Episode #98: Ed Yardeni, Yardeni Research, “We’ve Got Good Growth With Low Inflation And That’s A Very Good Environment For Stocks And Okay Environment For Bonds”
Guest: Dr. Ed Yardeni was on Wall Street for 25 years as the Chief Economist of EF Hutton, Prudential Securities, and CJ Lawrence. He was also the Chief Investment Strategist of Deutsche Bank Securities. Regarded as one of the leading independent investment strategists in the business, Ed appears frequently on CNBC and is widely quoted in the financial press. He worked at the Federal Reserve in Washington, DC and in New York City, as well as the US Treasury. He is the author of Predicting the Markets.
Date Recorded: 3/14/18 | Run-Time: 51:34
Summary: The episode starts with a fun story about Ed’s school days, studying off Janet Yellen’s notes in James Tobin’s class. But Meb soon brings up Ed’s new book, Predicting the Markets. In it, he writes that if books had theme songs, the appropriate song for his would be the 80s hit, “Don’t Worry Be Happy.” Ed explains this is because, when looking back over the past 40 years, the market has been extraordinarily bullish as a whole. There were plenty of reason to worry along the way, but all in all, the market rewarded brave investors.
This eventually leads into a conversation about valuations today that appear somewhat grim, and what Ed’s thoughts are looking forward.
Ed tells us it’s okay to be bearish, but don’t forget to get back into the market. He says, “history shows the smartest thing to do is just to invest over the years as you’re getting old, keep putting more money into the markets…recognizing that sometimes you’re going to get bargains and sometimes you’re not.”
The conversation drifts toward making macro predictions and the effect of Washington DC on the market. Ed tells us we’re overwhelmed with information and news, which is all the more reason to try to find the fundamental truth that’s out there. Washington doesn’t matter as much as Washington likes to think it matters. Ed gives us more of his thoughts on the market response to Obama, Trump, and the Fed, as well as what he believes actually creates jobs.
The conversation turns toward bonds, with Meb asking why bond movements can be challenging to predict. Ed points toward inflation, taking us back to the 50s to discuss bond yields and how they’ve moved in the years since. He brings in nominal GDP and central bankers into the mix. A conversation about negative yielding sovereigns brings various central bankers into the spotlight. Ed walks us through a look back at some of the effects of Fed involvement. He has some interesting thoughts on what the Fed does well – and not so well.
This is a great show, melding market history, implementable market wisdom, and Ed’s fascinating career. There’s way more, including where Ed sees the biggest changes coming in technology, and how it will affect markets… Ed’s favorite three indicators… which period over Ed’s 40-year career stands out the most… Ed’s movie reviews… and of course, his most memorable trade.
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Links from the Episode:
- 00:50 (First question) – Introduction and Ed’s background including how he learned off Janet Yellen’s classroom notes
- 1:24 – Predicting the Markets: A Professional Autobiography – Yardeni
- 2:35 – Why the theme song to his new book is “Don’t Worry, Be Happy”
- 4:38 – Idea of “current analysis”
- 6:24 – Ed’s view on current stock market valuations
- 6:58 – Ed’s blog
- 11:21 – What goes into making big macro predictions/forecasts about the market
- 12:20 – Washington’s impact, or lack thereof, on the markets
- 16:30 – Why bond movements are so challenging to predict
- 20:36 – Ed’s take on negative yielding sovereign bonds
- 23:16 – Ed’s view on the evolution of the Fed over the last few years and where it could go moving forward
- 27:37 – Big changes we’ll see in technology and how it will impact markets
- 32:13 – Ed’s favorite three indicators; CRB Raw Industrial Spot Price Index
- 35:26 – Boom/Bust Barometer
- 36:15 – Fundamental Stock Market Index
- 37:38 – Blue Angels economic indicator
- 41:16 – Any particularly memorable period of time that stands out to Ed
- 43:21 – What’s the new exciting project Ed is working on
- 45:55 – Ed’s most memorable investment
- 48:24 – A couple high rated movies from the past year
- 49:50 – 2018 Movie Reviews
- 50:20 – Connect with Ed – his new book, his website, and his blog
Transcript of Episode 98:
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.
Meb: Welcome, podcast listeners. Today we have an awesome show for you with one of the smartest guys in the biz. He was an economist with the Federal Reserve Bank of New York. He’s also held positions with Oak Associates, Prudential Group, Deutsche Bank. You’ve seen his writing in The Wall Street Journal, New York Times and Barron’s. He’s also got out a great new book which we’ll talk about today, and he’s now president of his own independent global investment strategy research group. Welcome to the show, Dr. Ed Yardeni.
Ed: Thank you very much.
Meb: Thanks so much for joining. This is going to be a lot of fun. I’d love to go back in time and start a little bit with your background. I polished off your new autobiography, and I thought there’s no better place to start than, you know, back in school. And I wanted to hear how you really started out studying off Janet Yellen’s notes. Maybe you can tell us a little bit about that.
Ed: Sure. I graduated from Yale in the Economics Department with a Ph.D. back in the late ’70s, and 6 years before that, Fed chair Janet Yellen had graduated in the same programme, and we both had Professor James Tobin as the chair of our dissertation committees. So obviously I didn’t meet Janet at the time but I did read her Tobin notes. You know how in school there always seems to be one kid sitting in the front of the class that’s just taking the copious notes that thinks that the teacher or the professor is the most amazing teacher there ever was? Well, that must have been Janet with Tobin because she took his meticulous notes, and they were subsequently xeroxed and passed along from generation to generation. So six years later, I studied the Tobin notes, which helped a lot because Tobin was a very demanding and difficult teacher.
Meb: Awesome. I love it. You know, the cool thing about this book, so the new book out is called “Predicting the Markets: A Professional Autobiography,” is not only does it take you through kind of your framework and how you think about markets, but also gives kinda readers a history of markets. So you’ll see names referenced that a lot of you will be familiar with like Paul Volcker, Louis Bacon, Leon Cooperman. But one of the things you had in the intro said if books came with a theme song, yours would be “Don’t Worry, Be Happy.” Maybe you can explain to our listeners what you mean by that.
Ed: At the beginning of my book I said it’s very unusual to consider or think that a book should have a theme song, but if I had to pick one, it would be “Don’t Worry, Be Happy.” Basically, if I look back over the past 40 years, I recall that in the late ’70s, the Dow was 1,000 and today it’s 25,000. My only regret is that, you know, I didn’t have a lot of money back then to put in the market. And I suspect if I did and I put it in the market, I probably would have gotten swung around and jumped in and out like a lot of people do.
But the basic trend of the stock market has been extraordinarily bullish, and along the way, investors certainly had plenty of reasons to worry that things were gonna end badly. And they did a couple of times. We had some pretty nasty recessions and bear markets back in 2008. It was a really ugly one. It really got to the point where a lot of people were wondering what they were gonna do in their next career. I guess my next career was gonna be a movie reviewer, as I pointed out in the book. But all in all, the market continued to do very well. And the same thing can be said for the bond market. Bond yields were over 10% when I started my career and now they’re down to about 2%, 2.5%. So we’ve had two extraordinary bull markets in stocks and in bonds, and along the way, they’ve been plenty of opportunities to worry, and if instead we’d all been kind of singing that song, maybe we would have stayed in and been happier.
Meb: It’s funny you say that because I was in a car ride today with a friend and he mentioned…we were talking about markets and he says, “You know, there’s just so much uncertainty.” I kind of laughed because I said, “When has there been a time in our lifetimes when there’s been no uncertainty,” right?
Meb: It’s like the constant worry gives you an easy excuse not to participate. So let’s stay broad for a minute and then we’ll kind of drill down a little more into some markets and ideas. But talk to me a bit about what you referenced in the book as current analysis. And so in your introduction, you likened it to solving a jigsaw puzzle. So maybe talk about kind of what variables go into that or your general framework for thinking about what current analysis means.
Ed: When Ben Bernanke joined the Fed as a governor rather than as a chairman, which he subsequently became, he gave a speech in which he said that he wishes that during his graduate education he had an opportunity to take a course in current analysis. And he said, “Well, that really wasn’t available,” because current analysis is kind of like learning by doing. It’s learning on the job. And when we’re talking about the financial markets, current analysis is really about being willing to do a lot of work, to get into the data to look at charts to really try to understand how the economy operates and come to conclusions about the markets based on a thorough analysis of the data. It’s fact-based rather than faith-based.
A lot of analysis, a lot of economic analysis, really starts out with theory and then tries to torture the data to fit the theory. Current analysis is really about, you know, having an open mind and starting with an empirical approach. How do things actually work? And then come up with your theory rather than the other way around.
Meb: Yeah. You know, it’s funny you look back in history to so many kind of investment ideas. I mean, even the old concept of beta and volatility where people, you know, say there’s a way the world looks, and it may fit a model, but it’s not actually how it plays out.
We’ll get into markets a little bit and kind of bounce around, but you mentioned Tobin as your old advisor in classes you took, you know, and one of his old metrics was a stock market valuation metric. And listeners, if you’re not familiar with Ed’s work yet, he also runs a pretty amazing blog with hundreds if not thousands of charts. But Tobin developed a broad stock market valuation indicator called Tobin’s Q. And so one of the takeaways from such valuation metric, one would kind of guess, would be that U.S. equity market forecast returns might be looking a little grim. Any comments on that or general thoughts about stock market and valuation, you know, and how do you see that given sort of the long-term optimism as well?
Ed: Well, again, as part of this theme song of “Don’t Worry, Be Happy,” if you are gonna worry, if you’re gonna be bearish, then, you know, if at some point you turned out to be right, don’t forget to turn bullish. I mean, it’s fine to be bearish and eventually see that you were right and be able to tell everybody, “I told you so,” but don’t forget to get back into the market. What I’m saying is it’s always better to buy assets, whether it’s stocks or bonds or real estate when nobody wants them, when they’re really cheap, when everybody is fearful. When everybody is worrying and nobody is happy, that’s really the time where you wanna start to think, “Well, maybe the markets have discounted a worst-case scenario and maybe it’s not gonna be that bad, and maybe there will be some mitigating policy responses, or things just don’t usually fall apart forever.” I mean, doomsdays happen but they don’t last very long as history shows.
So yeah, I would say that one of the main lessons here of my observing markets over the 40 past years is that when you do have very high valuations, when everybody loves a certain asset, there’s a good chance that that’s pretty close to the top, on a cyclical basis, and that it is gonna go down and get to be a lot cheaper with a lower valuation, and bam, that’s exactly where you wanna pounce on it and buy it. But, you know, that requires a certain skill of sort of timing the market cycle, and it also requires a lot of fortitude and mental discipline to say, “I know it looks terrible but this is a good time to buy.” And only a few investors really have that kind of stamina. Warren Buffett stands out as someone who has very often come in and seen value when everybody else was in a panic mode.
So looking at the current situation, stocks are definitely not cheap by historical valuation measures, whether you look at the Tobin Q or Warren Buffett’s ratio, but even Warren Buffett has said that his ratio may not be as relevant because not everything is the same. Inflation and interest rates are a lot lower than in the past when his ratio was this high. But as a general rule, I think it’s true that after a big bull market, if you’ve missed the first several years of a bull market, you’re not gonna be getting anything cheap and you may have to ride out the next bear market before you start making money again. I mean, the market today is a lot higher than it was in 2007 when it made its peak back then, but between now and the previous peak, we were down 58% at one point. So that was a gut-wrenching experience.
I think it really just depends on the kind of investor that you are. I mean, probably history shows the smartest thing to do is just to invest over the years. As you’re getting older, keep putting more money into the markets, stocks and bonds, and real estate and recognising that sometimes you’re gonna get the bargains and sometimes you’re not.
Meb: You know, I think you touched on a lot of great points there. I mean. I can’t tell you how many individual and other investors we talk to that really got scarred by, like, a ’08, the pain of, for many, their first drawdown, and never got back in. You know, they just said, “I can’t take it anymore.” They panic at the bottom and sell. And, you know, we often talk a lot about, you know, how the…
Ed: Look, I feel their pain. I mean, you know, a lot of these lessons learned were lessons learned. It wasn’t like, you know, I knew all these things along the way. And I guess I’d be a lot wealthier if I’d followed the advice that I’ve come up with now after 40 years of experience. But one of the reasons for writing the books is that I did learn some things along the way and why not pass them on.
Meb: So in your book, you kind of discuss various investment theses. One was a bullish thesis in the early ’80s, you know, which you became pretty known for and your 3D scenario. Talk to us a little bit about that, maybe, or kind of what goes into making these big macro predictions and forecasts, and where do people really kind of get those wrong?
Ed: Well, the problem we all have is we’re overwhelmed with information, we’re overwhelmed with news. And now as we know, there’s fake news on top of whatever is true news, so it’s a big mess out there. So all the more reason these days that you have to try to find the fundamental truth of it that’s out there. I think wasn’t it the “X-Files,” the TV show where the line was “The truth is out there?” You have to really try to focus on what really is important and what really matters.
For example, one of the things I’ve learned over the years is that Washington doesn’t matter as much as Washington thinks it matters. Every president will tell us that they created jobs, but the reality is that businesses create jobs. It’s especially small businesses that wanna become middle-sized and large businesses that create jobs. So one of the truisms that I’ve learned over the years is don’t get too involved in politics. Don’t be a preacher, be an investor. Don’t get too politicised in your investment approach.
You know, there were some people that were extremely bearish when Obama got elected, and, you know, we had this extraordinary bull market for eight years despite policies that some conservatives would argue wouldn’t be good for business or the stock market. But it turned out that well, we could have a debate on which policies did or did not help the economy under Obama, what really matter is the Federal Reserve was keeping interest rates near zero, and it was the monetary policy that mattered in Washington, not fiscal policy.
Now, on the other side of the coin, you’ve got Trump who’s probably the polar opposite in many ways of Obama, where some people think he’s the most bullish thing they’ve ever seen and others are totally depressed about his election. And no matter what you think of Trump, and I think everybody can agree that he’s got some behavioural issues and social issues in terms of interacting with people, but that’s not what’s important for the markets. What’s important is what are the policies that he’s promoting? And the market obviously likes the tax cuts a lot because they are very beneficial for corporate earnings. And at the end of the day, the market cares most about earnings. Anything else is sort of tangential.
Meb: It’s funny. I think you’re spot on. We were tweeting about this, you know, over a year and a half ago when the election was going on and said, “This is unpopular, but our opinion is that the outcome of this election is largely irrelevant to the stock market going forward.” And I don’t think a single person would have predicted that you would have had 15 up months in the stock market in a row with, like, some of the lowest volatility on record. And I tweeted at the beginning of this year, I said, “You know for the first time in history, we have a calendar year where every single month is up.” And it’s so funny you talk about the news and people’s reactions, you had one of three reactions. It was either, “Thanks, Obama,” or, “Make America great again,” something, or, “The Fed is manipulating, like, the world,” right? Like, everyone is a conspiracy theorist.
Ed: This is a good example of how you wanna stay open-minded and maybe not get into the emotional turmoil that’s in the headlines because coincidentally, with Trump winning the election, we were seeing more and more economic data showing that the global economy was enjoying something that hasn’t enjoyed in quite some time, which is a global synchronised boom. And that was really driving earnings up substantially, and that’s what the market really was to a large extent focusing on. I mean, Trump’s agenda sounded very Reaganesque. And there are many investors who fondly remember Reagan’s policy. They forget the fact that Reagan was about as protectionist as Donald Trump has been so far. Reagan imposed 100% tariffs on semiconductors, he forced Japanese automakers to accept voluntary restraints on their exports, so that forced them to produce more in the United States.
So again, there’s the headlines, there’s the emotional stuff that goes on, and then there’s what the market really cares about. And yeah, people still express surprise that despite some of the craziness we’re seeing coming out of Washington, that the market can hold its own and maybe even continue to go higher. And that’s because, at the end of the day, people care…what matters for the stocks is earnings, what matters most for bonds is inflation. And we’re in a world now where we’ve got good growth with low inflation, and that’s a pretty good environment for…that’s a very good environment for stocks and it’s an okay environment for bonds.
Meb: That’s a good segue. Let’s move into the bond world because that’s an area you’ve certainly spent a lot of time observing. And you had a great line in your book about bonds where you say, “So what do all the available data we have today tell us about bond markets in the predictable future? We can safely predict the bond yields will either rise, fall, or stay the same.” So, you know, you’ve seen into this amazing transition from a world in the ’70s where I think you said the 10-year maybe peaked at like 13% or 15% or something, and, you know, this totally different environment where yields are so much lower. So a lot of people would seem to think that predicting yields might seem easy, but why are bond movements so challenging for forecasters and investors?
Ed: Well, I think first and foremost is inflation. And people seem to respond to, I guess it’s just human nature, I mean, we respond to things that traumatised us in the past and we just can’t get over it, and it takes a lot of time sometimes to get over that. So in the ’50s, people that weren’t traumatised, they just kind of, like, went into a coma because inflation was not a problem and the Fed was basically pegging the interest rate at a very low level in an agreement that they had with the Treasury and everybody just kind of, like, bought bonds, with the yields about as low as they are today and didn’t think much about it. And then as inflation started to really pick up in the ’60s and ’70s, they just didn’t respond to it quickly enough.
And there actually were a few forecasters, very prominent forecasters like Henry Kaufman and Albert Wojnilower who were saying, “Guys and gals, bonds are death.” He didn’t say bonds are death exactly but in effect, he was saying that and people started to call him Dr. Death or Dr. Doom. And he was right. The bond yield went up, which meant bond prices got clobbered. And then wouldn’t you know, just when bond yields got into double digits and everybody was bearish, that was exactly when you wanted to own them. And I recall, in late ’70s, Henry Kaufman would have these annual gatherings at the Waldorf Astoria, and they’d be packed to the rafters because he was so widely respected. So, you know, his bearish sermon got the most people into the church really just at the wrong time because that was exactly when you wanted to own those bonds.
And then inflation came down much more rapidly than widely expected. I was a disinflationist. I believed inflation would come down but came down even faster than I thought. So, getting inflation right is extremely important for getting the bond market right. And, you know, the benefit of hindsight, it doesn’t look like it’s that hard. But look at today, I mean, you’ve got some people who are convinced that inflation is gonna make a remarkable rebound here because the labour market is tight. And then there’s lots of others saying that, “Well, but it hasn’t.” You know, put me in the sceptical camp, “Well, it hasn’t.” And I think there’s some powerful forces keeping it down.
I have found over the years that the bond yield, the 10-year bond yield tends to trade around the growth rate of nominal GDP. So right now, nominal GDP in the fourth quarter was up. And this is not just real GDP, it’s including the price component. And right now it’s up 4.4% and yet the bond yield is just below 3%. So, you know, when you look at that chart historically, you’ll see that the bond yield tends to be in the same neighbourhood but never quite in the same place as nominal GDP. And trying to figure out and assess why that’s the case is kind of important. So, you know, since 2008, the bond yield has been consistently below nominal GDP because the Federal Reserve and other central banks have kept bond yields down. So I guess the answer to your question is you’ve gotta get the inflation right, you’ve gotta get central bankers right, you’ve gotta get nominal GDP right, a lot of moving parts.
Meb: You had a great phrase you became pretty famous for when you were talking about bond yields and mentioned in the book where you had said that you were looking for bonds to get back to “hat size yields.” And I love that description, but it also made me think…I was laughing because bond yields have come down so low. What’s your opinions? At least to me, this has been one of the bigger surprises of this past cycle or last 10, 15, 20 years is…talk to me about a world where there is negative yielding sovereigns. You know, I think that would have surprised a lot of people and still does. What’s kind of your general…the thoughts on kind of that scenario?
Ed: You know, I try to be pragmatic and empirical about all these things, but I do have my own opinions that tend to be on the conservative side. And from that perspective, I thought these central bankers were nuts doing what they were doing, you know, with ultra-easy monetary policies. I guess I was all for QE1, you know, the first round of Fed purchases of treasuries in 2008, 2009 when everything looked like it was falling apart. But then they came up with two more similar programmes, and because interest rates, they brought interest rates down to zero and they couldn’t think of anything else to do other than going into the bond market and buying bonds. But that was, like, basically rigging the bond market. I mean, that’s not capitalism. I’m a big kind of free-market entrepreneurial capitalist, not a crony capitalist I should say. So I think that I didn’t see the purpose of distorting the bond market like that.
But on the other hand, look, I’ve gotta give him credit. I mean, the world did not fall apart. We are now seeing sustainable economic growth almost everywhere with low inflation. I guess there still could be a reckoning. I mean, right now the Fed has announced that over the next several years they intend to, you know, dramatically reduce the size of their holdings of treasuries. At the same time, the federal government has decided that they wanna increase the federal deficit. So if inflation ever does make a comeback, we’re gonna have a heck of a price to pay with higher bond yields and its impact on economic growth.
So I could envisage a really nasty, ugly scenario, which with the benefit of hindsight I would say that, you know, if you had gained and you’re kind of stealing from the future, at some point the future comes and bites you and you get the pain. But that’s just not happening. And again, there I go again being a preacher rather than an investor.
Meb: That’s all right. You can put on your academic hat here. I mean, I know for a long time that you, certainly a lot of commentary and observations of what’s going on in the Fed, and kind of looking back and, you know, as we transition from your fellow bulldog to new Fed chairman, any main observations? You know, there’s a great question in the book, and I can’t remember who asked it or what the intro to this was, but they basically said, “You know, why doesn’t the Fed just target, you know, a certain level of inflation?” And now it seems like it’s transitioned from where it was more of a monetary to an inflation targeting world. Maybe just talk a little bit about kind of the evolution of…you’ve been watching the Fed for over 30 years, and maybe just talk a little bit about the transition, what you’ve seen, the differences and kind of where you think the last few years and going forward kind of what the picture looks like.
Ed: Well, we’ve certainly been through a lot of business cycles with the Fed and many of them resulting from Fed policies. There was a time when people used to talk about the Fed raising interest rates too little too late, being behind the curve, and then the Fed would realise that that was the case and then they’d scramble to raise interest rates to get ahead of inflation. And that would cause a recession and then they get a financial crisis and they’d react to that by bringing interest rates right back down also. It was almost a dance. I mean, you know, it just happened over and over again.
Now, in early 2000, Ben Bernanke, again, before he was the Fed chairman but he was the Fed governor, started talking about the Great Moderation, the idea that monetary policy had succeeded in moderating the business cycle. And four years later, bam, we got hit with the Great Recession. And now ironically we seem to be going through the Great Moderation part two because growth has been fairly moderate and inflation really has been very subdued.
I think the Fed has come around to do a few things. One is they did go from having sort of implicit inflation targets to having an explicit one. And once you know it, they adopted an explicit inflation target just in time for wondering why they couldn’t get it up to that target. If they had adopted something like that many years ago when inflation was well above their target, we might have had less inflation because they would have responded more quickly to above-target inflation.
I think there’s still a lot of groupthink going on at the Fed. They don’t seem to completely be able to get away from their models, particularly the Phillips curve model which posits an inverse relation between inflation and unemployment. And they still think that with the unemployment rate so low, that at some point inflation should make a comeback. And they don’t seem to really see the big picture, which I think I’ve seen for the past 40 years, and that is that disinflation has been powered by globalisation as part of the end of the cold wars being fundamentally disinflationary if not deflationary because of global competition and cheaper labour around the world. They don’t really seem to really…
I mean, I don’t think they’ve got any economist studying technological disruption or innovation. They still kind of as a by the way say, “Oh, well, maybe Amazon has something to do with low inflation.” And they’ll spent lots of time and lots of statistics, statistical regression studying fairly conventional stuff. But when it comes to really trying to understand technology and how it disrupts the economy for both good and bad, they don’t have those tools. They don’t have those studies. They’re macroeconomists. They learned certain things in grad school and certain models and they can’t seem to get over that. Maybe that’s the one advantage of having Jerome Powell is that he’s a lawyer, something he’s maybe more open to different types of ways of viewing things. But you know Greenspan was a macroeconomist, Bernanke, Yellen. And there’s a lot of groupthink, a lot of focusing on models on the way the economy should behave and then surprise that it wasn’t behaving that way, rather than trying to figure out, “Well, what are we missing?”
Meb: I love it. It’s interesting. You know, you mentioned briefly there, you started to touch on technology, and your book sort of has an entire chapter on predicting the future. And so you talk a lot about productivity and disruption, revolutions in energy, robotics, cloud, so on. Where do you kinda see the biggest changes coming and any broad takeaways for listeners on how that may affect, you know, markets in general or any just kind of general thoughts there?
Ed: Well, I think we’re clearly seeing that the pace of technological innovation is increasing. Well, not only do we have newer and newer varieties of technologies but they are user-friendly sooner than in the past and they proliferate faster. So the PC revolution, the software revolution that came with the PC revolution, a lot of that took place during the 1990s. And then we saw that morph into more mobile devices like laptops and smartphones. And then we went from the server model of doing our work to the cloud, where instead of each one of our companies having their own servers or servers at a server farm, now everybody just kind of rents some space on the cloud.
Now I’m even hearing about computing on the edge, which is, you know, we’ve got all these Internet of Things now. I mean, an automobile that’s gonna be autonomous-driven is going to be basically an Internet of Things. It’s gonna be hooked into the internet, it’s gonna have GPS. But you don’t want it to be doing a lot of its computing on the cloud because it takes too many nanoseconds to kind of go back and forth. You wanna cut the computing time. So more and more computing is gonna be done on the edge, is gonna be done by the car itself rather on the cloud.
And then another revolutionary development here, apparently we’re on the edge of seeing something called quantum computers. I wrote about it and I still don’t quite understand it. It’s a radically different architecture for computing and there’s some things that it’s not gonna do very well but other things that it’s gonna do so much faster than we can do with our current technology. So it all means that artificial intelligence and robotics are gonna be innovations that are gonna be more and more incorporated into our daily lives. And I’m not pessimistic in thinking that it’s gonna replace us all and we’re all gonna be unemployed. I think Japan is a country that demonstrates that you can have a very low unemployment rate and still have lots of robotics. I think we’re gonna find that as populations age around the world and working populations growth rates slow down, that robotics and automation will be very much an integral part of our daily usage, of the way we run our businesses and the way we run our homes.
Of course, there’s some…technology always has its dark sides. I mean, I watched the Olympics in South Korea and along with everybody else was totally impressed by how they used all these thousands of drones to make all these beautiful figures up in the sky. But those technologies are being perfected now for…being used in a military fashion. So, you know, technology, as we learned from the atom bomb, can do some horrible things, and on the other hand, it could certainly increase everybody’s standard of living. I mean, you know, a $30,000 car is a better car today than a $30,000 car was 10 years ago. And everybody now has access to smartphones and even people in emerging economies that are dirt poor have smartphones and are using them for banking purposes.
And so technology I think is our future, it always has been, and it’s always been why Malthusians and other pessimists have been wrong is entrepreneurs see opportunities in scarcity, they see opportunities in problems and they come up with innovations that create solutions. You know, one of the problems is, you know, if you’ve got to pay too high a price for something, somebody solves the problem by innovating in a way that increases productivity and lowers that price.
Meb: That’s actually a great segue because you have a quote, famous trading quote in your book, talking about commodities, where you say, “You know, the cure for high prices is high prices and vice versa.” And I can sympathise that because we have a very unproductive wheat farm in Kansas currently that is suffering from the opposite side, which is low wheat prices. But you’re partially known, and one of my favourite things over the years has been following your charts and your blog. And you have in your book, you name your favourite three indicators, which I’m fairly certain no other person on the planet would probably name the same three indicators. So maybe you could talk to us a little bit about those indicators and what they are and how you use them. And I’m sure the listeners would love to hear a little more.
Ed: Well, my favourite, if you told me I could only have one and that’s all I could look at, I’d want the CRB Raw Industrials Spot Price Index. It’s been around for many, many years. It’s available daily. It’s got 13 industrial commodities and it’s been around for so long that it’s got some funky stuff like hides and tallow and rosin, but it’s also got zinc and tin and copper. And I like it partly because many of the commodities are not traded in the speculative commodity markets. They’re bought and sold by people who actually need the products. And it’s very, very highly correlated with the global business cycle as well as the U.S. business cycle because obviously more often than not, the U.S. economy kind of drives the whole global economy.
So I watch that on a daily basis. When I saw it take a dive in second half of 2014, I wasn’t that surprised because I thought that we might have been in a commodity supercycle bubble, and so I wasn’t surprised to see that bubble burst. But much to my surprise, the index started to turn back up in early 2016, which I thought that was way too early for coming out of a bursting bubble scenario. But that’s what it did. And with the benefit of hindsight, it looks like commodity producers just absolutely scrambled like mad to restructure their businesses. And meanwhile, the global economy was enjoying the benefits of lower oil prices and other cheaper commodities and started to respond positively to it.
So it started to tell me in early 2016 when everybody was, like, talking about, “You know, this is gonna be a disaster all over again,” that it was starting to show me that, “No, no, no, there’s something going on here to suggest that things are actually starting to look up again.” And then in 2016, 2017, it continued to signal that the global economy was doing better and better. So when Trump got elected, I argued it wasn’t just…I argued like you did. That it really didn’t matter who won, that the global economy was doing better and so earnings would be doing better.
I also look at the CRB as a ratio of initial unemployment claims. And I call that the Boom-Bust Barometer. And that I can do on a weekly basis because initial claims is available weekly. And it’s kind of bizarre when you think about it. On the numerator, we’ve got some cockamamie commodity index which tells us something about the global economy. And in the denominator, we’ve got initial claims, which tells us something about the labour market. But it works. You know, I’m a big fan of stuff that works. And it works great as a business cycle timing tool. And it’s not a leading indicator but because it’s available weekly, it’s an awfully good coincident indicator of kind of telling me when something is turning in the business cycle.
And then occasionally I’ll massage it by averaging it with…Bloomberg has something called the weekly Consumer Comfort Index. And when I kind of stir-fry those three together, I come up with something called the Fundamental Stock Market Index, which has been remarkably highly correlated with the stock market since about 2000. I don’t show the chart prior to that because it didn’t work prior to that. I mean, that’s the thing about models. They work for a while and then they stop working. So, you know, you’ve gotta stay open-minded about these things. But it’s been working like a charm since 2000. And to me, you know, it’s three…basically, if you asked me what three indicators would you like to have so that you can get some idea of what the global economy is doing, what inflation is doing, what the U.S. labour market is doing, and what the stock markets should be doing, it would be those three.
Meb: And what’s the output now? Is it pretty kind of what you mentioned?
Ed: It’s been flying. You know, it’s gone vertical, making new highs because initial claims is at, you know, the lowest it has been since the ’60s and the CRB isn’t at a record high but it continues to recover since early 2016. And what’s really started to really take off is the Consumer Comfort Index, which is not surprising since a lot of consumers have been getting…starting to see the tax cuts in their paychecks.
Meb: So my favourite indicator that you put out is probably the Blue Angels. Do you mind telling our listeners what that chart is?
Ed: Well, you know, the Blue Angels, you have to get my book to really fully understand it because it’s a little complicated. You know, when I think about what drives the market, I do try to keep things as simple as possible. I’m not that smart and I find that simple models work better for me than complicated models. And to me, the stock market is just P/E times E. That’s by definition. I always like to start with definitions, with accounting identities if at all possible. So P/E times E is what drives the market, the question is what’s E? What’s earnings? And what’s P/E? What’s the valuation multiple?
Well, I’ve gotta start out with earnings first to get the P/E. And what I use is I use forward earnings, what analysts, industry analysts think earnings will be over the coming year. Now, if you ask an individual analyst, “What do you think earnings will be over the next 12 months,” they’ll look at you like, “You know, what? Have you been in this business for, like, 2 hours?” I mean, there is no such thing. Analysts don’t forecast what earnings will be over the next 12 months. They’ll give you quarterly numbers, they’ll give you this year, next year.
So all I do is do something that I/B/E/S Thomson Reuters came up with many years ago, which is a proxy for 12 months ahead or 52-week ahead earnings, forward earnings. And that is why not just take analysts’ expectations for this year and next year and take a time-weighted average? So you’re always giving more and more weight to the coming year. And that’s a good thing because analysts always tend to be too optimistic about the coming year. And as reality dawns on them, they get a little bit more realistic.
But anyways, I’ll use that to derive what I call forward earnings, which again is analysts’ expectations for earnings over the next 12 months. I can also do it on a weekly basis, so 52 weeks. And I use that in my P/E times E equation for the market. The only time that is really misleading, I have to admit it’s a serious flaw, is in recessions. Analysts just don’t see recessions coming. But hey, that’s my job. You know, if I, you know, have strong convictions that there’s no recessions over the next 12 months then I find that the analysts’ expectations are actually pretty good for predicting earnings.
So in terms of the Blue Angels, I’ll take those weekly or monthly series for forward earnings, and then I’ll multiply it by P/Es of, I don’t know, 5 to 20 in increments of 5. Yeah, when you do that on the charts you get these Blue Angels, right? They fly in formation, they never collide with each other. And then on that very same chart, I can put the S&P 500 on there. And in one chart, I get P/E times E equals P. I can see the S&P 500 is equal to its forward P/E times its forward earnings. And so in one chart, I can see what’s driving the market. Well, there’s no surprises here. In the short-term, you know, when the market takes a dive and you have a correction, it’s almost always because the P/E is taking a dive because investors kind of drive P/E. They get squeamish if something bad is gonna happen.
And meanwhile, if I see analysts are telling me everything is still okay and my macro data says everything is okay then I kind of say this is probably gonna be a panic attack and that this too shall pass and we’ll move forward. It’s been very helpful to me in this bull market. I’ve counted 61 panic attacks where the Es continued to go up and the P/E took kind of a short-term dive and then we’ve recovered and here we are at record high territory.
Meb: So, you know, you do talk a lot about movies, and you wrote in the book that sometimes you feel like Tom Hanks in Forrest Gump, where you’ve lived through some interesting times. You know, as you look back, so is there any period that stands out most to you? And it could be a hardest for you to handle, you know, or a market cycle or whatever it may be. Is there any period that stands out over the past 40 years as particularly memorable?
Ed: Well, yeah. I mean, I don’t have to think that far back. I think I’ve had kind of the best call of my life with this bull market. You know, I mean, it was a few weeks after the market hit its low that I was Tom Hanks, not as Forrest Gump but as, you know, the symbolist in The Da Vinci Code. You know, the market got down to 666 on March 6, 2009. And I don’t know why but it’s just like if somebody told me, “You know, we just bounced off of 666,” I’d say, “Hey, that’s the devil number. I mean, we wanna get the hell out of there as quick as we possibly can.”
And then I started looking around at some other things. I had talked to my congressman about how mark-to-market accounting had sort of been sort of a doomsday machine that was creating this bear market, and then lo and behold I see that he and a committee that he was on on March 12th berated the head of FASB to suspend mark-to-market. And he said, “Do it or Barney Frank and I are going to do it.” And lo and behold, a couple weeks later, FASB announced that they were more or less suspending FASB. So yeah, I was sort of attuned to the things that suggested the market might start to turn around, and then I pretty much stuck with it. I mean, I really haven’t jumped off of it. And so, you know, I guess as you get older and you learn more, it’s nice to know that you can use some of the things you learned and sharpen your understanding of things. It’s nice that I’m gonna learn some useful things along the way.
Meb: Well, as you reflect back, and it’s fun to read the book because you talk about working at one of the…older-time listeners on this podcast will remember this name. The younger people won’t. But EF Hutton, classic brokerage name. They used to have the best tagline, “When EF Hutton talks, people listen.” So you’ve gone from a really interesting career trajectory where you’re now essentially over this past cycle been an entrepreneur and started your own company and been doing it that way. Is there anything particular that’s on your brain these days that you’re excited or are working on?
Ed: Well, that’s a good follow-up to the previous question because maybe that’s one of the reasons I’m having a particularly good time now is because I am sort of…I am independent. I have my own company, and, you know, whatever views I have I go market to whoever wants to hear it and do business with us. I’m not competing with other people in a major brokerage firm for face time with our accounts. I don’t have to get in on a schedule. I do my own scheduling. I try to travel about two, three days a week when it’s not snowing or when it’s not…the thunderstorms aren’t everywhere. So usually in the spring and the fall I’m on the road quite a bit talking to account.
But it has been a real insight being an entrepreneurial capitalist. I mean, when you’re working for a company, you’re working for a company. I mean, you know, even if they give you stock options, even if you’re, you know, got a good managerial job, it’s still different than running your own company. It’s scarier running your own company. I mean, if you don’t do well you’re out of business. But, you know, I also feel an obligation to all the people that work for me. I mean, we’re small so we’re not talking about a lot of people, but, you know, they all have families and all that. So there is a responsibility in that respect.
But yeah, I’ve done reasonably well and along the way I’ve been able to hire people. And that’s made me realise that, “You know what? It’s not presidents that create jobs, it’s me.” You know, if my business is good, I tend to expand and I tend to hire and I tend to spend more money with consultants and so their business is good. And I’ve got competitors and I’ve got some really good competitors. And fortunately, you know, in our business, we just don’t have that…I don’t think we’ve got any crony capitalists yet, you know, people who are in a position of power to use the political forces to put the rest of us out of business.
Meb: I love it. I can relate. All the agony and ecstasy of being an entrepreneur. It’s certainly a awesome venture but there’s the sleepless nights as well.
We’re gonna start to wind this down. I’d love to keep you all day but a couple more kind of shorter questions. Over this past year, we’ve been asking all of our guests, [inaudible 00:46:15] over your career, is there any particular investment that’s been most memorable for you? And so that could be, you know, your first trade, it could be a good one, it could be a terrible one, it could be whatever comes to mind, but is there a particularly memorable investment as you look back?
Ed: Yeah. You know, honestly, the one that comes to mind when you asked me the question is Digital Equipment early on in my career. And this was when Digital Equipment and Wang, you know, these companies that were competing with IBM and coming up with smaller mainframe machines. And I made a fortune trading that stock and then I gave it all back like just as fast as I made it. And I guess that’s where I got kind of my comeuppance and realising that, “You know, maybe what I really need to do is stick with my day job, which is understanding the economy, giving advice and then just kind of sticking with a long-term investment strategy based on that.” And personally, I’ve always invested very conservatively since that experience, especially now that I’ve got my own business. I just don’t wanna have the emotional bias. You know, if the market’s going down, I don’t wanna be depressed and have that reflected into my work. I wanna be objective.
Meb: I think that’s such a great description because so many investors and probably in a good way, you know, a lot of the cuts and bruises and bumps that we have, particularly early in our career can impact, you know, what kind of investors we turn into. So for me, it was becoming a quant. Now, this can also work out poorly. So for entire generations that you mentioned like the global financial crisis here or maybe the post-’80s bubble in Japan, where it impacts entire generation’s risk tolerance and how people see markets. You know, what you do with a lot of studies of history can help, you know, guide that as well. But for sure, a lot of my disastrous discretionary biotech stock trading in the late ’90s, early 2000s certainly prompted me to become a quant.
So we’re gonna start to wind down. So you’re a big movie buff, and the scale you run is minus three, plus three. I assume plus three being the best. Give me a couple plus threes you’ve seen over the past year. I haven’t seen a movie in forever. Give me something to cue up in my Netflix queue.
Ed: I watched the Oscars like everybody else and I didn’t think [inaudible 00:48:45] was an amazing movie, but I found it has some relevance to our business, you know. I mean, sometimes you get yourself into a situation where there’s so many clues telling you you should leave and get out and you just don’t pick up on those cues. And they’re just, like, staring you right in the face but you’re not looking at them. So I think it’s not a three-star movie, but it’s one that I think is very relevant to kind of what we do for a living.
Meb: Well, do you have a three-star that comes to mind? Because I watch the Oscars and I haven’t seen, like, any of these movies, which is a good thing because I fly a lot, and that means I’ve got a lot of movies to put in the queue on the plane. But is there any that stands out in the past year or so as something you just kind of love?
Ed: No. You know, the problem with Hollywood is they’re coming up with so many sequels and prequels, you know, so it’s been hard to get anything that really stands out.
Meb: Well, it’s a shame because we have a movie theatre right down the street and I always say we’re gonna go cut out during the middle of the day and go watch a movie and I’ve never done it. So that’s on the to-do list.
Ed: You can go on my website, most of it’s open to the public, yardeni.com, and at the very bottom there’s movie reviews. And I’ve got one for almost every week going back several years. So you can scroll through that.
Meb: Perfect. We will mine that and Jeff and I will post a few links to some of your top ones. And Ed, I also wanna thank you. The amount of content that you share for free in charts and everything else has been a really big resource over the years. Where can our listeners find more information about you, go to your websites, what’s the best places?
Ed: Yeah. I mean, you know, the book is…you can read about the book at yardenibook.com, and then that gives you links to Amazon. And then yardeni.com is my website, and there’s hundreds of chart publications that are open to the public, blog.yardeni.com is open to the public. So yeah, I mean, I still have the professor in me likes to teach a little bit and educate and try to show people the right way to look at things objectively and empirically.
Meb: Ed, thanks so much for joining us today.
Ed: My pleasure. Thank you.
Meb: Listeners, we’ll post show notes and links to all Ed’s works. The websites he mentioned, some good movie reviews, and of course, his book, which I highly recommend, “Predicting the Markets: A Professional Autobiography” at mebfaber.com/podcast. You can always leave us a review if you like the show, hate it, anything in between. Thanks for listening, friends, and good investing.