Episode #74: Jeff Sherman, DoubleLine, “There’s This ‘Buy-The-Dip’ Mentality… Do You Play In It, Or Just Shake Your Head?”
Guest: Jeffrey Sherman is the Deputy Chief Investment Officer at DoubleLine and is a member of DoubleLine’s Executive Management and Fixed Income Asset Allocation Committees. He additionally, serves as a portfolio manager for derivative-based and multi-asset strategies.
Date Recorded: 9/28/17 | Run-Time: 1:14:13
Summary: We start with Jeff’s background – it’s a fun recap, including stories of running the scoreboard for The Stockton Ports… being a bank teller… earning graduate degrees… there’s a brief aside into catastrophe bonds which is a good primer if you’re less familiar with them… then back into Jeff’s background with DoubleLine.
This dovetails into Meb asking about the type of shop DoubleLine is, as well as its overall investing framework. We learn that DoubleLine will go into whatever market it finds interesting. They’re also a macro shop, which led them to fixed income. After all, Jeff tells us “If you want to know what’s going on in the world macroeconomically, the bond market tells you.”
Next, Meb asks how the world looks to Jeff today.
Everything is growing, but it’s not the same old growth. The difference is debt. Overall, it has been a positive environment for investing; inflation is low, but the price of assets now reflects this good environment and people are projecting that forward – but it’s not realistic. Many assets are expensive now. Jeff puts a point on the situation by saying “There’s this ‘buy-the-dip’ mentality… Do you play in it or just shake your head?”
The guys cover lots of ground here: Prices in the bond market have gotten ridiculous… Policy mistakes from the Fed… How this is “The Jay Cutler bull market” meaning it’s very “ho-hum”… how Europe is growing at the same rate as the U.S., yet they are continuing to do QE, while we’ve hiked rates four times… we’re talking about unwinding bonds while they’re buying – there’s a disconnect. And we don’t truly know what unwinding is going to look like.
This leads into a great discussion of bonds and how they respond to a rising rate environment. As Meb notes, most people hear “interest rates are going up” and they think “bond prices must be going down.” But that doesn’t have to be the case. Jeff dives into some great detail here on the math behind bond returns and rising rates. If you’re a bond guy, make sure to catch this part of the episode.
A few twists and turns later, Meb brings up a DoubleLine fund that combines U.S. equities in various sectors, paired with a fixed income component. He asks how is it designed, the benefit, and so on.
Amongst other details Jeff tells us, we learn that the fund applies a sector rotation strategy based on Professor Shiller’s CAPE ratio. Historically, people have used CAPE to evaluate markets. Jeff wondered why one couldn’t apply it to smaller subsets of the markets – sectors. For instance, utilities and tech have different profiles re: beta and whatnot. So why not take each sector’s CAPE and compare it to its own CAPE history? You then look for the cheapest sectors of the market. And you can avoid buying a value trap by apply momentum (in Jeff’s strategy, they throw away the worst one-year momentum sector).
Meb asks which sectors look good from a CAPE perspective now. Jeff tells us he’s looking at technology, consumer discretionary, consumer staples, and health care. He was looking at energy, but he booted it due to its bad momentum. He tells us another high flier is the financial sector. Up 35% or so since the election.
Meb asks a Twitter question next – how much does DoubleLine incorporate technicals into their process? Jeff tells us that he uses technical more on trade implementation and things that are hard to value like FX.
There’s so much more in this episode: sentiment… Trump, and the D.C. status quo… commodities… the “Four Asset” portfolio… More write-in questions from Twitter… a quick descent into a crypto-rant… the biggest mistakes Jeff is seeing investors make… and of course, his most memorable trade.
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Links from the Episode:
- 1:57 – Introducing this week’s guest, Jeff Sherman of DoubleLine
- 3:44 – The Sherman Show
- 3:55 – Jeff’s bio and path that led him to where he is today
- 9:24 – First time stumbling across quants on wall street
- 11:15 – Catastrophe bonds
- 14:02 – Jeff’s move over to TCW
- 14:45 – The formation and early years of DoubleLine
- 18:34 – The general framework of DoubleLine
- 22:17 – How does the macro landscape look in the eyes of DoubleLine
- 25:50 – Assessing policy from the Federal Reserve and its impact on the macroeceonomic landscape
- 29:53 – The Sherman Ratio
- 34:35 – The Handbook of Fixed Income Securities – Fabozzi
- 35:37 – DoubleLine research
- 37:06 – Pairing an equity strategy with a fixed income component
- 37:30 – DoubleLine Interview with Shiller
- 42:07 – “Changing Times, Changing Values: A Historical Analysis of Sectors within the US Stock Market 1872-2013” – Bunn & Shiller
- 44:47 – DoubleLine’s current positioning
- 47:28 – Why people struggle to follow trend or formula based strategies
- 51:00 – Twitter Question – How much do guys like DoubleLine use technical in making their investing decisions
- 52:17 – The importance of sentiment in market strategy
- 55:18 – Sponsor: Roofstock
- 56:28 – How does Jeff think about commodities
- 1:02:10 – Famous Financial Fiascos – Train
- 1:05:50 – Meb Faber Show (Mark Yusko episode)
- 1:06:01 – Twitter question: Fannie, Freddies preferred, yes or no?
- 1:06:30 – Twitter question: who wins long in 3 months, US dollar or 10-year US Treasury?
- 1:07:22 – Bitcoin funds
- 1:08:56 – What are the biggest mistakes individuals or institutional investors make
- 1:11:17 – Most memorable trade or investment
Transcript of Episode 74:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: Hello, podcast listeners. Today we have a very special guest. Before we get to him, a real quick, housekeeping. I’m gonna be travelling to Lake Tahoe, New York City, Orlando, San Diego and Amsterdam in the coming two months. So if you’re in one of the cities, come say hello, and we’ll grab a coffee or a beer or something. But now back to the show. All right, we got the deputy CIO of the institutional management group Double Line. Also, serves as a portfolio manager for a whole slew of funds. He’s also been a stat and math instructor at the Florida State Seminoles and Pacific. And Risk Magazine named him Institutional Investor of the Year. Welcome to show Jeff Sherman.
Jeff: Thank you. I noticed you didn’t know the mascot of the Pacific.
Meb: We’ll get to that. That was my intro question. So people call you Sherman to distinguish a little bit from the other Jeff that you work with. Does anyone ever call you the Shermanator?
Jeff: Yeah. Actually, that’s not a reference I really cared for originally, but there was a colleague of mine who used it extensively and it was Bonny Baha, who, unfortunately, recently, passed away last year. And so I’ve absorbed it as a term of endearment too. So I was always the Shermanator to her or also Shermi, but I don’t get that very often from most people.
Meb: I can relate a little bit for someone who has a bit of an odd name. Every morning at Pete’s I get about 30 different derivations of Meb or Ben or Mary. But, anyway…
Jeff: Is that your real name?
Jeff: You ever get that one too?
Meb: Once at the DMV, I had a DMV say, “Are you male or female?” And I said, “Seriously?” And they said, “I got it wrong once, so I just got to ask.” Anyway. But Meb…
Jeff: That’s flattering actually.
Meb: …I do know the Meb is a surname, and so I actually… There are some girls in the south name Mebane as well. So there you go. All right, let’s get back to the topic at hand.
Jeff: Don’t judge a book by its cover, right?
Meb: Yeah. So some people may be familiar and, by the way, Sherman has his own podcast, “The Sherman Show.” You should check it out. It’s one of the newer…he only down about 20 episodes but great podcasts out, recently launched. Just check it out. We’ll put some show note links in there. But let’s talk a little bit about origin story, you know, you started…one of your first job was running the scoreboard for the Stockton Ports.
Jeff: Yeah, exactly. So the University of…
Meb: Is that short for something or does it I mean like…
Jeff: Actually Stockton, has a big port in there. So it’s off the Delta River. So it’s the plural of being the port. So, for those who don’t know, the University of Pacific is in Stockton and they’re also the Tigers very generic mascot name.
Meb: And for those who don’t know, Stockton is where?
Jeff: Stockton is in the northern part of the Central Valley of California. So it’s about 40 miles south of Sacramento. And if you went due west, it would be about a hundred miles to the Bay Area.
Meb: Is that somewhere near the Delta? Is that like, the water system? Is that kind of?
Jeff: Right. So we’re just talking about the port is off the Delta river. So, yes, exactly. So, Lawrence Livermore, like, the Livermore is right up there. So if you think of the Lawrence Livermore Labs, it’s right outside of Stockton.
Meb: So, I used to share a wakeboarding boat with a friend where I live in San Francisco, and he kept it in the Delta for part of year. And I never knew quite exactly where it was but we used to go wakeboarding there. It reminded me a lot of wakeboarding or being on the lakes in the South.
Jeff: Right. And then it actually goes all the way up to Sacramento too, so it’s famous during the gold rush and the likes too. And every year end after finals or during finals week and the like, from the University of Pacific, we always rented houseboats, so all the fraternities and sororities each got their own house. But it was the one week a year that everybody got along.
Meb: I love it. So having a boat is kind of the best and worst thing of all time and huge money pit. But probably the best purchase I’ve ever made.
Jeff: And they say those are the two joyous days Is when you buy the boat and then when you finally get to actually sell it.
Meb: And there’s like no leaks around L.A. is the problem. You have to kind of go up to… And so we used it, when I when I moved L.A., we used to pick out lakes on the map they were in between San Francisco and L.A., and just go to these random lakes. And so I saw plenty kind of houseboat link ups and big part, everything there, a lot of fun.
Jeff: Yeah. But they were about 60 miles north of [inaudible 00:05:48] 70 is Pyramid Lake, right?
Meb: Yeah, I’ve been there. Nascimento. All right, okay, let’s go back to minor league baseball. So, you were working at Stockton Ports, scoreboard operator?
Jeff: Scoreboard operator. And so this was a very lucrative position that I obtained through one of my fraternity brothers because he was working there and he ultimately got into major league baseball and like doing a lot of the behind the scenes work of personnel, and he needed a scoreboard operator. And it paid $10 a game which is awesome, right? I mean that’s definitely money for the week. And I had this great perquisite, all you could eat food. And so as a… In the middle of college undergrad, I think I was a junior at the Sophomore Junior at the time. I mean, who could think of a better way you can stuff your face all night, watch a game of baseball and you get $10 when you walk away.
Meb: How are baseball typically ballpark, minor league ballpark food is not quite the healthiest. I mean, we’re talking hot dogs…
Jeff: Yeah. I mean, nachos, I mean, pretzels. I mean, my sodium intake is probably through the charts but again, you are young enough to gonna work it off.
Meb: You’re in school in college.
Jeff: And I rode my bike over there. So, again, from campus to the ballpark is maybe about two and a half to three miles, and so…and it was not the best neighbourhood so I kind of elevated heart rate going through it so I trying to get there pretty fast not to mention pumped up on sodium.
Meb: So you studied math, I believe, and then studied a thing about…you did a little grad school?
Jeff: Yes. So the next job was actually as a bank teller, so that’s my first job in finance.
Meb: Talk about a job that’s probably not going to system another five years.
Jeff: Yeah. I don’t know the last time I’ve actually went inside of one. Once I found out you can actually wire money on the internet, I don’t I don’t think I’ve been back. But bank teller, I guess I was decent I had to do the commercial line which just means you have to count more money. It’s kind of interesting from interaction standpoint but from there, I was graduating in school as a mathematician. I started on the side of doing pure math trying to be a teacher. So I thought, “Hey, I’ll be a high school teacher.” You know, do something like that. And just realized that, wow, redundancy would just kill me, you know, just as you started doing more. And so I actually switched to Applied Math and then realized I didn’t know what map location was.
So, I’d say it’s a lot of statistics and kind of econometrics and things to that effect. And so I was always better on the numerical side and it just seemed I got this a great job. But I forgot to get a job. So, all of a sudden, it’s rolling around and I forgot that there’s this thing that, you know, once you graduate you have to do something. So, I take it… I went to the GRE’s and just applied to grad school. So I actually went to grad school straight out from undergrad. I guess somebody would call it a non-traditional path. And so actually, that’s where I ended up going to Florida State.
Meb: Seminoles, you know, it’s interesting. My intention was to go straight to grad school and my brother said, “Meb, take a year off.” Because I think it took him like a decade to finish his PhD. So take a year off, make some money and then, of course, I never went back. So it’s probably good thing that you went. All right. So down in Tallahassee then…
Jeff: And my naiveties what took me there was like I was…I grew up in California, my, “Hey, I’d applied to a few schools.” You know, I actually had whittled it down [inaudible 00:08:44] all places like Texas Tech, Lubbock Texas, versus Tallahassee Florida. So for all the options out there for mathematicians, somehow I’d stumbled in put these two towards the end. And so the final decision was California, Florida, they both have sun. I didn’t realize Tallahassee exactly the location of it when I went out there. And so it was a little different, culturally, but I adopted pretty quickly.
Meb: So what brought you all west? How did you come back?
Jeff: So, actually… So, I was I was in school there, I went there early in the summer to learn how to teach, I was a TA, that’s where did some of that. Kind of taught pre-calc and calc in the things like that. And I was studying numerical analysis and I stumbled across quant on Wall Street and, you know, this was like ’99ish, 2000. And, you know, seeing kind of this revolution…what I had deemed to be a revolution.
Meb: Do you remember, like, is there any, like, exact moment where you like flipping through the paper or is there a book you read, it a TV, or is it just kind of a…?
Jeff: It was a conversation I had with one of the other grad students because I was disadvantaged when I went to Florida State, from a mathematical standpoint, because I had studied all the statistical courses, probability, measure theory, you know, really interesting stuff for people out there. And the problem is, is if you’re not familiar with location Tallahassee, they have a pretty big school in meteorology because they have a lot of hurricanes. And so all of the mathematical students there are encouraged to go towards studying Fluid Dynamics and Fluid Mechanics to make sure you can do that. And to someone who studied Statistics and Probability, and hasn’t touched physics in a few years, man, I was lost.
So I was looking for an application, at the time, Numerical Analysis was something that was kind of barging me. I mean, it’s always been there, and solving problems with computers at the time, it was simply programming and doing a lot of, kind of, partial differential equation like. So there is really interesting stuff for finance people. But, someone had said, “This heat formula…” you know, the diffusion of heat or a [inaudible 00:10:41], “this is the same as the black shores offshore pricing.” What do you mean? It’s like, “These guys make money.” I’m like, “Well, I’m a poor kid.” Here I am, you know, living on my stipend here in Tallahassee. “What do you mean they make money?” And so, that’s how I actually stumbled across it and they had a financial math program for the state, it wasn’t the strongest in my viewpoint, and so actually, I transferred back at the school here to a Financial Engineering program in the city of Claremont. And so, Claremont Graduate University is where I’m graduating from with a Masters in Financial Engineering.
Meb: I wonder if that’ll like, you know, thinking about it would be good practice for catastrophe bonds, which is an area, I don’t know, do you guys do anything in that world at all?
Jeff: No. That’s like…that one like crossing the double line of risk things. And so cat bonds great correlation structure right? The idea behind it, is a good one, it’s just tail risk, right? Reinsurers, you know, have all this risking out there. I would say that, you know, the thing about cat bonds they’d been popular last few years. In fact, we looked at them probably back in ’04, ’05. [crosstalk 00:11:41]
Meb: You didn’t come down a lot.
Jeff: I suspected going up. given the fact, and again, I do wanna to make light of some of these situations, but the fact you’ve had three major hurricanes hit U.S. property, or at least, you know, including Puerto Rico, there is a lot of risk in that stuff. So, it’s a tail risk event that it’s such a…its exogenous thing that how do you forecast it and perceive it because you have to believe in the correlation aspect.
Meb: And for listeners unfamiliar catastrophe bonds or for state or municipality, or country even, wants to insure against a hurricane, or an earthquake, or whatever this risk may be, you know, they issue these bonds that would pay a certain amount of yield but, if this event happens or trigger happens is simplified, if a hurricane happens and hits this and does this much damage, it’s more complicated than that. But, you know, you’ll essentially lose part, most, all of your investment. And so the challenge of modelling these is, of course, if you have this one in a hundred years, or two, or is it two in a hundred years? Or is it 10? You know, and global warming. So, it’s a really interesting field. But it’s also something that really, kind of, correlates to nothing else but there’s been a ton of money flowing into it in the past decade.
Jeff: Well, it’s been a ton of money because there hasn’t been these natural disasters too. So it looked like, you know, it’s a classic nickels in front of the steamroller. It’s like, “Oh, this hasn’t happened.” So instead of thinking it’s about to happen, people just extrapolate the good history. But, the thing about it is that, I don’t know about you Meb, but even with my Florida State classes in Fluid Mechanics or the one I took, that I just got crushed miserably, it’s very difficult to forecast a hurricane, and especially when you’re selling this risk for seven years. So the cat bonds are five, seven, ten-year tenure. And so this reminds me of like people talking about forecasting mortgage repayments bid. It’s like it’s very tough to forecast the next month. How are you going to model our hurricane risk over five years, seven years, ten years? And that’s why they had such sexy yields for some people.
Meb: Yeah, and that’s the thing. Is you just have to come up with a number that makes you feel comfortable and just coming from someone who’s never invested in one, but been very curious for many years, a number that’s comfortable enough to compensate and then come up with a diversified enough portfolio that would hopefully zig and zag… Anyway, there you go. It’s a new product idea for you guys, we don’t do much in the fixed income world so…
Jeff: Yeah, I mean. And for investors, if you’re gonna buy cat bonds, I mean, it should not be more than 1%, 2% of the portfolio, I mean, the tail risk there is massive.
Meb: Yeah. All right. So you are back at Pacific. Then did you immediately hook up with TCW next or there was there some other stops on the road?
Jeff: No, no. I was, you know, I was on a short narrow path there. So, when I was at Claremont Graduate University, one of the gentlemen who was an advisor of the program worked at TCW, and his name is Ed Franks. And he was looking for interns for a summer and so I applied for that position, it’s a little longer story than that there are some complication about it but, essentially, that’s how I got to TCW. So, I had… Because of the transferring from getting some credit from my year and a half of Florida State, I had like one class left after I did the internship so I technically still had to go to school in the fall that year, but I stayed on and got a job full time at TCW.
Meb: Cool. And so listeners who are not familiar, TCW is kind of the jumping off point, the origin story of DoubleLine, which I think was a very exciting…exciting may be the wrong word, but transition into starting the firm. When did the DoubleLine get started?
Jeff: December of 2009. And so it’s exciting…
Meb: Talk about an exciting time.
Jeff: It was harrowing a bit. It’s got all the makings of a good anticlimactic movie out there too, for some people, but…
Meb: Great who would play you? That’s such a great question, we’ll all have to think about it.
Jeff: And so that’s what everybody says…
Meb: Ask your co-workers later.
Jeff: Yeah, I mean, usually when you ask co-workers it’s not as flattering as you think of yourself, too. Some people say I look a little bit like Adrian Brody or stuff like that.
Meb: Okay, Tom Cruise, all right.
Jeff: I think I’m a little taller than him, but we’ll see.
Meb: So, you all started DoubleLine and its quickly growing, was there a seed first couple of months amount of [inaudible 00:15:33] your own? Because you guys have grown too well, over a hundred billion now.
Jeff: So, we got into business, we became a registered advisor on…what was it, December 13th I think it was. It was a Monday, we had a backing by OakTree and by December 31, we had one client. We had one client of $1 billion.
Meb: That’s awesome.
Jeff: Yeah, it sounds great, except you look at each other and say, “There is 45 of us here.” We were talking…now that your friend is getting close to a billion, you have how many? Seven. So, think about revenue and things where people came…and remember this is December of 2009. And if you’re not familiar with the investment business out there, bonuses tend to be accrued throughout the year and they get paid around this time of the year, which means, no one had them. So, yes, a billion dollar sounds great, it’s one account across two strategies, so what do we do? And you start to talk to clients…
Meb: All in.
Jeff: You’ve… All in. And I remember the days as all hands meetings, where we got together, you get the email of all hands, you’re getting together, it’s like, “Are we going out of business or are we doing something good?” You never knew what it was going to be that day. And so…
Meb: Some days is, all hands, holding hands.
Jeff: There was a lot of kumbaya moments, there was… But I have to say the experience and the camaraderie that’s built through that experience is that…it’s something that, for co-workers I don’t think it can ever be replaced.
Meb: Yeah. I mean, and when we talked about this before about being a…just surviving in the investment management business is a pretty big compliment. You see so many firms that get huge and then also just slowly or very quickly implode for various reasons. So, being able to grow it is a pretty big compliment. So, you guys over a decade took up to 100 billion, so you’re probably sustainable now?
Jeff: Yeah. Some people still question the profitability at times but it’s kind of, hard when you, you know, it’s simple Math, you know, you take AUM times an average fee, I think we’re doing okay.
Meb: I just remember my first bonus was a…I think probably the only bonus I’ve ever received in my life, was a gift card at Cabelas. I get a fly fishing rod. It was worth it. I still use it
Jeff: You’re probably [inaudible 00:17:36] stocked on that.
Meb: I just took it over to Iceland, it didn’t work that much there.
Jeff: I read too, because you said you saw the northern lights there [crosstalk 00:17:44] and I read too that this is gonna be one of the last years that they’re gonna go stagnant for a while. I just saw some…
Meb: That’s kind of sad.
Jeff: It is now, I’m depressed because we just went to Iceland and saw this, I’m like… Yeah, I guess there is a trip to Alaska, something in the near future.
Meb: I saw it first night there my brother and I were in a pub and we came out and I saw it, and I was just screaming like a little kid, I was just so happy, and my brother is like, “That’s not a Northern light, that’s a jet.” I’m like, “Are you kidding me right now?” How much “benovane” or what do they, call the black plague, they have Black Death. It’s schnapps they have there that’s… I wouldn’t recommend it.
Anyway, back on topic. All right, so y’all started DoubleLine, and most people know you all as a fixed-income shop. We’re going to get into a couple of topics here, but you’ve, kind of, had your hands in a number of areas as deputy CIO. There is equities, there is commodities, I want to touch on both of you all. But what’s the general framework if you had the kind of distil DoubleLine, and tell someone this is… Because a lot of the people are like, “Hey, we’re a distressed debt shop,” or “we’re a value investment.” What’s the double line framework for how you guys see the world?
Jeff: I try to describe us as, we’re two-form. I consider us Markets people. So, if we find an interesting idea in markets, and we’ll get ourselves up to speed, or we’ll find the people we need to surround ourselves with to do that. But, I also think about our investments philosophy, we’re very micro-economically oriented. And so our viewpoint is that if you can get the broad strokes right, and you can, kind of, get the sentiment of what’s going on the macro landscape, that leads well into fixed income. So, obviously growing up in those areas of fixed income, macro is very important.
But that said, they can be applied to other parts, the difference is, I think there is horizon differences. And so, I mentioned this before that for instance, the bond market is more contemporaneous. If you wanna know what’s going on in the world micro-economically, the bond market, the bond market tells you from yields spreads, the various types of products out there, you can glean what’s going on. The stock market has a different horizon, right? And so, it’s said, this inner temporal differences between how markets view each other, and so try and use macro to allocate to equities is gonna be a little bit lot different because the time frame, in fact, you think about the depths of the crisis when the data is so poor, that’s when the data starts to take off again. Right? After you’ve had these corrections. And so you have to change your thinking from a macro standpoint to change that time frame that you’re thinking about things. So, my experience has been… When I started at TSW, I worked in a risk group or analytical group that calculated a lot of things for the various portfolio managers. I had exposure to the equity markets, I had exposure to the commodity markets, FX markets.
I had that training ground, or at least it was self-imposed training that got exposure there. And, you know, the critical thing to this business is you have to read. You have to push yourself, and so we are always looking for interesting ideas. Having a quantitative background, I mean, I like factor investing, I like looking at things from a non-fundamental standpoint. And so, if I have to define DoubleLine what I’d say is, you know, we’re markets people, we’re macro focused, but we’re still entrepreneurial enough that if we see a good idea that think it has merit, we’re gonna invest in that part of the business.
Meb: Quick comment then we’ll keep going. I remember listening to…there is a bunch of students that asked one of Buffett’s lieutenants, I can’t remember which one, but it said, “Can you give advice to these young students, to us, As young investors, how do we get to be in your shoes one day?” And you said, “Read 500 pages a day.” That’s maybe a lot.
Jeff: That’s overwhelming I’d say, you know. But again, I remember that too when I started. And my history of becoming a Math major is that it was, you know, something that was a little more natural. We have those proclivities because of things. Things are a little easier. But I remember, you know, that first semester having this literature class and having to read like a thousand pages over the semester and I’m like, “Men, I can read three pages of Math a night,” or “I can read a hundred pages of these books, I’m becoming a Math major.” So, I remember when I first started working though, and this is, you know, finally emails catching on and I was like, “There is so much to read every day.” And so I think I did myself a little of a disservice by neglecting that but obviously, I’ve caught up over the years.
Meb: Curation is a big theme there. I mean it’s the same thing as perfect practice or practice. Are you just reading for the sake of reading, or you’re actually reading thoughtfully, stuff that’s useful? We struggle a lot with curation, the needle in the haystack sort of ideas. Don’t have to get answers, but anyway…all right, let’s go back. What’s the general sense of what…how does the world look right now to you? If you guys had the kind of, described the macro, sort of, landscape. What’s kind of the picture? How thing s look out the window downtown?
Jeff: I mean, when you look at, for instance, the OECD part of the world, I mean, everything is growing right now. So, there is no really challenging spots there when it comes to growth. Now, is growth the magnitude it’s been historically? No, it’s suppressed. And the question is why we believe that’s a lot of data out there, right? When you [inaudible 00:22:42] yourself out of debt, you’ve pulled forward consumption, so that’s not very profound there. However, that said, inflations seems to be a global phenomenon. It doesn’t seem to be localized in markets. You know, you have the Venezuela situation, you always gonna have this hyperinflation environment somewhere that’s just bad government. But when you look around the world, and in spite of some price, a lot of it has to be commodity-related when you calculate a lot of this consumption baskets, but, what you find is that you have a world that’s growing, all be it, at a slower pace than historical standards, you have inflation relatively contained. So, it’s actually a very positive environment for investing. Now, this presents the challenge of valuation. Right?
Because it has been a very positive environment, the last couple of years have been this way since we had depths of the credit problems in late ’15, and so what you find is that, looking forward in the world it looks relatively okay right now but the price of the assets already reflect that and beyond. And so it’s a phrase that we use a lot of naïve extrapolation. People use what’s happened most recently and think that will go on forever. And so even though there are these bright spots, the U.S. economy is doing just fine, ahead of releasing the GDP today. It says, you know, we are still in a year of year basis like 2.2, on a real base it’s 3.8 normally. And what does that mean? It means we are growing. Not growing like what we want to be, but you don’t see the fault problems. Yeah, there is a few in the energy sector, there is some portending ideas on the retail side but you know that, right? So it’s not exogenous shock, so the complacency, and lack of the volatility you’ve all see in the market, it’s all reflective, essentially of the economic data being somehow complacent as well. However, we all know that that will go awry at some point in time.
Meb: There is a great quote and I forget who says it but it’s like, when you say, “But.” Everything before the, but, is bullshit. So, everything you just said, let’s…now we’re gonna hear where you said, however…
Jeff: However, he said so…we can go that side, and so the thing is however, things are expensive, let’s not kid ourselves whether that’s, you know, equity evaluation in the U.S., whether that’s, you know, high yield bonds here in the U.S., loans are becoming more so, investment and great credit seems one of the most ridiculously, priced segments of the bond market. We just had a bond market sale off in rates, we’ve had a 25 basis point in backup, and rates and credit is outperforming massively still in this little short window. So, what you have is a market that people are buying the debt too. Right? It just by the debt mentality, it’s been out there for a while and so the thing is, do you play in it or do you just shake your head? And what we found is that, you know, for the last year or so, we think prices in the bond market, a lot of them have gotten ridiculous at times you may have heard my boss go out there and say, “You sell everything in a market.” Which I had to calm investors. He doesn’t mean sell everything really, but if you ask me [inaudible 00:25:21] I might sell everything, it means, you know, take a little less risk.
And so we’ve been doing that and it’s not been a popular thing to do but if you look at some of the performances of our strategies and like, we’ve hang in there, we’ve done with a lot less risk. And no one cares about risks, you have lower vol in a low vol environment, but that’s exactly what we care about. And we think the problems arise perhaps, you know, say here is this couching segment, but policy mistakes from the fed. I mean, Miss Yellen coming out there and just essentially saying that she doesn’t know what’s going on in the economy, does the labour work? The speech she gave this week was kind of, strange but she did tell you she’s raising rates and it’s her last hurrah, and she’s gonna go out as a champion. she’s gonna hit the targets, the dot plots, she’ll get her three rate hikes this year, she’ll start to unwind the balance sheet and she can say, “See ya.” I mean, who wouldn’t want to go on top? And guess what? The poor person that has to take that next step.
Meb: So that’s a good transition. By the way, we described the current environment as the Jay Cutlerble [SP] market. Which is the…
Jeff: I love that. I heard that, I listened in the car today, I was dying laughing.
Meb: Complacent, kind of melancholy, he doesn’t really care. Although… and it’s probably a bad example because he’s not a great performer.
Jeff: But he’s not so [inaudible 00:26:36], you know. Like he is just moving the ball down the field a little bit, but, no, I think that’s a perfect analogy here. But, you know, it’s kind of old Misky stuff that stability breeds instability. And, at some point, there will be a hiccup here. And what we see the disconnect majorly in the macro world is, how can you have the European economy generally growing at the same rate as we are? So, let’s take Germany for example, essentially, normal GDPs are the same in both countries, the Germany economy and the US economy. They are continuing to do QE, right? They have a -40 basis points of [inaudible 00:27:08], so they’ve got negative [inaudible 00:27:09] policy. We’ve hiked four times. They’re continuing to buy bonds. We are talking about unwinding, not just stop buying, we are unwinding the by putting more supply in the market is a complete disconnect. And so, if the ECV ever starts to taper, I think that’s gonna be…it could be a catalyst for some of this, kind of, the bumpiness to appear.
But also I think the fed can be just as complacent here. They’re gonna raise their rates, we already have this pre-described schedule of…it’s not really unwind the balance sheets, we’ve invested in less of the securities that are maturity…they have a huge maturity wall next year so it’s very convenient that this has happened. I mean, they’re academies, they’re pretty smart they know what’s happen in their maturity schedule. But what you see there is you have tightening from that process, if we continue to have hubris of tightening interest rates, I call it hubris because we don’t know what the impact of the balance sheet reduction or the lack of reinvestment will look like. We’ve only done it once in history and there is a big depression in the middle of it. Are they correlated? Who knows? The sample size is one.
But, I’m concerned that they’re gonna have this low level, or this bondry purchase that it’s like 10 billion a month then it 20 and they’re gonna have consequences because it has no leach in the economy yet. And so, then they raise rates and then we have this, kind of, double tightening and at the same backdrop, you’ve had other banks around the world tightening, like Bank of Canada, Bank of England is even now talking about talking hiking again or perhaps maybe reducing some of their purchases. And you just don’t have this liquidity transfer that we did when they fed… The fed worked out perfectly, the fed, as soon as they stopped, they started tapering and then went into the idea of raising rates, the ECV pick up the flack, right? They ratcheted their programming so when you look at the amount of liquidity provided in the market, that’s why the feds was able to escape the way they were. So our concern is that, this isn’t a concern for three months from now, it’s a concern that’s probably 9 months, 12 months,15 months away as this stuff builds up because liquidity is what runs the world.
And pulling these bonds out at the margin, it’s a supply issue, there is gonna be more supply, means it has to put pressure on rates and so ultimately, how does that play out for all this asset? Again, I don’t think it’s a carnage, but the fed just tells us they’re gonna be able to…they’re gonna observe it in the mark and they can back down. Come on? That’s certainly hubris.
Meb: And I think most listeners listening to this, will hear one thing in particular, and you talked about this in a recent paper, so we’ll expand on a little bit. Which is, interest rates coming up, it means bonds going down. You guys have talked about this a lot before but you also talked about…
Jeff: If you read The Wall Street Journal they’ll tell you that too, right?
Meb: Yeah, everywhere.
Jeff: I don’t know if anyone reads that anymore.
Meb: I think it has to be like, you know, they have the disclaimers on, you know, making sure people understand it. But, as you guys have talked about it before, that’s not necessarily the case. And so maybe talk a little bit about the Sherman ratio, the Shermanator ratio, and what that is, and maybe, you know, how you’re not guaranteed to get [inaudible 00:29:58] in the rising rate environment if you are investing in bonds. What are some of the options there?
Jeff: The worst thing is as a bond investor is not rising rates. It’s rising rates in, like a veracious, very quick manner. So a spike in interest rates overnight, or a spike over the course of a month let’s say. I think Taper Tantrum where the most investors were caught offside during the Taper Tantrum. It came out of nowhere, right? Bernanke just all of a sudden announces while in the middle of buying that perhaps we’re gonna start doing this, and the market responded very, very rapidly. But, when you talk about investing in fixed income, the key thing is knowing your interest rate risk. And so it’s a thing called duration. So, we’ll act like the Wall Street Journal explained it all, but the durations or whatever you’re explaining your interest rates sensitivity of your investment. And so what you can have is you can look like the bond market which some people call the Barclays Aggregate that has a duration of six today. That means is that if interest rates go up 1% over the course of next year, you will lose 6% just due to price depreciation. That’s the math.
The nice thing about it is they’re just then called yield. You get to add that back in the equation and, you know, the good thing about it is if you can have the yield and the duration’s kind of matching, that’s what we call a kind of Sherman ratio, is that you give yourself a chance. And so if you take the yield in your portfolio, and this is not a perfect science here, there’s a lot of nuance here, but if you take the yield and you divide it by your duration. What that does so let’s just say you got a yield of three in a duration of six. You know it’s not what the Barclays Aggregate is, but let’s just call it that. You have 0.5. What that means is 50 basis points go…the rates go up 50 basis points over the course of next year, your yield will completely offset your duration. That is 0.5 times the six duration, you lose 3%, you have 3% yield that net. Net, zero. I guess it’s just nut, there’s no two nets. But let’s just say instead.
Meb: Net, net, net.
Jeff: Yes, net, net, net… Well, now we’re talking about leases, those are triple nets. But what you see it’s like… let’s just say instead you had to deal to five and a duration of six. Now, it’s at 50 basis point move you lose 3% still from the move, but you have 5% yield to do that. So, inherently, that ratio tells you how much rates can go up over the course of next year, can all things be unequal in order to essentially offset your yield? So when these ratios are extremely low like they are in the Barclays US Aggregate, what you are doing is you are importing more interest rate sensitivity in the portfolio even though the duration is still the same because the yield is not there.
So what happens to, and people, kind of, just say they act so viscerally to this it’s like rates go up, bonds go down. Well, what if interest rates go up 100 basis points on a perfect, linear scale? So let’s call it what, eight in a third basis points a month. Well, guess what? If I have multiple bonds and they are cash flowing, that means I reinvest along the way.
Meb: And higher rates too.
Jeff: Right, and they are up higher rates, higher yields. And so this is the dirty secret of bond investing is that the more income you can throw off, and reinvest in a rising rate environment is positive to portfolio and it increases and empower the portfolio. And so people, I think last year Jeffrey, got like since then like well, if rates go to 6%, we’ll do much…we’ll get the same rate returns if they stayed here forever. And people are like, “What are you talking about? You’re going to lose all your money.” Well, if it goes in a measured way, and you reinvest on [inaudible 00:33:13] you’re gonna be better off. And so people miss that. And that’s the whole thing is that you got to manage these things, and that’s why we think active managing and fixed income works, I think it works in all sectors of the market by the way, but, and more importantly is its controlling these risks, and so, again why these… I’ll give you the fallacy of the ratio too. Is that duration is just looking at, kind of, interest rate duration, there’s spread duration, there’s default risk if you’re buying corporate bonds, so you need to adjust your duration numbers for those things. But, you know, intuitively, it has a very good appeal.
Meb: You know, so I mean people always talk about bonds as if it’s like it’s just U.S. government bonds really is the main thing to think about, or the Barclay Agg, but I was looking at one of the historical allocation charts and it’s got U.S bonds but agency RMBS, Munis, Investments Great Credits, CMBS, ABS, CLO, Bank Loan, High Old credit, International Merging, everything in between.
Jeff: Right. But it’s what I call the CNBC effect. When interest rates go up in a meaningful way over a short period of time, what do they troll out? The 30-year treasury bond, right? So the Loan Bond comes out because it has the most duration, the most interest rates sensitivity of that. They don’t show you what the one year did, or the two year did, and they don’t…
Meb: They’re sure bringing out the zeros that means more…even more exciting,
Jeff: Thirty-two zeros is what you should show, but, you know, that would be too simple because that has always had a duration of 30 by definition there, but what about the negative yielding bonds, Meb? They don’t teach you that in the Fabozzi handbook. Either these 10-year Swiss bonds their negative yields, the duration is longer than 10. That will blow people’s mind up there.
Meb: I think that blew out people’s minds in general over the past decade, I mean, just seeing those negative yielding sovereigns. You would probably ask people 10 years ago if that was impossible, I think most would say, no.
Jeff: And there was actually, I don’t know if most people know this, but Nestle was the only corporation actually, issue a negative coupon on a bond too. So they actually got to get paid to borrow money.
Meb: So you guys bought the whole issue?
Jeff: Well, no. But we did, we put out a blanket request that if anybody wants negative yields and they want to buy negative yielding bonds, at DoubleLine, we are proud to write you a negative yielding bond all day long, in an infinite amount of size because guess what? The more money we borrow, the better our credit rating because we have more and more assets and we just got a revenue stream behind it. So, again, we went the other way and just said, “Hey, we’d like to tap the markets, who’s there?” And I mean, the underwriters got excited but no one showed up for the offerings.
Meb: Weird times we live in.
Jeff: You mentioned these other sectors of the market and that’s, you know, is part of this piece we put out earlier in the year. And we did it because everybody is worried about interest rates with the new administration, inflation pressures building up, they said, “Look. The thing is, let’s go back to the bond and let’s show how certain things can behave, different parts to the curve and different pieces of the market.” So, you know, we’ve been talking about this recently, but if you take the bottom end markets in February, of I think its 11th or 16th, it’s kind of the bottom, and you take the performance of sectors of the bond market.
So, if you just look at the treasury market as a whole, it’s had essentially a flat return, okay? So you have this flat return, so bonds stunk. Well, if you bought investments great credit, it has a double-digit return, and high yield bonds have a high teens return, and EMD had a 25% return. And if you did this in actually in active merit it had 40% and 50% returns. And so the difference is, is that knowing how to use the pieces of the market. And the beautiful thing about being asked so, like, you’re in a fixed income, we actually do get correlation benefits. Credits and rates tend to be negatively correlated. They’re not gonna always be prefect in the short room. We know that, we know that the covariance matrixes aren’t stable. However, what’s very important about it is that we know these things give us natural offsets, so we can balance risks between these two things. And again, any savvy investment, kind of a systematic process of doing it, but when you mentioned the [inaudible 00:36:56] of those sectors in the markets it’s because I can find specific risk factors from these pieces of the market, and they blend together quite well, and they play nicely together.
Meb: Let’s shift a little bit but kind of similar where you’re talking about pairing two kinds of ideas into one concept. You guys have a fund? I mean, we’ll talking about the strategy, but it’s funds done great, raise over 4 billion where you combine U.S. sector valuations and equities through, I’m a partnership with one of my favourite people in the planet, Professor Schiller, and…
Jeff: He’s awesome by the way.
Meb: He’s the best, and loved the interview with him. First episode. He’s such a humble, just genuine person for…anyway.
Jeff: It was just great to get into his mind, the psyche, right? Listen to how he’s thinking and…He’s a really amazing person.
Meb: We’ll post show notes too and link to it. But, you know, basically, you all came up with the concept where you were pairing this equity strategy with fixed income components. Will, tell us a little bit about the thinking on, kind of, how that’s designed for the strategy and what the, kind of, benefits are, and just let you roll with that.
Jeff: Yeah. So, we were approached by some folks at Barclays with Professor Schiller about looking at an index. And, again, that’s why I always talk about being entrepreneurial and just open to ideas yeah, we’ll listen, we have a macro firm, we can trade this stuff. And so we obviously, took to being more because of, to me, Professor Schiller, of course. But that being said we saw the idea and it seem somewhat interesting. So, did a little analytical work, did a lot of factor analysis on it. And realized that it didn’t have these traditional value factors, and so…I’m actually going somewhere with this. So what we did is said, “Oh, my gosh, this is something interesting that it looks to help…” It’s a different value exposure because sector rotation, it does use evaluation matrix but it doesn’t load up on your traditional [inaudible 00:38:39] frames the way you think it should.
Meb: Which surprised me a little bit.
Jeff: Yeah, and it did me too. I hadn’t actually…I had to tell the story about the analysis, so I did. I was like, “Did you subtract cash? Did you [inaudible 00:38:48]? You obviously did a wrong issue…are your dates lined up? What kind of period DC you used?” And we did it again, we get the same results, so then I’m like, “Okay, now it’s time for the rolling windows, right? Okay, show me…” And what we find is its time-varying. So the exposure is time-varying which intuitively has an appeal. I like value, I’m with you, and value, trend, momentum, I like…
Meb: Explain, real quick, how the strategy works for listeners.
Jeff: Oh, yeah. So, I was gonna get there, yes. Anyway, we had this index. So the ideas that we’re gonna access these all through a swop. And so the reason for doing that is that we don’t wanna do trading, I don’t wanna have to sit there and replicate trading, it’s an ease of transition, but it also does one thing, we do the swops unfunded, meaning that what I get to do is I get all the capital. So, investors bring me $100, I can do something with that $100 instead of just replicating the strategy. And so the question is, what do you do with $100? I already…If it’s $100 I get exposure to the equity market through the swop, but also want the $100 to be free to do what I wanna do. I can put it in Tee bills, then I get the total rate on the index less execution, or we could use our expertise in fixed income to try to enhance the return, hence it’s the name of the strategy.
And so what happens is that we can build a bond portfolio that tries to outperform Libor because that’s what to pay to get my equity exposure, but I get that return, and I get return on the equity market. So it’s not a balance strategy, what it is, is that $100 comes in, and we put it in this, kind of, short interest rates sensitivity, not short by being short in the market, but low-interest rates sensitivity, kind of a higher credit quality stuff, sector rotation within the fixed income market, so try to get an incremental return, and that’s what we pay as a dividend, and simultaneously, for that $100 you get $100 in the sector rotation strategy based upon the Academic Researcher, Professor Schiller.
Meb: And somewhat back in the day, they may have called this a Portable Offer Strategy? PIMCO used to do something, kind of, like this.
Jeff: So portable offer got a black eye, right? Like every strategy that you do too much, or like CDOs got a really bad eye. CDOs are fine, by the way, it’s just when you have fraud underneath them it doesn’t work out too well. And also people should probably actually do a little bit of research of how the profiles look of them. That said, this used to be… This is what I call an overlay, right? So a lot of FX strategy or currency strategies do overlays on top of portfolios, you know, some other people have done this in their business. We did not create this structure. But being well studied and knowing about it, you can do that. So the portable alpha was like, “What we’re going to do is we’re going to take the strategy and port it on top of something else, and we’re going to get rid of all the risks in the marketplace.” And so I think it was sold as a panacea and the execution was poured on it, so a lot of people had bad experience, but it’s just a traditional overlay.
Meb: But you guys call the fixed incomes the Shint Portfolio, does that stand for Sherman is not [crosstalk 00:41:37]
Jeff: No, that’s good. And for those at home at Shint, it has an N and a T, for everybody listening, it’s short to intermediate duration. I am not that clever to come up with anything in that regard and I don’t want people listening out to try to fill out acronym either.
Jeff: Shint would sound like something people would…would actually be a word people use in the South. It sounds like something like one of our friends in Winston, North Carolina would say. “Shint gonna do this,” I don’t know.
Jeff: Shint gonna do this?
Meb: Yeah, there you go, perfect. You get some Florida in you. All right, but back to the equity side. So Schiller wrote a paper on sector rotation, we’ll post the link in the show notes. And you can replicate this with French pharma [SP], but talk to me a little bit about the mechanics of how the equity side works, and I have a few comments to make on it because I loved this paper.
Jeff: Are you talking about the one the Journal Portfolio Manager?
Meb: The name of it, I can tell you the name of it, but he basically looked at sectors back to like 1880 or something.
Jeff: So that is the premise for this strategy.
Meb: But it’s “Changing Times, Changing Values: A Historical Analysis of Sectors within the US Stock Market 1872-2013” and we’ll post a show note link. It’s great.
Jeff: Yeah. And so the idea here is that people historically have used the Cap Ratio to assess markets, so the broad U.S. market, you can call it SMP, you can call it the [inaudible 00:42:48] Database, whatever you wanna call it and applying the evaluation there. And I always kid and give the academics a hard time but say, if you asked an academic if something is cheap or rich, they compare it to history. And that’s kind of what you’re taught your first week in an investing class. And so the concept was wide, you can only apply this to smaller subsets of the market, hence, the sectors of let’s call it Large Cap U.S. Equity. So, the idea was that you can calculate all these ratios and find out what are the cheap and rich sectors. But there is a caviar to that and the issue is, is that you don’t just for how people treat certain sectors of the market so think…and if you see the two extreme like utilities which are low bidder, high dividend, low vol, traded lower multiples and something like let’s say tech. The sexy, new, growthy, levered economy type play and we can argue of tech is really that anymore, I don’t know if it’s different.
But the idea is that why not take each sectors cap ratio and to calculate the same like 10 years of inflation just [inaudible 00:43:47]. So it’s just evaluation metric, longer term, and compare each sector’s ratio to its own history. And by doing that now you somewhat normalize then because of say, okay, well, I like to describe as that where do the sectors multiple trade relative history? It’s kind of hard to think about it. And “Why don’t we try to buy the cheaper parts of the market?” And so the idea was to take the 10 sectors as defined, cut the universe in a half, you rank them on these relative ratios, right? So you’re left for five sectors, and do one slight adjustment, knowing that historically using evaluation, you can get the value trap, we all know it, I think we’ve all had one of those experiences in our own PAs, how we keep buying as it goes down, right? But to avoid that, what you do is you apply momentum to the academic way of thinking about value or lack of breath, I should say. And by…what you do is those five sectors are the cheapest whichever has the worst one-year total return. So, again, rooted in [inaudible 00:44:40] and Tippmann, and throw that one away. You got four left you’re with…those are the four sectors you wanna buy.
Meb: Can you tell us a little bit how you guys positioned now?
Jeff: Yeah. Well, the four sectors of the market today are technology, which again befuddled some people because of the fangs and their performances are late. But remember not all those fangs sit in the technology sector. We have consumer discretionary, consumer staples, so a little more defensive size, historically, a defensive sector and healthcare. So it is kind of balanced when you think about growth in, kind of, defensive sectors at least on a historical basis that’s what the valuations tell you [crosstalk 00:45:17]
Meb: And then you mentioned energy as something where it’s, you know, one would think it’s cheap relative to history, but…
Jeff: Yeah, it is, but that’s where this momentum filter kicks in to try to help avoid value traps. And so energy is the fit of one of those five chippers but it has been kicked out because of the lack of breath, or the worst performing sector of those five. However, after this month’s performance, I think… read something about like 17 of 19 last trading days, energy has been up. It may actually, follow the evaluation side equation. So, even though the momentum is back in it because evaluation is paramount in the strategy, you may not see it in there in the next month.
Meb: It will be fun to see a rebound because I love to see what the computer kicks out because, you know, we do a country related one. And personally, I was cheering for China last spring and China got kicked out, you know, in favour of, I can’t remember who it was, Turkey or someone else, Singapore. But, anyway, we all have our favourites and…
Jeff: But it’s fun too because you have your favourites but then like, the other thing, is you kind of root against the things you don’t know and sometimes too. And like, you know, the high flying sectors like the most overvalued is actually the financial sector. And a lot of people say, “How can that be?” Well if you look at the price action since the election, I mean, you’re up like 35% or so. And so what’s happened is earnings haven’t followed through on the deregulation trade and the like. So, it’s a little bit of the market, kind of, front-running those things and so the valuation is quite high.
And the other one that, you know, I’ve always looked at is the utility sector, and [inaudible 00:46:43] are all… The real estate sectors also one that’s extremely overvalued, and that makes complete sense to a blond guy. Right? These are the yield proxies where people have been going to get yield in marketplace, and so they’ve been a little bit agnostic to the valuation. I’d say utilities also with the low vol phenomenon we saw a couple years ago. People piling into these ETFs the mutual funds that try to extract the low vol premium a lot of that was healthcare related. So, it’s really cool to like apply the quartz stuff outside of what you know. You have your methodology and then all of a sudden you start to apply this to the market and it has some intuitive appeal but, there’s time for where I’m “I’m ready to get…” “Don’t get into the portfolio right now.”
Meb: A good example is trend following too. We used to run these trend following strategies and people would email me all the time. So it might have been ’07 when real estate started to roll over. And so that quantitative strategy would exit from REITs and people would say, “Well, is it actually…” And so we used the 10-month symbol moving average. They say, “Well, does it have to close like 1% under or are they start trying to massage the rules to get the answer that they were looking for? You know, and so like that’s the entire point of having codified rules is that it tells you black or white, yes or no. And so your interpretation but that people struggle philosophically with Trend Following but they also struggle with a lot, like we talked earlier, about the Formula Investing where people struggle with value picking too.
Jeff: Well, two things in that. One is that I had someone on a webcast ask back in September of ’14. And yes I do remember this to the webcast because they wrote an answer like, “Well, you’ve been in energy all year you just kicked it out because of momentum. You know, I mean, [inaudible 00:48:14] did you sell at the bottom?” And so I said, “Well, I don’t know. I don’t know. You know, we’re doing the best.” It was one of those… I kind of kept the email and I wrote back and I said, “Nope. Nope, I didn’t.” But, you know, try not to heckle people of course, but you talk about the rules. And so as a quartz too when you start to look at some of these things, and you just…if you just say, simply look at monthly data, right? And you’re gonna do this process on a monthly data or a certain periodicity, then you start to watch to intra that period. You calculate the signals and everything. You just [inaudible 00:48:43] the noise in the signals. Right? And that’s the other thing that can be a little disconcerting for younger [inaudible 00:48:48], it’s like, “Oh, if I hadn’t done it yesterday and I got this different result and…” And so it’s believing in robust. I always love when you’re testing strategies like, “What if we did in the middle of the month, or do the first week and see how those results differ?” And so, again, those are one of my, kind of, pet peeves on robustness in making sure it’s not just simply that periodicity.
Meb: Well, that’s one of the beauties of using the 10-year price earnings ratio is that yes, it is a better valuation metric than one year trailing, but it also reduces the turnover. And so you have a much smoother lower turnover strategy in, you know, Research [inaudible 00:49:18] has on a lot of work on this is the other. So it applies to stocks applies to sectors, applies to country and you end up with, kind of, a smoother less noisy signal.
Jeff: Right. And that’s what you’re looking for. It’s a signal…signal noise ratio, right? You wanna try to amplify as much as much as you can. But also, what a lot of people don’t realize with using this cap ratio, is that, you know, the turnover is there still. And so what I like to… Draws the parallel to the bond market like there’s no bad bond just bad prices, is all the trading saying. But the thing here is that even though you’re using this ratio, the, P, matters. It’s not just that… Thing about it, 120 months you look, next month you have 119 overlapping months. So the earnings don’t change drastically that period, but the P, moves a lot. And so we noticed too is that it is better to apply this process more frequently. Again, you got to give it some time. That’s the balance, this is, like how long do you let it run versus starting to reconstituting things? Because you need some dispersion so you don’t wanna rebalance every day I’d say the costliness of it but you got to give tanks time to run and have dispersion.
Meb: There’s a great quote from Ralph Acampora, old-school technician. One of the finest minds out there he has been around forever. But, he has a quote, he’s like, “I love talking to these pure fundamental people that are very dismissive of technicals or…” And he’s like, “I always ask them, what’s your favourite indicator?” And they’ll say, “Price Earnings Ratio.” And he says, “What’s the numerator?” You know it’s a technical input. And, by the way, it’s the one that usually moves, it’s usually not that E, that’s jumping around. So anyway…
Jeff: And the P is the noisy part of process. And even to that point, you know, when you’re talking about these things people say, “Well, I’m a fundamentalist, I’m a technician.” Why can’t you be all? Right?
Meb: Well, this was actually a Twitter question. So, I’m gonna interrupt you but then let you expand on it. Where one of the tweep said, “How much do you guys go on lock and others… DoubleLine talk a fair amount about technicals, and speeches, and tweets, and stuff? How much is that actually used in the process?” And so momentum is a good example. But is it a small input, is it dependent on the fund and concept? What the…
Jeff: It’s a way of thinking. And so, you have an idea, you have a macro idea, when do you do the trade? Right? And so I think of it more the technicals as trade implementation. We have an idea, we have something we wanna do, how does the chart look? And then what’s the set up there? And so, the setup is more important for that execution in the marketplace. So it’s done on that level. The things that are hard to value fundamentally so let’s talk about FX, commodities, things like that. Where you don’t just, I mean, at Fairfax, you kind, of have the interest rate differential models, but what’s the true value of these two things? And so, I like technicals in quant more in the things that are harder to value fundamentally. But, I think they all have an important piece of the puzzle. And so fundamentals are extremely important, you know, that’s the root of investing and I believe, you know, I’m kind of, value guy as well.
The technicals are important and for a location, but the one thing you can never dismiss is sentiment. And so regardless of how you felt about the election, the impacts of this new presidency, you had to respect the momentum in the market and the sentiment, and how the market’s behaving irrespective of fundamentals. It kind of leads into technicals too. But the one thing is, is that the forces of the behavioural side can be much more powerful than the other two. So, I’m gonna take the corporate answer and say they’re all involved, but you get into kind of how I’m thinking about.
Meb: And so this is actually a really good example, and you think back about how many people’s mental processes muck up their investment success. I cannot tell you how many e-mails, comments, tweets I received in the six months leading up to the election. I’m gonna wait till the election and see, and invest when things are more certain. You know, and then everyone got surprised by the election and say, “Well, you are feeling more certain now?” Right? But if you were to tell someone…
Jeff: I certainly feel more uncertain, yes.
Meb: That’s a great quote.
Jeff: You can take it.
Meb: I will. I tweeted this the other day because if you had told someone this the day after the election, or anytime in the following six months said, “Stocks have closed up 11 months in a row. Only three times in history has it been a longer streak.” 1936 is 12 months, 1950 is 12 months, 1959 there is 15 months. And not only that, we have the lowest SMP drawdown for a year ever, and we still got a couple months to go.
Jeff: The lack of the 30% move, right?
Meb: Echoes in 1987. But one of the least volatile, consistent markets ever in any way, it’s just…it goes to show so many people’s emotions and sentiment being a great example, just works against them.
Jeff: I would also almost argue that the reason, or one of the reasons that you’ve probably seen that, is markets don’t like change, markets like status quo. And regardless of how you perceive President Trump, he is actually delivered status quo. Nothing gets done in Congress. It’s exactly the way it’s been for many, many years or many administrations even. The last time we got cooperation I think was in one of the Bush administration. And it wasn’t that lap or long. So, it’s so funny that people say they don’t understand President Trump, they can’t get a read on him, but what he’s actually done is just actually deliver the status quo. Yes, there’s this idea of reform and things, we have to see what can come of that. Again, if you’ve been ineffective for nine months or eight months, you know, how effective are you gonna be going forward? I don’t know. But, guess what, you can’t rule the guy out. I mean, and that’s the thing about it, and, you know, I think that’s part of why you’ve seen some of this kind of lack of volatility things because we know we’re gonna get nothing. Right?
Meb: Yeah. There’s an academic study I wanna do, we’ll have to partner up on some time when find some good professors to run with it. Which is go back to 1900, pick the top, I don’t know, 20 or 50 geopolitical events that are on the front page of The Journal or New York Times or whatever, and say, “All right, I’m gonna give you tomorrow’s news today, and you tell me what stocks did the next week, month, year.” And then you know how this probably the results would be. It will be people will have no ability to predict whatsoever of course, but it’s just kind of fascinating people like, all the question…
Jeff: [crosstalk 00:55:10] gonna improve their results.
Meb: Yeah. I mean all the questions [crosstalk 00:55:12] you get about markets are always geopolitical and stuff that really has no effect.
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Meb: All right, I wanna shift one more thing while I have you here before we got to let you go. Which is a topic that is hard for a lot of people. And for the last decade, we’ve seen two pretty extreme views from the institutional world and flows, which has been, commodities. So mid-2000s every conference I went to, was, how do you invest in commodities? And then from the last three years was headlines news of every institution puking their commodity exposure. Why would we ever [inaudible 00:56:57]. Talk to me a little bit about how you think about commodities. I know you guys have a commodities fund you’re involved in, it’s an area that has been near and dear to my heart for many years particularly for someone who has a, probably, the least profitable wheat farm in the country. So, tell me a little bit how you all think about commodities.
Jeff: Well, one it’s an asset class that has been hated. And it’s hated because, again, people jumped in at the wrong time and I think a lot of money jumped in the institution [inaudible 00:57:21] came in and pushed a lot of prices around. But some people called it the financialization of commodity. But, ultimately, you know, commodities have their role in the portfolio obviously, the diversification. The question is, are they an asset class? You know, I always like this and you go back to definition of asset classes, there should be some correlation amongst its constituency. And to that, commodity is gonna feel that. But that actually makes those beneficial because you get…the idea is…
Meb: It’s more of a feature.
Jeff: That’s right. The wheat is not, you know, wheat crop even if is a bad crop that you are harvesting, you know, how correlate should that be to nickel production? Right? And so you pull these things together and you realize you get this nice diversification benefit from it. Now, there are structural issues with investing it they have term structures, right? You know, the idea that you can’t just buy…unless you’re gonna take delivery, you don’t buy a spot of oil or a spot copper, you get to buy invest in the futures market. And so that introduces a new wrinkle of complexity of what does the shape of the curve look like? So, commodities had their first up year in 2016 in like five. I like your idea of it’s been down four years in a row or five years in a row, it’s gonna come back. And my… I was stocked about it telling my team like, “Look, man, Commodity is finally back. What a good year.” Oh, it did exactly what the S&P did. Yeah.
So the index did and then hopefully, you know, I think we had a low performance. And so, the idea is that I think there’s merits to being long-only, there’s merits to having long-short, and there’s merits to CTAs, the momentum stuff it works well. So, when we built the strategy and a colleague of mine first started on it. Sam Lao and I, he’s my co-host on my podcast, we built a long-short strategy. And so we’ve been using this in our macro fund for, you know, going on six years now, about five years. And so, it’s just long-short. But, when we deliver a product, this is where you have a good business side that you talked about this before, right? You know, it’s running money versus the business of money. And I think that’s a great structure to have. I love the correlation, you’re building the portfolio, to me that’s the ultimate way to run it. But people want to buy commodity have the upside too. Right? So you’re long-short you may not be in the right area to participate and all of a sudden the geopolitical risk is we just talked about, you know, bombs dropping in Venezuela kind of production.
So why not try to have a better way of investing the long-only? You know, so trying to bring all these ideas together we’ve learned about TARP structures and how structural inefficiencies in certain parts of the market make that be your beta. Also, have your alpha or your long short component, and then that’s allocated between the two. And why not use some form of momentum which we know is the way that people do the long-only investing right? Whether it’s long in cash or long in long-short, and pull those things together. So, that’s what we’ve, kind of, launched as a strategy a couple years back. It’s been extremely successful of garnering no interest. But we could…we stay committed to the business, we think it’s a…
Meb: See, I like hearing. This makes me excited about…it’s everything lining up. It’s the same thing we’re talking about emerging markets too where we say, “Look, you know it’s hated, it’s cheap, it’s done poorly.” You see the signs of people closing their funds and getting rid of the allocations. Those are all positives.
Jeff: And that’s why we launched it in ’15. It was the…there was headwinds being there. And look, obviously, the timing is horrible usually launch at the peak of a market, or something negative can happen. But, I mean, it’s been mile long, it’s done well, it’s done exactly what it’s supposed to do. It’s behaving the vol structure, and at some point, people are gonna want it again. And that’s, you know, because you asked how you define DoubleLine it’s a perfect example. We’ve built something we think has merit. I don’t care if you’re wanting that right now, I’m not here to shove it down your throat. I want you know that this is the way we think about the markets, we have papers on why we think it behaves well, and when you’re ready, here’s the offering. You know, and guess what, when you want to sell it sell it too. You know, it’s a two-way market.
Meb: You know it’s just funny. One of the things I think a lot about, I mean, my buddy Steve Sugar who was on here, and we were, kind of, debating and he often talks about collectables. And I kind of think about some of the commodities in this way, you know, because if you ask the older investors and you talk about gold. You know, gold had a very different role on people’s minds for most of the 20th century than it does to young people today.
Jeff: Oh, yeah, completely. Because, I mean, at one point, it was the store of value. We call it the OG, commodity. Right? I mean, it has biblical street-cred of being around forever, right? So, you know, it was the OG cryptocurrency out there, right? That was the first one. But then it was also managed like, you know, the pegs of currencies around the world and everything to it, and the dynamics changed but, the collective aspect is quite interesting. But, most things that are truly collectable, if you put any size with enough capital, you’re gonna move the market. So, you think of fine wine, I’ve seen these classic car and funds and fine wines like, you are your own marginal bids. So as a dollar comes, you’re bidding your own market up, is a quintessential momentum, and then can you ever unload the other side? But, I think collectables are outside of financial because they have some sentimental value too.
Meb: And I was reading a fun story, cryptocurrency inspired, I’ve been brushing up on all the famous bubbles, and so I had…I bought one that I’d never heard of called something like, Famous Financial Fiascos or something like that. I’d never heard of it either. And I was reading through it and it’s talking about two [inaudible 01:02:24] and it had a funny story where it said there was a couple that showed up to buy an all-new Black Tulip that was just like the rage, and I forget the number, let’s call it a thousand thalers or whatever the cost was just unprecedented amount. They bought it, they merely took it, threw it on the ground and stomped on it. And like I said, “Oh, my God. What are you doing? That cost more than like 20 houses. You just…” And he says, “I own another one of this.” And he said. “Oh, the only other one existence now mine is twice more than twice it’s valuable.” But, thinking about, you know, it’s funny…
Jeff: Unfortunately you can’t do that with your clients.
Jeff: You can say, “Let me destroy this, I’m going to make to make it better.” You know.
Meb: But if you look and see something like gold, you know, if you go back into historical simulations, if you were to pick one asset that probably most people don’t have that does a really great job of improving the risk-adjusted returns of portfolio, gold…like evidence-based gold unlike particularly the ’70’s but the question is you know does the future look like the past? And I think part of the use case is not really American and young people, it’s, you know, India for example.
Jeff: Oh, yeah. I love that when people troll out the idea. “Well, India’s got a wedding season coming and they’re gonna buy gold.” And no one’s ever heard of the Indian wedding season before so you need to trade it. Or, you know, what I always talk about the supplies all the gold ever minable in the world still exist today, right? Because of the malleability and everything. And so, it brings me back to like, I read early on, in my career, the four assets portfolio and I got the trinity portfolio, I’m gonna go to four assets here and they said, “What you need to own is…” It’s just a dumb simple equally weighted allocation. Twenty five percent stocks, 25% bonds, 25% real estate, and 25% gold. And…
Meb: That’s, kind of, like the Permanent Portfolio.
Jeff: It really is. It’s very… and that’s where I believe where the Permanent Portfolio came from although I’m not gonna to try to say that anyone’s or anyone’s idea. But, the thing is, is that I think investors reject the correlation idea. This is why I think that they don’t want the long-short fund, they want the long-short fund when the market goes down. They want a long fund when it’s up and I’m like, “Why stop there? Why would you shut it when it’s down to be completely clairvoyant?”
That said, is that we know these problems of [inaudible 01:04:28] that’s why you have this prevalence of like mathematicians coming in the industry over the last few decades. And the idea is that, we sell people on this but people’s behaviour just overwhelms everything and it’s the fear of missing out the [inaudible 01:04:41] approach, right? And this is what really deviates, you know, people’s behaviour from what is the academic or the economists that says, “Assume rationality.” Right? Because, what’s rational to the economists, may not be rational to that person, you know. When someone comes to me and say, “I have $2,000 to invest…” It’s a friend of a friend or a friend of a family, “I’ve got $2,000 to invest. What can you do?” Am like, “Just buy this low duration fund. You need to do better than your money market.” “Will it give me 20% a year? You know, well, that’s what I need man.”
Meb: In 20 years, it will.
Jeff: Right. Well, that makes me high exactly. If we have a hyperinflation it will ultimately get to 20% a year. So, anyway, but the commodity thing, commodities deserve a role, there’s been a lot of evolution there, you know, there’s the, you know, I’ve heard you talk about the 1.0 commodity [inaudible 01:05:27] which was totally the front ran the 2.0s came along. And I think we’re in the process of the 3.0 type of revolution there. And what it is that, you know, there’s more ideas out there in the space and I think they’ve been neglected because it’s been a low [inaudible 01:05:41].
Meb: Yeah. And people get smarter over time too. But, I think of the asset classes. There’s always so many asset classes, you know, we had Mark Hughes going and he says, “People always buy what they wished they had bought. But commodities to me always have a place depending on how you want to do it whether it’s long-only or long-short we’ve always love them.” All right, we’re just, sort of, wind down because you’ve been here a long time and we’re gonna ask you a couple Twitter questions, they will be unfiltered so don’t blame me. But, one, and if you can’t answer them for some sort of compliance just say, pass.
Meb: All of them? Really?
Jeff: Oh, no. Let’s go, let’s get them.
Meb: You’ve already answered one. Fannie, Freddie preferred, yes or no?
Meb: Okay. That was easy.
Jeff: You didn’t say why, so that’s easy.
Meb: There was another one where did it go? All right, let’s see. This is…I’m gonna particularly hold you to this one. Who wins long over the next three months? U.S. dollar or 10-year U.S. Treasury? Gun to your head.
Jeff: Well, those two trades have been extremely correlated this year, that is yields to dollar. And so if I only got three months, that’s a tough one. I think I’d rather own the 10-year. I think the dollar rallies a little bit like we’ve been calling on a technical basis, but there’s just so many structural reasons as these [inaudible 01:06:59] on the dollar should decline. So, I’m gonna go with the 10-year even though I think they’re both not very attractive today.
Meb: So, listeners, you can see the video version of this but Sherman just flipped a coin. So he said heads.
Jeff: I flipped a Bitcoin.
Meb: He flipped a Bitcoin. Men, the next hour we’re gonna have to get you back on next time. We haven’t even delved into the crypto world. I just saw that Novogratz was planning on launching a $500 million Bitcoin fund.
Jeff: I saw that. With like a hundred of his own…
Meb: A hundred of his own man.
Jeff: And a 350 rise. I mean that’s, I mean, why don’t you just put the 150 in?
Meb: There was a tweet that someone said, “You know, we track crypto currency hedge fund launches and there’s 60. The average age of the portfolio manager is 26.”
Jeff: I mean, I actually I would be worried if it was a 57-year old, you know. I think if you’re gonna have an edge, you’re got to be young. And this comes back to, you know, when you talk about bubbles and phenomenon of sentiment is that a couple weeks ago, I was at a restaurant it was actually the opening night of football, Thursday night football so I decided to sit in a bar and watch the game, and five guys came in and one guy’s wearing Ico shirt sure like he did an initial coin offering, they talked about it. So, whatever these people that… So, what happens is the bartender is talking about…
Meb: And the guy was Floyd Mayweather?
Jeff: It was not Floyd Mayweather, it wasn’t Paris Hilton and it wasn’t any of these celebs that we’re seeing there. But, the thing is, the bartender was quoting prices at these different cryptos. And then the other guy can like another like waiter they were, like, it was crypto mania.
Meb: Could you ask if you can pay for anything in the cryptos, could you?
Jeff: I don’t I don’t believe so, Meb. I just use the traditional credit card there. But that being said, you know, it does remind me of the taxi drivers New York City owning five and six houses back in ’05 and ’06 just the mania around it. But the fact that he is wearing a one Ico shirt, and he’s gonna give a discount to get in it, it seems a little mania but who am I to judge?
Meb: It seems a lot of mania. Okay, a couple more quick hits and then we’ll let you go. You know, we talked a little bit about individual investors and this could apply to institutions as well, so take your pick. But, what are the biggest mistakes you see them making, kind of, consistently and is there a good, kind of, prescription for that?
Jeff: That’s a really tough one and that could be its own show itself. Because I think, what it is, is it’s the fear of missing out at times. It’s a lot of the buzz around things, and by the time that hits, it’s usually close to peak valuation. You know there’s a lot of the, “I wanna be in but I can’t take the draw down.” And so it’s the timing. I know you’ve discussed the past which I love is like having a liquidity, protecting investors from themselves, the fact he can’t give you can’t take your money out. But also…
Meb: Said from two portfolio manager.
Jeff: Correct, correct. Yeah, yeah. Your business is to keep a [inaudible 01:09:40] in place, you know. But I look at the lack of funds we had, you know, going into the crisis where we were saying up lock up funds for the distressed mortgage opportunity. And if people would have saw some of the marks where we’re buying this stuff, they would have freaked out. But that’s where you got to have conviction, you got to have that idea. But, I also think that, you know, the consistent mistake is just trying to tie managers and asset classes all the time. You know, not saying it’s a prescription, I like the idea you’ve started out there about have your little play money account, you know, take 5% of your capital, just trade if you feel like you have to. And when you lose it all, we’re not giving any of it back. You don’t get to refund it you got to resupply it yourself but there’s this too much trading, there’s too much trading going on.
Meb: I like the concept of the kind of, the coffee can. You buy something and you can’t sell it. Or you can only sell like one investment per year. It’s like one in one out. That seems to me like that’d be a good discipline because then you’d be a lot more thoughtful about…
Jeff: Well, stop taking your statements. I’ve heard this thing about the Robin Hood too. you’re taking all the time, I mean, I look at my brokerage statement like a couple times a year, just because I mentally know what I own, I own a lot DoubleLine stuff. But, importantly, it’s like I’m not trying to tweak around the margin, like, look, if something starts to get cheap, just go buy and you put it in the account. And most trades we do or buys, we’re not trying to rebalance things all the time, at least in our own PAs.
Meb: I was having a conversation with a friend who’s a money manager and he says, “Hey, have you ever experimented with sending out text messages to your client?” And I said, “Oh, my God. You want them, you know, checking it less not more. God forbid e-mails now you’re texting them at home.”
Jeff: Usually that phrase is used in a malicious way, I experimented. Right? So I wouldn’t recommend that.
Meb: I said, “I’ll let you try. Let me know how it goes.” This is a question we’re asking everyone in 2017. So, what is the most memorable trade or investment you’ve had? And this could be good, it could bad, it could be both.
Jeff: Yeah, that’s a tough one.
Meb: Take your time.
Jeff: You know, I mean, probably the best trade I ever did in my life, and this is going to sound sappy, but it was actually joining DoubleLine. It was one of the best trades I have made of you know taking a risk and, you know, obviously this far it’s paid off. But, in markets, as well, I think early on, you know, the hubris the model says this, I had a few of those where model says this, it must be right, I have to do it, and having that high dependency on the math. And not really…I realize there’s other forces at play and just being stubborn. And so I think that, you know, that was kind of low options trading early on thinking I could get leverage.
Meb: [Inaudible 01:12:11] just perked up.
Jeff: Yeah, yeah, he is excited. He is… I don’t know, maybe I could challenge her for being one the worst option traders at least on single equity out there. We used to love to trade the options on those three times levered Nasdaq’s and everything. Those are just [inaudible 01:12:23] but you want a lot. And I learned too from that like the bid-offer spread because at that time they were nickel wide and so you had to watch the build-up behind at the bid of the better of the offer because about to flip over on the nickel. And so, that was a great experience of realizing that the rounding error between these two was so big. So if that if you can watch the book build, you can see it’s about to flip on the bit of the offer side. So, kind of, interesting things of entry points but, yeah, it’s kind of cop-out answer.
Meb: Well, and so, I mean, the funny thing about joining, at that time you were probably mid 20s?
Jeff: I was in my early 30s actually. It was a time to take a risk in my career, and I thought, what better way? And like, you know, look…
Meb: You can always go back to being a professor.
Jeff: Also like, you know, I mean, maybe I had some hubris too, but say, “Hey, if it doesn’t work out, who’s going to blame me for trying to join gunlock and try to start something, right?”
Meb: Well, you’re screwed now.
Jeff: Yeah, exactly. So that didn’t work out as that plan’s the backup plan but the primary plan worked out.
Meb: Florida State will proud to have you back. Sherman, it’s been awesome. We’ll link to all these papers, show notes, etc. Where can people find you if they want to follow you for more info?
Jeff: Yeah, well, on doubleline.com/podcast is where we do… we post all of our podcast. You can get it on iTunes, Sound Cloud, the usual suspects, and you can always just go to firstname.lastname@example.org and, you know, people will forward on to me and we’ll get back to you.
Meb: Sherm, it’s been a blast.
Jeff: Awesome, thanks for having, Meb.
Meb: Listeners, things for taking the time to listen today. We always welcome feedback, questions, the mailbags, send them in. email@example.com. As a reminder, you can always find the show notes and other episodes at mebfaber.com/podcasts. Just try the show on iTunes. If you like it, please leave a review even if you hate it. Thanks for listening friends, and good investing.