested in things that have done really poorly.
So most people, what they do, intentional or not, they’ll look at a fund, they’ll compare it to a benchmark, if it’s outperforming, they get more excited to pursue than if it’s underperforming. And there’s some caveats to this, of course. There’s a lot of strategies out there that…which will always underperform or just not least of…the cheeseburger index is one. But there’s strategies that are reasonable, time-tested, that makes sense, check all the boxes, low-cost, transparent, that you are better suited investing during drawdowns or when times are going poorly.
So the vast majority of people, that’s not the way their brain thinks. And all of the studies that look at investor flows demonstrate this, you know. And in general…and the index investors are better, but the active investors guys are even worse, but they chase performance to me. If you look at a lot of the most famous mutual fund managers over the past decade, the Bruce Berkowitzes at Fairholme, the Kenneth Heebners at CMG Funds that have had these great returns and periods, the money washes in when times are good and washes out when times are bad, and it’s so stupid and it’s so detrimental a return.
So if your adviser and investor are thinking about this, you’re probably asking the wrong question or you’re asking it, looking for the wrong answer, which is, “Has this fund done well over the short period? Should I be investing in it when it’s beat in the market by whatever percent?” You should probably be asking…looking for the opposite.
Jeff: When I was in my early 20s, I opened up a Roth IRA, and I didn’t know anything about investing at that time, or very little. And when looking…when it was time to, you know, allocate new dollars each year, when looking at historical returns to funds, I did exactly what you’re describing. I would basically look or I will…what did, you know, what did the U.S. REIT Fund do last year? What did this sort of Global Fund do? And I’d basically picked the highest ones thinking, “All right, well, that’s what I could expect going forward.” And then nowadays, you look at that and you realize that more times than not, it seems like you’re picking something that’s, you know, had its best days behind it, and yet you’re getting into it now in the wrong time. It’s just a great way to lose money or to underperform [inaudible 0:56:51] money unnecessarily.
Meb: Look, I mean it’s natural. Humans have evolved to extrapolate trends. And the best quote I’ve ever seen on this is Arnott’s, in our podcast, he said, “Humans didn’t evolve to run towards the tiger,” you know. So to thinking about risk and thinking about trends where you extrapolate where, “Hey, look, this fund has been great,” you extrapolated in the future. And my favorite example of this recently is I did a post on Twitter where I looked at the 5 nominees for mutual fund manager the decade of the 2000s where they just destroyed the S&P 500, all 5 have underperformed the S&P 500 sense, and that’s what I would expect, you know. And so it’s not just managers, it’s styles and approaches and asset classes.
So one idea that I love that we’ve actually never talked about, are you familiar with the coffee can portfolio?
Meb: That’s one of these lazy portfolios, but where people buy something and put it away forever, essentially. And I was thinking the other day I said, “You know what, interesting strategy, we could tie in maybe to our book project one of these days, is simply the idea of you buy an investment on your personal portfolio for people that are kind of averaging it over the years, and you’re gonna make…let’s make it up. One or two investments per year and that’s it. But you buy it with the express purpose of never selling it. Meaning, this goes in your portfolio and it’s there. So people would be a lot more thoughtful and say, “Maybe we get two entries per year, Jan 1 and June 1.” And you get to buy one investment with this entire chunk and that’s it, and it sits there.
So I think people would be a lot more thoughtful about, you know, ways to allocate. And I spend a lot of time thinking about behavioral ways to set up portfolios and funds for people to avoid behavioral issues. I mean, I think a wonderful idea would be something like, you know, we talked about this with Edelman a few weeks ago where most people say, they’re long-term investors, right? They say, “My goal is 10, 20, 30, 40, 50 years, save for retirement, save for my kids, grandkids, you know, college,” and then they behave on the week to a quarterly time frame.
I would love to see some sort of fun. This has something along the line of look, “We’re gonna charge you 0%,” sort of like what our trending portfolios do. “We’re gonna charge you 0%, they’re very low-cost,” or whatever, “and we’re going to lock you up for 10 years, or 20, or 30.” Like that’ll be choices, it’ll be 10 years, 20, 30, 50, whatever. “And the good news is you get very low costs but you can’t exit.” And I’m sure there’s some way to figure this out. You say, “Maybe you can exit if you die,” you know, but legally, you probably have to transfer it then. But otherwise, if you exit, maybe there’s like a penalty, like, it’s like 1% penalty or something, or maybe it’s a descending penalty on how long you’ve held it. That’s not a bad idea like, “All right, you’re investing in the 30-year forever fund, we’re gonna charge you 0%, But if you liquidate year 1, it’s a 10% penalty, you liquidate year 5, it’s 5% all the way down,” and maybe like year 10 or something. Anyway, the…
Jeff: Coffee can idea is interesting to me in the sense that I feel like the valuation metrics or your valuation screening would be very different, specifically for me, when I think about buying a stock right now, my mind automatically gravitates towards just what’s the current valuation. You know, am I more than likely to make money or beat, whatever the benchmark is based upon the current valuation or not. But if you’re looking to buy something 20, 30, 40, 50 years as a hold period, then actually tying back into what Edelman said, it seems like we are…it’s a different set of criteria right now. Rather than just looking at valuation, you have to look at the longevity of the business itself. And so that’s about the stock, and it’s more about what’s the overall…what’s the company doing? You know, it’s not just, you know, is it a fairly priced investment at the moment? It’s are you buying the type of company that’s gonna be around 20, 30, 40, years? You’re not buying the buggy whips or whatever it’s gonna be, the Kodaks of the world. That’s a different challenge right there, especially given the pace of growth right now.
Meb: There’s a little bit of survivor bias here, right? So imagine if we go back 50 years, you probably would say, “Look, Kodak is the world’s best technology company, this is gonna be around forever, obviously,” you know? Where, you know, where you say, IBM or Enron or, you know, whatever may be around forever obviously but…
Jeff: But that’s my point, that’s the challenge.
Meb: The one benefit this does give you, it eliminates the behavioral bias that so many people have, which is that they sell too quickly. So almost everyone has a really hard life. You look at the chart of Amazon or Apple, no one’s held that all the way through because they’ve…these are multiple, 50 plus percent drawdowns over and over again on path to having many multiple thousand percent returns. But in this sort of idea and concept, it would guarantee you own it. So indexing, of course, is one way to guarantee you own winners. You obviously own all the losers too but…and most people never sell on the downside.
So thinking about this is at least it corrects one of those, which is selling too soon. So I think it’s a fun experiment. I don’t know how practical it is. I don’t think most people have the fortitude to build a portfolio like that, certainly. But I think if you could build a structure…maybe this is another idea. So two ideas we have, we have the forever fund and then we have the kind of coffee can portfolio that allows you to buy in but never to sell. I don’t know if, you know, those are commercially viable, and maybe this is the fact that I haven’t slept in three days, we come up with these, brainstorming these really terrible ideas on day three of no sleep.
But I spend a lot of time thinking about that, how to keep people from being their own worst enemies. I haven’t come up with any great solutions. Ritholtz’s crew does that with Josh and Barry where they reduce the management fee based on client retention, basically how long you’ve stuck around, they’ll reduce your fee. We’ve kind of backed ourselves into a corner because we charge no management fee and so we can’t go negative.
Jeff: To have them pay us, exactly.
Meb: Yeah, right, we’ll pay you to be a client. Anyway, so all good ideas. How are we doing on time, Jeff? Are we getting pretty far along? We got time for anymore last thoughts?
Jeff: Well, you tell me, we’re at a minute and four. You know, apparently, you just had a child, I assume you wanna go be a father. We can tackle one more topic or we can call it for today.
Meb: Sure, let’s do one more. This will get me out of at least one more diaper.
Jeff: All right. All right. So something that’s pretty interesting you shot me was an article about investing in Europe. It’s called, “Investing in Europe: Where’s the Return?” And in essence, it talks about just a lost decade for European investments how U.S. markets have…was it beaten by 100% over the time period given? And historically, you know, when this happens, there’s outperformance from the European markets going forward. So that’s a very, you know, quick overview. You maybe wanna give some more color on what your thoughts on that?
Meb: Yeah, this is really simple. We’ve talked about this before, but, you know, U.S. versus foreign historically has been a coin flip, 50-50 in a given year. U.S. is one of the best performing markets in the world going back to 1900, but that’s an outlier and that’s what you expect out of outliers. It wasn’t the best. I think South Africa was the best performing country and it wasn’t the worst, you know. Austria was the worst developed country but are developed and emerging, but you also had the realistic outcomes like China and Russia closing their capital markets altogether and you losing 100%.
But historically, U.S. versus foreign is a coin flip. So we talked about this in “The Trinity Portfolio” white paper. But if you…but they go through the cycles. So every once in a while, emerging markets will beat everything else, and sometimes foreign developed will beat everything else. There’s other times the U.S. is the worst performer.
U.S. is the best performing stock market in the world since the bottom in 2009. I’m not sure if that’s still the case over the past year because foreign has really started ripping, but it was the case last summer. And that’s…it almost never happens. And so the U.S. now, then that’s the way that it works. When something is the best performer, the valuations go up, and the U.S. is now one of the most expensive stock markets in the world. I think we are the third most expensive, but the good news is the rest of world is really cheap.
So I think in the article, Professor Bob Shiller, inventor of the CAPE ratio or just popularized it, you know, he was on TV and talking about this. And it’s so funny because he’s so sensible. Everything he says makes sense and is good advice because he’s like, “Look, you know, the U.S. is expensive, it doesn’t mean it’s gonna crash. Europe’s a lot cheaper, you know, it’s reasonable to diversify globally but it’s not guaranteed.” He speaks like someone who knows what they’re talking about, but it makes…and I apologize to you ahead of time, Professor, it makes for poor TV. You know, what CNBC wants is someone to say, “No, I guarantee you, you know, Europe is going to go up 20% a year and the U.S. has to crash. And we’re looking for recession in ‘Q2, and we’re looking for the market as it hits 23-65 to turnover and getting out,” right, the certainty and extreme positioning, but that’s really not the best way to invest, of course.
So, you know, that’s the way…we believe it and we’ve been saying this for a long time. It’s finally good to see the world line up with our beliefs, and it hasn’t always been the case. But you’ve really seen this shift since last summer, which is foreign starting to gain momentum away from the U.S. So all these foreign markets starting to outperform and all of them now being in an uptrend. And we talked about in the [inaudible 1:05:54] podcast, my favorite scenario is a cheap market in an uptrend and you’re just seeing it almost across the board. And a lot of these cheap countries, you know, the cheapest we have in the world, although it’s a very small country and there’s no ETF that tracks it, Czech Republic for example, but other…a lot of Europe, Eastern Europe, emerging Europe, super cheap. And, you know, Russia and Brazil have had big runs but also still in the very cheap category.
So a lot of opportunity in the world, and we disagree with Bogle on this, you know, and think that investors, at a minimum should have…in the U.S., should have half their asset…half their equities in foreign, but I could make an argument easily for 70% to 100% in foreign instead of the U.S.
Jeff: That actually reminds me of what are not said about over-rebalancing. And given the potential tailwinds lining up for a lot of these global markets, to what extent would you not just make sure you’re suitably allocated there, but you’re actually over-allocated or over-rebalanced?
Meb: Yeah, that’s why, you know, I think that I…someone could come to me and say, “Hey, Meb, look, I actually…I’m gonna put 70% in global equities with a value tilt and only a third in the U.S.” I would say it’s totally reasonable. Somebody’s gonna need some [inaudible 1:07:06] at 100% in foreign equities and none in the U.S., I would not, like, throw down my phone and say, “That’s a really dumb thing.” I think that’s a totally reasonable approach. I think the…
Jeff: You reserve your phone throwing down for people who want to put 100% into Snapchat though?
Meb: I think the opposite… Don’t even get me started on that. I think the opposite, however, is horrible advice. I think putting 100% in U.S. equities is a phone throw down because they’re expensive, and despite being, you know, the world’s biggest economy, should only be about half of the global allocation. So the starting point from any of your decisions is half, and then you can move from there based on whatever, you know, financial astrology you believe in, but that is the starting point. And I think making an active bet, which is what most people do and put 70% in the U.S., same as they do in every country, is a really dumb idea. The converse, I don’t think, is a terrible idea though.
Jeff: All right. So, listeners, make sure you’re not too heavily invested in the U.S. All right, Meb, let’s call it a day. You have a child to go visit. You wanna take us out?
Meb: Yeah. Everyone, pray for me. Hopefully I get some sleep tonight, but it’s been a lot of fun. Look, seriously, Jeff and I wanna say a huge thank you. We love getting the emails from you guys, the feedback is awesome. We read everyone, we respond to all of them, we try to incorporate them into the questions. And this journey to 1 million downloads has been really a blast, so thank you all for listening. It’s meant a lot to us, and it makes sitting in a hospital waiting room for an hour even more fun. So thanks for taking the time today. Look, guys, please send us feedback. We’ve mentioned this a lot, but firstname.lastname@example.org
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