Episode #118: Radio Show: Record-Setting US Valuations… Emerging Market Opportunities… VC Bad Behavior… and Listener Q&A
Guest: Episode #118 has no guest but is co-hosted by Jeff Remsburg.
Date Recorded: 8/15/18 | Run-Time: 1:11:28
Summary: In this Radio Show, we cover numerous Tweets of the Week from Meb, as well as some write-in questions. We start by discussing articles Meb posted in his Tweets of the Week. These include a piece by Jason Zweig about how your broker might be making 10-times more money off your cash balance than you could make on it. Then there’s discussion of valuations – a chart by Leuthold shows how one measure of US market valuation has matched its 2000 level, and another has doubled it. At the same time, Longboard released a chart referencing a Goldman market outlook that claims “in 99% of the time at current valuation levels, equity returns have been single digit or negative”. We talk about US valuations and when “selling” might trump buy-and-hold.
Then we jump to foreign valuations. GMO believes emerging markets are the biggest opportunity relative to other assets in the past 20+ years. Meb clarifies what this really means. Then there’s discussion of home country geographic sector bias, whether the VC market is in a bubble (Meb tells us about some bad behavior he’s beginning to see in the space), and how the American savings rate is pretty grim.
We then get into listener Q&A. Some that you’ll hear Meb address include:
- Are momentum funds just camouflaging another factor? For instance, if Value became the “in” factor, wouldn’t Momentum pick it up, so Momentum would then just look like a Value fund?
- Assuming the U.S. economy does not enter a recession in the near future, the Shiller PE’s 10-year earnings average will soon consist of all economic boom and no bust as the depressed earnings of 2008 and 2009 roll out of its calculation. How useful is a CAPE that only includes a period of profit expansion?
- Regarding your global value strategy, have you ever tested the strategy using relative CAPE ratios versus absolute to determine country allocations in order to avoid countries with structurally low CAPE ratios?
- I’ve never heard of a 401k plan offering ETF options. Is there a reason logistically, legally, etc. that prevents 401k plans from offering ETF options?
- How do I structure my portfolio for a 4% yield, after tax?
- I like your shareholder yield strategy, but if I get capital returned through buybacks and share appreciation, how do I get monthly income without selling shares and triggering taxes? I just don’t see how I can implement a monthly income plan with this strategy.
Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159
Interested in sponsoring an episode? Email Jeff at firstname.lastname@example.org
Links from the Episode:
- Meb’s Tweets of the Week 1
- Meb’s Tweets of the Week 2
- Meb’s Tweets of the Week 3
- 0:50 – Welcome to the show
- 1:55 – Wes Gray’s March for the Fallen
- 2:56 – New book published The Best Investment Writing – Volume 2: Selected writing from leading investors and authors – Faber
- 4:58 – “Nobody Ever Got Fired For Buying Vanguard…” Well, Maybe They Should Be? – Faber
- 6:02 – AQR podcast with Jack Bogle
- 10:23 – “Think Income and Growth Don’t Exist in this Market, Think Again” – Faber
- 10:25 – “Think Income and Growth Don’t Exist Around the Globe? Think Again” – Faber
- 11:54 – Fidelity no fee fund
- 14:55 – “How your Brokers Can Make 10 Times More on Your Cash Than You Do” – Zweig
- 18:40 – Valuations of the market
- 22:06 – Listener Question: How do you use CAPE in a time of profit expansion
- 22:44 – “Making Adjustments (i.e. What If 2008 Never Happened?)” – Faber
- 23:52 – Emerging market ETFs and their exposure to China/Asia
- 31:04 – Investor bias doesn’t just apply to a country, it can apply to a region
- 33:43 – Brian Taylor article – 1st million-dollar market cap
- 33:45 – Bryan Taylor Podcast Episode
- 37:35 – Is VC investing in a bubble
- 47:59 – “Only 39% of Americans have enough savings to cover a $1,000 emergency” – CNBC
- 48:23 – “The Investment Pyramid” – Faber
- 55:18 – Are momentum funds camouflaging another factor
- 57:52 – Global value strategy, ever tested it with relative CAPE ratios vs absolute
- 59:27 – Any reason 401k plans don’t offer ETFs
- 1:02:39 – Still charging too much for index funds
- 1:03:35 – How to implement a monthly income plan from investing and how to get 4% yield after tax
- 1:07:13 – How to conduct a back test
- 1:08:20 – Free Data Sources
Transcript of Episode 118:
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 podcasts 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 to a near end of summer episode, which has me very melancholic. I’m sad about that. I haven’t had enough summer yet. I’m actually, by the time you listen to that today, I will be in Colorado. So, we’ve got a radio show today. Welcome, Jeff.
Jeff: Hey, what’s happening?
Meb: Not much. How’s your summer been?
Jeff: Like you, it’s been a little short, which is why you need to be throwing us a Labor Day cookout pretty soon.
Meb: Well, you know, the fall time is the best time ever to be in LA. And so, I try really hard not to travel, but that’s September, October is also always like the heaviest travel months with conferences and things. So listeners, by the way, we’ll be in, as I mentioned, I’m in Colorado this week as you’re listening to this. So if you’re in Colorado and wanna say hi, let me know. And then we’ll be at various points in the coming months in Nashville, Vegas, San Antonio, and I think Rhode Island and hopefully, hopefully, hopefully, drag you to do this as well as hopefully a couple of other employees, West Gray’s march for the fallen. You laugh as if you haven’t walked 28 miles in a long time. Listeners, if you wanna come hang out with a whole gaggle of 100 plus, and maybe 200 plus quant finance nerds and all of their friends and walk I think it’s 28 miles.
Jeff: No, come on, man. You’re not doing that. There’s no way. You would keel over.
Meb: But I’ve got a marathon in my back pocket. I’ve got an Olympic triathlon.
Jeff: You attempted marathon up in the Rockies a few years ago, it was one of the best stories ever. You gasping.
Meb: But like, it’s walking. Like, how hard can walking be?
Jeff: Oh, man. You’re out of shape my friend.
Meb: There’s two levels where people do it with a 45-pound pack. Anyway, you guys Google it, “March for the Fallen West Gray” sign up, very likely join. The problem for me is that I’ve never seen Pearl Jam and they’re playing here locally, so I’m gonna have to miss that. And so I’m just a little conflicted.
Jeff: Anyway, I guess you don’t care for the fallen that much.
Meb: Before we get started with the radio show, big news, we just published our new book, can’t really claim it’s our book. I was just the editor with Jeff’s help where we curated the best investment writing volume two. It’s about twice the size as volume one. We’re really proud of it. It’s about 40 curated essays ranging in length from one page to, what’s the longest? Like 30 pages?
Jeff: Around there.
Meb: And it’s pretty awesome. I mean, some of the smartest, best writers in our world. It’s a pretty fantastic read. You can pick it up, put it down, it’s on Kindle and on Amazon at like 20, 30 bucks or something?
Jeff: Yep. And we’ll also be dripping out the bonus episodes.
Meb: That’s right. On every Monday for the next month or two, you guys will notice we just did our first one. By the time this comes out too, bonus episodes on Mondays where we’ve asked some of the authors if they wanted to read their submission that they could. So you’ll hear all sorts of different voices on the podcast. It’s a lot of fun. You get little snippets. By the way, all the proceeds go to charity of the author’s choice. And I don’t think a single charity has ever been named twice in duplicate. And it’s a pretty wide spectrum of charities. The best part was the last year. Only like five people send in their charities. And I was like, “I’m not gonna hound you people over email.” So these five people got big checks for the entire book just because no one else responded. There was one guy is like local church wrote me like, they’re like, “Oh my God. Thank you so much for this. Are you kidding me?” I said, “Well, thank all the other authors because none of them responded.” Anyway, it’s a really wonderful book. We’re proud of it. Take it for a spin and let us know what you think. Write a review on Amazon. I don’t think we have any yet. Do we?
Jeff: I haven’t seen any.
Meb: It’s a really fun book. And hopefully, we’ll be doing it for many years to come. Just laughing because he borrows a lot of the brunt this year. So you guys send Jeff thank you if you think it’s a good book. What are we talking about today?
Jeff: Let’s do our standard where we get into some of your tweets, and then let’s tackle some listener Q&A. Let’s start with one of your recent articles though. The one about nobody ever got fired for buying Vanguard. Why don’t you just give a quick recap for anybody who’s not familiar with it, and then give us the main takeaway?
Meb: I was trying to write an article and we took to twitter to do a poll. And I said, “Which title do you want?” And the first title was something like, “Are you still investing in dividends? Seriously?” But it was the S-R-S-L-Y. It’s like the acronym for millennials. One was, “Nobody Ever Got Fired for Investing with Vanguard. Maybe They Should Be.” And the last one, I forget what it was. Something about dividends. But the point of the article was, we’ve done a couple of white papers and long time listeners will have great degree of familiarity with this topic. We’ve talked about a number of times, but basically the concept is, “Look, we love Vanguard. We’ve mentioned it many times, think Bolo is a national treasure. We think that they’ve done more to help our investing world than anyone else, any other company. We use Vanguard funds, have more good things to say about them than anyone else.” That having been said, and by the way, I listened to a great podcast with Bogle. AQR has new podcasts, by the way, I forgot what it’s called, Curious Investor or something. But they had a good one with Cliff and Jack, well worth listening to.
And by the way, listeners, as we love to get off topic, we have a new feature for the idea forum where we send out the top podcast of the week. I would pay like $10,000 a year for this. Actually, we do because we hired someone to do it, but we send out our top podcast of the week, investment podcast. Some weeks they’ll be zero, some weeks they’ll probably be five in any popery episodes. But a pretty awesome feature. I wish someone else would have done it, but we’re happy to be doing. Okay. So, anyway, Jack and Cliff were talking, so I think Vanguard’s fantastic. That even said, not every fund company has all good funds, and then not all good funds are good all the time. And so, Vanguard’s got all sorts of screwy funds that are not really necessarily on brand, people don’t know this, they have hedge fund-like strategies. They had a strategy, I think it’s still around, it charges over 1% a year. They have more active mutual funds than passive mutual funds. A lot of people are very surprised about that, but in general, they’re pretty awesome.
However, we wanted to pick on the dividends space because we’ve been ranting about this for years where we said, “Look, a lot of these strategies, focusing on dividends alone is totally nonsensical. It literally makes no sense to focus just on dividends. My caveat was, of course, that if you use a valuation filter and some other screens, then it’s reasonable. But it makes no sense just to focus on dividends. And that having been said, if you do focus just on dividends, it gives you a slight value tilt historically. So what really getting is a slight tilt towards value in junkier companies. Most people think that high yield on dividend stocks are higher quality, but on average they’re worst quality. They have higher leverage, etc. So, we took a look at some of the top dividend ETFs, and the biggest, of course, is Vanguard’s. It’s got like 30 billion in assets vig. And the problem with that fund, and I think it’s based on the Nasdaq dividend aristocrats, it’s I think the screening criteria is simply you had to pay a dividend for 15 years in a row or something.
Jeff: Pay, it might be increasing.
Meb: Increasing. So Apple, the largest stock in the world isn’t even eligible for another decade or something. Right? Like that’s how nonsensical the strategy is, no valuation filter. So, the problem is going back to not every fund complex has good funds and not every good fund is good all the time. It’s already a nonsensical investment strategy, but add on top of that the fact that you’ve had this massive search for yield over the past 18 years and it’s pushed all these dividend stocks and dividend yielding funds, high yielders into very expensive territory. And we’ve been preaching this for the last couple of years. And they’re still expensive. So you guys don’t believe me. You can look at our white paper or blog post on this or type your dividend fund into Morning star and it’ll spit out the valuation, and vague is like the most expensive ETF in the dividends space, like across all the metrics, and it gives you like the same as the yield is the S&P. So why in God’s name would anyone want that? And it’s been under-performing by a mile the last couple of years and we think it will continue to under-perform.
So, obviously, we compared it to the other top five dividend ETFs, we compared it to the buyback ETF, we compared it to our shareholder yield fun. Anyway, it was just an interesting comparison to get people out of their comfort zone and think for a little bit because the origins of the article which you had touched upon because you wrote that part of it was, the phrase goes back to IBM, right? Where it was, no one gets fired for buying IBM. Meaning if you buy a product and it’s IBM and it doesn’t work, well, you can easily blame, “Hey, it’s IBM. It’s not my fault.” But if you bought some crazy new startup’s product and it didn’t work, you get fired. If it does work, pat on the back. That also goes to explain so much in our world of career risk. So, if you go buy a fund that’s Vanguard and it’s vague, you can say, “Well, it’s Vanguard.” But…
Jeff: What’s that supposed to do?
Meb: But under-performs by 20 percentage points? Then you know, “Hey, it’s Vanguard.” It’s high-quality aristocrat. I mean, great marketing, by the way. Aristocrats.
Jeff: Listeners, if you’re looking for more information on the comparisons, the white papers Meb was referencing is on our website under investing insights. I think it’s called “Think Income and Growth don’t Exist in This Market? Think Again.” Then the sister paper’s “Think Income and Growth Don’t Exist Around the Globe? Think Again.” So, you can check out the various comparisons.
Meb: If you hear that ripping sound, that’s me opening a green Kit Kat. If anyone’s ever been to Japan, they have all sorts of like 50 different Kit Kat flavors, and we had a coworker come back from Japan. So we are not eating. I’m eating a green Kit Kat. Jeff would never touch a green Kit Kat.
Jeff: That’s why I’m going to survive that fun run or whatever, and you’re gonna be over there dying.
Meb: Oh, that’s why I’m calorie loading a month ahead of time. I think it’s September 28th listeners, by the way. I’m calorie loading to get a little buffer around the belly.
Jeff: Do you wanna talk about your crossfit strategy a while ago where they had that contest and you thought that you would sort of…?
Meb: Oh, yeah. It was who could lose the most…who’d become the fittest over the course of a month or a quarter. I can’t remember which, but it was like who could lose the most fat percentage.
Jeff: [inaudible 00:11:26]
Meb: So, I was gonna try to, you know, game the contest by upping my fat percentage a week or two ahead of time. It didn’t work.
Jeff: Well, no…
Meb: I basically just got fatter for two weeks and then plateaued for a month.
Jeff: I think what happened is you got fatter and then something stopped you from being in the contest anymore, so you just stayed at that fat level. Anyway, all right. Back to Vanguard. Despite the article, they just had an announcement pretty great for investors along with Fidelity. Wanna fill us in on this?
Meb: Are you talking about the no-fee fund?
Meb: Fidelity zero. Well, hopefully, it was our rumor of doing this for the last couple of years that caused him to do this because we never really actually wanted to launch this. We just wanted to stir up the pot a little bit and cause mass panic and confusion in the industry. So Fidelity came out with the announcement that they were launching a couple zero fee mutual funds, market cap weighted. And even if they don’t ever launch them, it got them publicity in every single publication around the world, they’ve got a ton of attention, it’s good for them. And there was a lot of confusion when they launched. Why are they doing this? How are they doing this? And I had assumed that they were gonna do with the route that we express makes sense, which is launching them at zero fee but keeping the short lending revenue. That’s not where they’re doing. They’re just launching them for free, and you have to have an account at Fidelity. So they’re basically using it as a huge lead gen to try and get people into other Fidelity products, open accounts. It’s basically a toaster. They’re giving away toasters to try and get people in. And people are like, “Oh, my God, how are they gonna make money? Is it the end of the industry? What in the world?”
And then our buddy Eric Balchunas from Bloomy started tweeting, he said, “Look, you don’t need to worry about Fidelity. Their annual revenue is almost $20 billion. Their revenue alone is 2X the entire ETF industry.” So this is kind of going back to everyone’s like, “Oh my God, Index funds are crushing all the old school active managers, which is true. And all the assets are flying towards low fee, better products like ETFs, low-cost ETFs, which is true.” But still, these old school shops that have many of them, trillions in assets, it’s such a long runway and they have so much money and so much cash in the meantime. So, anyway, it’s an interesting product, but when you go back to the baseline, and today we’re comparing apples to apples, you know, they already had a total market index fund that was at one basis point, or two basis points. So really all they did was just say, “Hey, we’re gonna go from two to zero, whoop de Doo.”
Jeff: Wrapping up the publicity in the media.
Meb: Yeah. So this goes back to our whole articles I’ve been writing over the past couple years about what a wonderful time it is to be an investor. People don’t understand already. And we’ve said this many times, every time we say it, it surprises people. There’s already zero fee and negative fee funds because if you have a fund, say an ETF that’s at 20 basis points, and if they’re a good custodian, a good stewarder, capital, they’ll do some short lending and then return it to the shareholders, so that 20 basis points might actually be a negative 10, 20, 30, 50 basis points. In other words, you’re getting paid to own the fund that has a negative expense ratio, which is really cool. The problem is it’s harder to find the short lending revenue information, so it’s not like you’re gonna go on Morning Star typing a fund and we’ll see -0.5, you know, it’ll say 0.2. So it’s a little harder to compare apples to apples around this world, but these tentacles extend into every aspect of the investment business.
So Jason Zweig had a good article where he was talking about all the other ways that brokerages make money. So people said, “How is Robin Hood gonna make money when they don’t have any commissions?” Well, a lot of people don’t know this, but brokerages make about half their money from hosing you under cash balance. So, if you have a cash balance, so you just keep 10%, 50%, 100% in cash, the default for many of these brokerages is either zero or it’s a money market fund that maybe get, I don’t know, 20 basis points or something. When that fund could easily in a CD or other money market funds that aren’t from the parent company, be earning 1%, 1.5%, maybe even 2% now. So all of a sudden, they’re earning that spread of two percentage points. This is what Schwab got into big trouble, not big trouble, but they got bad publicity when they launched their Robo which was free, no commissions, but they forced you to have a huge cash chunk, which they then earn the spread on.
So you’ve gotta kind of add in all these costs and there’s a lot of different ways to think about it. So you just got to be careful as always, all the different ways you could potentially be getting skimmed off or fleeced or etc.
Jeff: Zweig’s article on that was interesting, making the point about the sweeps and how, you know, you have a right to be more in control of how these brokerages are using your money, but at present, there’s really not a whole hell of a lot you can do. You’re just sort of subject to it. It’s all legal. It’s not…
Meb: It’d be cool if there was a brokerage, and readers, maybe there is, email me. I think Michael Kitsis was talking about this where it says, “Tell you what, we’re gonna be totally transparent, and we’re gonna only charge like a basis point fee or something. We’ll charge 10 basis points. But we’re not gonna charge you commissions. We’ll act, not necessarily as a fiduciary, but we’ll act in your best interest in every way possible. So the sweep accounts will go into a good vehicle that’s gonna earn you high interest instead of some junk. We’re not gonna sell like all this crazy order flow to give you bad executions.” You know, just like it’s like almost like a fiduciary brokerage, but they’ll charge a reasonable fee for doing it.
Jeff: Start it.
Meb: No. No, no, no, no, no, no. No, no, no, no, no.
Jeff: Anything else on Zweig’s article you wanna talk on?
Meb: You know, the short lending is an interesting area because there’s not a whole, unless you’re super high net worth, there’s not a whole lot of brokerages that will do the short-lending for you and distribute the revenue. And it can be a very material revenue source.
Jeff: How many basis points we’re talking here ballpark?
Meb: If it’s a US S&P 500 stock fund, you’re literally talking basis points. So, a couple of basis points probably. And most regulated funds can only lend out about a third of their shares. So you’re only optimizing on the highest fee products, but for stuff like maybe foreign or emerging, for biotech, for real estate, you could easily be getting 50 to 100 basis points. So already covers the costs of the management fee. And then in some areas, we had a Colly Hoffsteen, or somebody, I’m sorry, I can’t even remember who, we were talking about it. It might’ve been Jacob economic peak, where he said, “The lending rate on HYG ETF is like 2% points.” He said, “Meb, you should do an ETF that just buys HYG and lends it out. And all of a sudden you have a negative 150 basis point expense ratio. Just call it HYGG, I don’t know. That’s a hilarious idea, but ironically it’s like a viable interesting concept.
So, but most investors don’t do any sort of short lending, but in many cases, you gotta be careful because your brokerages might be keeping it. So ideally, would be a situation. This is the beauty of ETFs is that most of the providers launched the funds and returned the short lending to the consumer. So they’re being good guys in the scenario.
Jeff: All right. Well, why don’t we transition from that now to another one of your tweets? Let’s get into some valuations. You had a chart from Leuthold that shows how one measure of the market has matched its 2000 valuation level, and another has doubled. Now, specifically we’re talking about the S&P 500 median price to sales, and we’re talking about the S&P 500 cap weighted price to sales. So we’ve combined that with another one of your tweets. Longboard released a study. Actually, it was a chart referencing a Goldman market study that claims quote, “In 99% of the time at current valuation levels, equity returns have been single digit or negative.” All right. So we put all this together right now and I wanna get your take on the market valuation in a second. I know it’s gonna be, obviously, we’re frothy. But, are we at a point where you’re saying, “All right. Obviously, I’m not gonna allocate more to U.S. equities at this point,” but are we at a point where you would actually recommend turning down a position based upon where the investor is? Because hell, you know, it’s better to sell and maybe hit some taxes versus sit through 30% if it’s gonna have that kind of a draw-down next few years. But you don’t know. So, how do you analyze it?
Meb: I think you should sell it all.
Jeff: U.S. stock, look, we’ve been saying this for a while. U.S. stocks are expensive. You know, we love reverencing Cape Ratio, people pull their hair out, gnash their teeth when it comes to Cape. I don’t know why. Almost any other method of valuation. If you look at the chart you mentioned from Leuthold, price to sales, hitting all-time highs, every single valuation chart says the same thing, and every single tangential valuation chart says the same thing. Like percentage of your portfolio in stocks. You know, that’s levels that predict low future returns. But that’s the way evaluation works, is it can always get higher. GMO, I was tweeting, I think they got to their highest negative prediction I’ve seen for the next seven years for US stocks, is -5% per year rio for the next seven years.
Meb: That’s Grantham.
Jeff: That’s GMO, yeah, stinky. They managed 80 billion. But, you know, I mean, it is what it is. It’s, I think as I mentioned a thousand times before, for me it’s like a green, yellow, red stop light. The valuation gets you to the yellow flashing light, and for me the red light is trend. So when the U.S. market is still in an uptrend chugging along, it’s when it finally rolls over to me, that’s the red flashing light. Not there yet. But certainly, it’s…
Meb: But you will not sit by as a passive by and hold, you will get out and act on it.
Jeff: I mean, all of our client strategies do that already. So we have a strategy that hedges half the portfolio based on valuation and half based on trend. It’s been hedged on valuation for years now. And trend, it’s not. So, it’s about a 50% net long. Anything that’s momentum and trend bases in the U.S. now, because U.S. is still clobbering everything else. U.S. dollar is going up, that’s having effects on commodities, that’s having effects on emerging markets. So the U.S. is ironically one of the highest yielding currencies and bond markets in the world. That’s crazy to think of, but it almost made it into our sovereign high yield fund. It’s weird to think about, so it’s like a bunch of emerging markets, and potentially the U.S. U.S. isn’t quite there yet, but it’s close. So it’s the same old. Nothing new to talk about, just U.S. is expensive.
Meb: While we’re on the topic of a Cape evaluation, let’s jump ahead, actually. Let’s try to make this a little bit more logical in terms of our ordering. We have a Q&A writing question. Let me go ahead and just knock that out while we’re here. It says, assuming the U.S. economy does not enter a recession in the near future, Shiller P.E. 10 year earnings average will soon consist of all economic boom and no bust as the depressed earnings of 2008 and 2009 rollout of this calculation. Average earnings will increase and the Shiller P.E will likely appear less expensive. So is this an issue of how useful the Cape is when it only includes a period of profit expansion? How do we handle this?
Jeff: We did an article many years ago that said, “What if 2008 Never Happened?” And we just sliced out 2008 and said earning stayed consistent. And, basically, it has the effect of causing Cape to go from whatever it is now, let’s call it 33 to like 30.
Meb: That’s it?
Meb: Yeah. I mean, that’s the whole point of the cave, is it’s 10 years worth. You could do 15 years, you could do 20 years, you could do 5 years. None of them matter. They all say the same thing, which is kinda the whole point. You want these very broad measures of what matters. And so, it’s funny because back when 2008, 2009 happened and people would criticize Cape, depending on their investment stance, bullish or bearish, they’d say, “No, no. You can’t use 2008 because it’s depressed earnings.” Obviously, that’s gonna have a huge effect when they roll off. Therefore, Capes will be lower and I’m bullish. But the same people also said, “No, no, Meb. You can’t use 2007. Those earnings were distorted to the upside because of all what’s going on with the real estate market was in a bubble and all these other things. You obviously can’t use 2007. Arrow Cape should be higher and you should be bearish on this. You know, so people see what they wanna see, but that’s the whole point is your valuation is a very blunt tool.
The valuations in my mind tell you, you’re gonna have pretty meager returns. It’s not like specific to two decimals where you’re gonna have -2.89% per year. That’s just not the way it works. Gerald, astronomy, your old Hubble telescope example.
Jeff: Yeah, yeah. That was a good one.
Meb: He was a big nerd astronomer as a child.
Jeff: Remember what it was?
Meb: Yeah. You’re talking about discounted cash flows. What piece was this? Was it one of our pieces? It was in one of our written pieces. Yeah. You wanna repeat it?
Jeff: Something like changing the interest rate and your DCF calculation is a bit like the Hubble telescope. Move either one a centimeter and all of a sudden you’re looking at a new galaxy.
Meb: Yep. That’s it. Thank you, Galileo.
Jeff: Yeah. All right.
Meb: So jumping from frothy valuations to a discounted valuations. You touched on GMO a minute ago. But another one of your tweets was referencing how GMO, it might’ve been the same thing, but a GMO believes emerging markets are the biggest opportunity relative to other assets in the last 20 plus years. One question on this. I’ve looked at a lot of these large-cap emerging market ETFs and a lot of them seem to have substantial exposure to China and just Asia in general. So, is that what you have in mind when you think about emerging markets or would it be better off to capture more of an equal weight emerging markets that’s not quite as weighted towards just Asia.
Jeff: Real quick before we get there. I just remembered, you know, when I tweeted this about GMO, you got this litany of people that were like, “How long? They’re still bearish. Oh my God. How long until they go out of business?” And I just responded, “Guys, like, do you realize like they managed and still manage, they manage like $140 billion, and now they manage still like almost a hundred.” You’re not going out of business if you manage $100 billion. What are you talking about? But there’s a classically GMO in Grantham during the 2000 bubble, lost about half their assets while clients left during the late technology boom. And then came back in spades after the bear market. But it’s just funny to read people’s responses because they’re, “These guys are always bearish.” And I said, “Well, that’s interesting.” I went and looked up the March, 2009 projection for equity returns and for U.S. It ranged from 9% to 15%.
Meb: GMOs said that in 2009?
Jeff: Right, because at the bottom of the bear market, right? And so, high quality was something like 14% or 15% per year for the next seven years. So people love to get, you know, negative about people projecting something against their worldview. Anyway, I think it’s interesting, but so, to the cm chart, they had published a chart that says the margin of superiority is they looked at all the assets they track, and the one that’s number one, which for them right now is emerging markets. What’s the spread between that and the second best asset? And so, right now it’s the highest margin you’ve ever seen. So emerging markets look better versus everything else and it’s not even close. Now, this isn’t in their mind, this is not necessarily it just ringing endorsement of emerging markets, but rather it’s just everything else is so bad. So if you look back to the 1999 bubble there are at least places to hide, so small caps, dividend-paying stocks, even real estate commodities, bonds, all those did fine through the tech bubble. But the example right now is a lot of people have coined the term everything bubble with a lot of stuff just looks more expensive. Now, I disagree. I think foreign developed and emerging are quite a bit cheaper and I think you can actually potentially see double-digit returns in the cheap stuff.
Meb: So even foreign-developed. I know EM’s pretty good, but you still think there’s a lot of good foreign belt.
Jeff: I liked foreign-developed and emerging, but if you look at the cheapest countries or parts of the world, a lot of that happens to be in foreign-developed. So if you had to choose one or the other, emerging markets are cheaper than developed markets. So, if you look at Cambria’s shows, for example, U.S. is at 33, foreign-developed maybe 22. I’m spitballing here. Emerging markets maybe 15. So, there’s no question emerging are cheaper. However, if you just look at the cheapest bucket, a lot of the cheapest countries are still developed markets. I think a lot of Europe, right? Depends how you wanna characterize Greece. But anyway, so going to emerging markets, and, again, it’s so much simpler than people make it out to be. A lot of these countries are, U.S. is hitting new highs, a lot of these countries are down 40%, 60%, 80%. And Turkey pretty soon gonna be down 99.9%. They’ve just been puking very quickly getting into the cheapest bucket, the cheapest of the cheapest bucket. We still have Russia as the cheapest but not by far. So, anyway, back to your question.
Meb: About China, as Donald Trump would pronounce it, China, there’s the Quan side of me and then there’s the sort of subjective side of me. Subjective side of me loves the China story, loves it because I think Chinese equities are cheap, loves it for a long-term play. And even on the Quan side, Chinese equities are cheap. Okay? And it’s a big story, you should go look the podcast, go back and listen to a lot of people have talked about it. As China gets added to a lot of these indices, there’s a lot of dollars that have to flow into China regardless whether they want to or not. By mandate, a lot of these indexes have had under exposure to China, are gonna be forced to buy it over the coming years. So I’m in particular a bull on China. But your question wasn’t really that. Your question was kind of how do you weigh emerging market exposure? So it’s funny because, again, do you characterize certain countries as developed or as emerging, or as frontier and sometimes they come in and out. It’s like that soccer leagues in Europe, right? Where you win, you move up to the next bracket, you lose, you go down, etc.
So some of it’s a little bit arbitrary, but emerging markets currently, China’s the biggest chunk and by far. But it goes back to the age-old question, you know, do you create these arbitrary geographic style and size buckets? So geographic being U.S. foreign developed, foreign emerging frontier, style being value and growth, but any other factor and size being large cap, mid cap, small cap? Or do you just say, “Hey, I’m totally agnostic, and I’m gonna go bottom up and buy the 200 cheapest stocks around the world wherever they may be and have constraints based on sectors?” There’s a million different ways to skin the cat. And I’ve said, using one of our funds compared to like one the West’s funds as an example. Totally different mandates, they end up in the same place because when you broadly do value, you end up in a lot of the same places. It’s kind of a shotgunny. You know, there they overlap. But also you’re avoiding the really expensive stuff. So if you would say, “Meb, how are you gonna do emerging markets?” My entire 401K because we can’t use Cambria funds, just defaults into a market cap weighted Vanguard emerging market fund, every month. And dollar cost average in.
Meb: So I’m assuming that does overweight you in Asia.
Jeff: Yeah, well compared to the global market cap. I mean, compared to the global market cap or compared to emerging markets?
Meb: Emerging markets.
Jeff: Well, it’s not an overweight because that is the market cap, but yes, you are highly exposed to Asia.
Meb: Right. But my question though, I guess is, yes, I agree and that’s all as it should be. But if you’re really trying to play emerging markets and capture all the potential gains from these various countries that have great locates that are probably lower than China, is there no room to say, “All right, 10% Russia, 10% China, 10% Greece, and you just keep going.”
Jeff: Yeah. Now you’re describing our largest fund. Thank you.
Meb: There’s a million different ways to do it and providers have a lot of different methodologies, but value to me is still a totally reasonable approach. I mean, market cap is a great first step, adding value, adding other ideas I think are totally reasonable.
Jeff: All right. Anything else on this one?
Jeff: All right. Next tweet. Moving from valuation. Let’s get into some biases. You had a chart that demonstrates investor allocation by region here in the United States, and takeaways that home country bias doesn’t just apply to stocks and your country. It also applies to industries in your region. So, it’s an interesting sort of graphic of how out here on the west coast, a lot of people are overweight technology and they’re underweight technology in other parts of the country. So, one question for you, Meb, how much of this sort of behavioral bias based upon region, how much of that really is bad investing versus qualified plans? People investing in their own companies that are specifically…
Meb: So much of the bias out there, and so much what goes on in investing is just people just kind of letting it fluctuate and ride. So the allocation by region, the west is higher exposure to tech taxes, higher exposure to energy in midwest, industrials, Northeast financials. That all makes sense. But it’s probably because, yeah, like you mentioned, everybody in New York City works at banks who then have put their foolishly, by the way, put their retirement plan also in the company stock, same thing that people did at Enron in Texas, much to their dismay and detriment. Same thing that people do in Silicon Valley with tech. And they just let it ride. But it is still a very active bet, and it’s still one you need to be aware of. It may be smart, and you may be making it intentionally but still an active bet.
Same thing with US versus Foreign. I think it’s very foolish. a lot of people would say, “No. I want a huge home country bias in the U.S. I’m comfortable.” Then I say, “Fine, go for it.” But I think it’s a very foolish uncompensated for risk.
Meb: You know, there’s some anecdotal sort of tangential evidence that happens. Like magazine covers stuff. So, we recently saw, Robert and I was talking about the largest companies in the world by decade and usually it’s a mix, but during certain periods when certain countries are doing much better, mid 2000s is China, 80s isJapan, you know, you see the representation of what percentage of the top 10 or where. And right now I don’t remember if it’s the top 10 is all U.S., but it’s pretty darn close and it’s pretty much all tech, which is crazy because you go back a few years and it’s a mix of all sorts of different countries, you know, in the top 10. Part of that is a good example where recently, Apple just hit the trillion market cap mark. First stock, first company to ever hit a trillion. We actually had an article from Brian Taylor who was on the podcast from global financial data who had compiled the firsts for various milestones, which I thought was really cool. The first million dollar market cap in the U.S was Bank of North America. The first 10 million mark cap, Bank of the U.S. First100 million market cap, New York Central railroad. First a billion AT&T, first 10 billion GM, first 100 billion GE, and first trillion, Apple.
And then if you do it globally, it’s even more interesting because again, going back to the same example, the U.S. the whole snowglobe isn’t just the U.S. but first million dollar company in the world was Dutch-East India company, famous, very famous company. First 10 million same thing. First 100 million, another famous company, Mississippi company. First billion AT&T, first 10 billion GM, also the U.S., first 100 billion, Nippon Telegraph and Telephone company, is Japan. And then first trillion, I said Apple, but I think it was actually petrol China briefly, which is sense just gotten murdered from the Chinese and commodity bubble in the mid-2000s and that’s deflated. So now it’s just Apple. And historically, it’s funny, any time a company has hit 4% of market cap in the U.S. as a percentage of the stock market, it’s been like the death now and really struggled afterwards.
Jeff: We talked about on the show was not, who was that?
Meb: I dunno, probably me. Like returns going forward were…it’s probably me and you, we’re on flashbacks. Listeners, Jeff started microdosing LSD during the podcast. So if he starts saying some weird words. No, so that was… We talked about it, and it might’ve been lethal because they’ve published charts on it, but it’s sort of one of the things that are interesting. It’s kind of an artifact of data mining because there’s plenty of other countries where stocks represent 10% or 20% or even sectors where they represent way more. But in the U.S. historically that’s been a bar. That’s been really hard for stocks to get above that 4%.
Meb: Again, it’s just color on the painting of when everything in the globe, all the biggest stocks are U.S. When U.S. is outperforming everything, when the U.S. is, you know, one of the most expensive countries in the world, those are all sort of the same data point expressed five different ways.
Jeff: It’s interesting. There’s the, you know, what you just mentioned would serve as a bit of a red flag for Apple, or at least a sort of investment with caution. But then, the news we just got either today or yesterday was that buffet had either increased or held his large position on Apple.
Meb: Well, don’t forget the news is always good for the stuff hitting new highs. Like the news is always good when you’re on the left side of the chart where you’re hitting new highs, like that’s the whole point. That’s how you got there. The news is always bad with stuff that’s cheap, but personally, I do agree. I think, I mean, I love Apple. I think it’s not very expensive. It’s in some of our portfolios quantitatively. We’re not picking it. I think, by the way, listeners, if you don’t own a pair of air pods, it is the single best product I’ve bought in probably last five years.
Jeff: That’s an amazing exaggeration.
Meb: It is. Name something better. But I said that other thing is…
Jeff: That you bought?
Jeff: That you’ve bought?
Meb: Yeah. My other thing is my levitating plan, the life planner. That’s up there, but…
Jeff: The one I destroyed with the pen?
Meb: Yeah. If I lost airpods, I would immediately replace them. They’re magical. Just full of delight. You need to get a pair. I’m serious. When you do your run walks.
Jeff: This should go back to that segment we did a couple of years ago on this show, something I find useful, magical…
Meb: Beautiful, useful, magical.
Meb: It’s the best thing I’ve purchased in years. Listeners, get a pair. If you use special code, M-E-B. I’m just kidding. All right. Let’s move on to private investing VCs. You had a graphic with the title monthly count of VC deals raising 100 million or more worldwide since 2007. And the takeaway basically is from 2007 to 2014, that number hovered around five per month. Starting close to 2017, the number skyrocketed. Now, has had nearly 40 and has a vertical slope. So is VC in a bubble? What’s going on there? You’re doing a lot of investing in that.
Jeff: Actually, I started seeing increasing amounts of bad behavior.
Meb: What does that look like?
Jeff: Well, a couple things. One is sort of like misleading efforts. I saw a write-up. I mean, the biggest challenge is the private is buyer beware because you just don’t have that much information. And so, I had a syndicate come across where I read through it and I’m like, “Oh, I remember this.” I was like, one of the first people I’m friends with founder. I was one of the first people to like download his app from three years ago, and then I emailed him. I was like, “Dude, congrats on the new round. I’m excited to participate. I’m gonna kick you some cash. I wanna follow you. I like you, etc.” And he wrote back, he’s like, “Hey, thanks, man. The news isn’t actually public. Where did you hear about it?” And I said, “Oh, there’s a syndicate going on for investors.” And he said, “Oh, that’s interesting. Can you let me know where you saw that? Because that’s not authorized.” I said, “That’s weird.” And sent it to him. And I said, “Oh, that’s a bummer. Okay.” And then got news that the syndicate was closed. And then a few days later they said, “Oh, there’s a new syndicate map, do you wanna invest in this company?” And I said, “Sure.”
Meb: Wait, wait, wait. Was the syndicate trying to solicit your money and they’re gonna just walk away with it? And then close down?
Jeff: No. I don’t think it’s fraud. I mean, if I had to guess what happened is that, let’s say like a VC got a $2 million allocation and somebody at the VC or somebody related to it is trying to carve out their own separate little allocation so that they get paid to carry instead of the company or something, I don’t know. It happened a second time. I am out with him and I go, “Oh, I see you figured it out. I’m looking forward to participating.” He said, “Are you kidding me?” He Said, “No, this isn’t legit.” And so he said, “I’ll tell you what? I’ll just let you invest through the actual real round, just give me her information and we’ll do it.” But…
Meb: That’s sketchy.
Jeff: Yeah. And then the other one I saw was, and I think most of them are legit. Look, let’s be honest. I mean, again, it’s buyer beware, you invest in a brewery and the brewery goes to zero, that’s on you and that’s fine. But at least like make it real, so not being misleading. Another one was doing around, was it here? They’re growing revenue last year, 50% growth from two to three million. So, as I do, just Googling and spending time researching the company, trying to find information and reach out to friends. And the company has been around for a while and has done a pivot, I think, but a couple of years ago it was doing like 12 million in revenue. And I said, “How?” And I emailed the guy and said, “By the way, this company, it seems like it was doing $12 million in revenue. It’s kind of misleading to say it’s doing two, and is now growing 50% year over year to 3 million when it used to be doing 12.” And he goes, “No, no. That’s not true.” And I just send him the link. So I was like, “Look, this was in this magazine, this magazine, this magazine,” and never heard back. I was like, “That’s pretty sketchy view to be sending this out to everyone. It’s like really misleading.”
Or you have done no homework, in which case it’s also embarrassing. But you start to see. I mean, having done about 50 of these deals, you see a very large separation between, I think the really excellent leads and I would put some of our guests on there, Phil and Adele, Jason Calacanis, a couple of others. They require pro rata rights. They say the companies have to updates all this good behavior. And then it’s like almost everyone else. So many of these companies just don’t even do updates whatsoever.
Meb: Well, how did you? All right. So, if we have listeners out there who are on angel list or whatever and they’re looking for syndicate leads to follow. Sure, there’s some big names like Nudel, Rubalcava. But besides that, if you’re trying to find anybody new, are you shooting from the hip? Because it sounds like you’ve found a couple sort of side tangential guys to follow and obviously a couple of them are kind of flaking on you a little bit.
Meb: If you remember back to the early days of me starting to do this, I said, “Look, I’m gonna spend some money doing this. I expect it to be tuition. If I lose all of it, fine.” And it’s actually worked out great so far, knock on wood. But I consider this tuition, I wanna learn. There’s no way I’ll follow this to the extent that I need to without putting real money to work. So I’m gonna spend the time. And so, having done this, I’ve started to filter out the guys that are kind of clowns and the guys that are legit.
Jeff: All right. So, tell our listeners what is one of the filtration methods?
Meb: And part of this is personal. I don’t fathom, cannot fathom, don’t understand why anyone would not give updates. Even yearly, quarterly is fine, monthly, great. But like so many of these companies just do no updates. And I don’t understand that as a founder, as an entrepreneur, as an investor, because what is your biggest resource? It’s this magical group of people that’s given you money as an invested, interested in seeing you succeed. You should be using them as a springboard, you know, as a resource. Not as an antagonistic, “Oh, I don’t have time for you, sort of thing.” Like, that’s absurd. So that’s one for me. But that’s personal. Some people don’t care about updates. Right? I think that’s crazy. Anyway, but we talked about some of the bad behavior going on the podcast with, I think it was Jason too and Phil. So, I don’t know how you would avoid it other than spending the time following people.
Jeff: Had you, going back to your previous example, had you not known that founder and reached out to him personally, do you think you would have sent in money? And was that just gonna be one of those?
Meb: I tried to send in money.
Jeff: But was that gonna be one of those just hard learning lessons or you think that was just gonna be gone? Written it off?
Meb: Well, it’s not gone. It’s not like someone’s just…It’s not like ponzi scheme or fraud where they’re keeping the money. I think that it’s in that specific case, it was not authorized. My guess is that someone tried to peel off their own piece of the pie.
Jeff: Oh, okay. Fair enough. So, it wouldn’t have been that bad, but let’s say it was a little more nefarious in nature. That was the deck they sent you, I mean, would you have bought on it in terms of good revenues? Everything looked fine on this guy?
Meb: I love the idea, which is funny because I don’t wanna get into the specific company or even the website, but the first idea was so non-sensical and you guys actually downloaded it and used it. And the second idea they pivoted to immediately I was like, “Oh, yeah. I love this. This is brilliant.” This is so much better. But it’s so funny because a phrase I have referring to a specific company who’ll also not be named. The funny thing, Silicon Valley pivot is seen as like a fan. It’s like the best thing, like, “Hey, congrats. Kudos. You realize your business is failing, pivot it to something else.” But I love the phrase that Silicone Valley calls it a pivot. The rest of the country just calls you being full of shit. You know, and so, in so many cases where someone, in the case where it’s like, you believe something and it’s a philosophy, and then you shift to something else, people are just like, “Really, dude? Like, come on.” But if it’s a business model and you’re actually trying to find a product-market fit, it’s beautiful, it’s a wonderful thing. It’s a fine line in some areas of our world.
Jeff: It’s a nice euphemism.
Meb: Yeah, you feel free to steal it, just cite me. But there were two other really horrible pieces of behavior that crossed my mind and then, oh, what was the other one? The other one was this magazine that says, “Hey, Meb, good news. I’m writing a profile of Cambria in this published magazine that many people on this podcast listen to or read. Can we talk on the phone so we can like, get a little more background?” And I said, “Sure.” And they said, “Oh, by the way, just FYI, just so we can help, you know, we’re writers so we need help keep the lights on here. We actually asked the profiles to sponsor, you know, an advertising campaign on the issue.” And I said, “Well, we don’t do any advertising. So just, that’s a no.” And he was basically, “Okay. Well, I guess we’re not going to do it.” But I was like, “Oh, wait, that’s the pre-requisite?” By the way, there’s another one. If any of you have fallen through this for this next one, then this is on you. I get emails at least once a quarter, maybe once a month from a production studio. I think it’s based in Florida, not surprising. And they do segments on whatever your industry is. The old ones used to be narrated by Shatner or Larry King and the new one is Rob Lowe.
I got one yesterday and I was like, “Hey, Meb. We’d love to feature Cambria in a segment on global investing. And Rob Lowe will narrate it and like help produce it,” and I haven’t responded to the last 75 of these emails, but it’s like 20 grand.
Jeff: I remember talking to you about the Shatner one.
Jeff: It looked good on the surface, and then you spend five minutes looking into it and they basically want you to open up your wallet.
Meb: Silly scammer. At every turn, there’s just scammers everywhere. What were we even talk…oh, so, going way back to the original question, which was talking about VCs. Look, when money’s sloshing around year 10 bull market, people can call QU, whatever. Well, there’s a lot of money to be had. You see a lot of particular nonsense going on, right? The percentage of these ICOs that are failing is like 90-something percent. That’s where we talking about, by the way, people absconding with your money. Good luck. I can’t even name a single ICO that has a product or a business that anyone uses. Can you? I can’t.
Jeff: Not a fan.
Meb: Anyway, yeah. Let’s go talk about when there’s all this money sloshing around in your cryptos and all the funds are charging three. So private equity and venture capital funds are at record levels of fundraising. And what they can possibly gonna be spending all this money on? The private equity guys, we were talking on the Rasmuson episode, it just causes the valuation to go up and up and almost all the evidence shows that all the returns come from buying low valuations. But you think all these black stones of the world are gonna sit on that cash or return it to shareholders? Yeah, right. You’re getting 2 and 20. You’re gonna find something to buy.
Jeff: Great episode.
Meb: That’ll lead you to Tesla.
Jeff: Great older episode of Silicon Valley where they were talking about the valuation at which the company should go out and they were getting offers for whatever, 100 million or whatever. The astute VCs advice was not go out at 25, so you have more ability to grow and you’re not sort of pegged to this high valuation where you can expand from there. So, I guess that’s not what we’re seeing now though. A lot of money out there.
All right. One more tweet from you then we’ll just hop into a couple of listener Q&As;. Posted on an article titled, “Do Americans have enough emergency savings?” So, it went on to kind of give the same spiel everybody’s heard, which is basically that it’s not that clients don’t understand the need for a savings fund, they just don’t have enough in mind. Meb, you are a big proponent of written financial plans. And we kind of touched on that on our investment pyramid piece, but for listeners with smaller capital basis and for younger listeners, you know, what’s the suggestion for the balance between having enough savings and cash or money market to help out in case of an emergency, but it’s really doing nothing for you, o real returns, no interest, versus the need to have, you know, your money working for you and the benefits of the long-term compounding? But if you have it working for you, then you don’t necessarily have it as readily available if things go bad. So, how do you find that balance? And have you written that out yourself?
Meb: You touched on a number of different topics here. The first is the woeful state of most Americans’ savings, and that’s kind of terrible. And, again, it goes back to it’s easy to give this advice, but if people are living paycheck to paycheck, it’s hard to really get by. Now there’s a whole movement of people that are trying to live more frugal lifestyles, Mr. Money Mustache is a famous one, you know, Colorado actually got. So it’s easy to say, probably harder to do in reality. So there’s a tradeoff when you’re living on the bubble of survival day-to-day, month-to-month of the desperation of putting money away/enjoying today. You know, but how many examples have we seen of frugal people that have saved money and become multimillionaires? So many, of the janitor, of the teacher, of everyone who just thoughtfully saved and put away money. So it’s doable. It’s absolutely doable when making reasonable decisions. As much guff as I give Dave Ramsey on his investment advice, I think his personal finance advice is almost universally fantastic, which is you don’t need to buy a $50,000 car when a $5,000 one will do. Stuff like that. So, it’s tough. But, yes. I think it’s important to have a buffer life. It’s so much simpler when you don’t have credit card debt, other sorts of debt, and you have a cash balance. It’s a big sleep at night sort of thing. I think you and I both can relate to that.
We’ve had periods where life with debt and uncertainties it’s kind of miserable. On the flip side, let’s get into a philosophical discussion, which is, let’s say you do have some assets, a lot of people have what they call an emergency fund or cash balances, etc. And we discussed earlier in the show, cash balances often get paid zero. Your Bank of America account, probably zero. If you have a sweep, you might, depending if it’s a conflicted brokerage, you may get 10, 20, 30 basis points, but you really should be earning more in a CD or bonds, but the interesting debate, and I’m trying to convince our friend Dan Egan at betterment to write this article because it was originally his idea, it’s what he doesn’t practice in real life, but I consider him to be somewhat of an outlier.
He actually uses his brokerage account as a checking account, pays bills, everything, and he uses it. The default is his investment account at Betterment. And so, this is fascinating to me because I said, “Okay, most people would never do that because of the fluctuations. You run the risk of having a draw-down. You run the risk of month-to-month volatility.” But if you flip it on its head, say okay, let’s say you invested your checking account, emergency account, and the most risk-free asset, T-bills. Okay? Historically, that’s gotten you about 1% after inflation. However, due to inflation, that’s lost 13% in a year and it’s also had a 50% drawdown. So there’s a fun thought experiment. You say, “Okay, if you invest in the global market portfolio, a diversified portfolio of stocks and bonds, yada, yada, yada, yada. You could be earning instead of 1% a year, 5% a year, real.” So, or call it, you know, instead of it being 4% nominal, back when interest rates were 4%. Instead of 4% you were earning 10% for probably not much more volatility and drawdowns.
So, you’re the old copywriter. The headline can be something like how your savings account could yield 3% more per year. And essentially, no more risk, no more volatility. And it’s an interesting concept. It’s philosophical, it’s a philosophical one.
Jeff: I’m not fully following how you set this up because if I’m writing checks on some account, it’s gotta be completely liquid. I can write checks on it. But you’re also saying that you invest in T Bills. Help me understand.
Meb: My comparison was, “Okay, let’s say here’s your Bank of America account.” And let’s say you have $100,000 in it. And let’s say, you know, and that $100,000 is gonna earn, if you put it in the default Bank of America, probably nothing. If you optimize it, you’ll maybe make a thousand dollars here. However, if you put it in a Betterment account as an example, that is investing that money, and you make the historical return, 5%, 10%, all of a sudden that $1,000 is actually $5,000 or $10,000 yield.
Meb: All right. So are you saying that I have to sort of realize a gain to get the cash to pay my electric bill though?
Jeff: I think the beauty of a Betterment account and a lot of these accounts is they optimize your withdrawals and deposits for taxable purposes.
Meb: So, it’s an interesting takeaway. So the takeaway being if you’re comfortable with a little more volatility on a nominal basis, then in the long run, it’s actually quite a big benefit to keep your money invested rather than keeping in nothing.
Jeff: Idle cash kills long run. But…
Meb: I don’t know if it kills.
Jeff: I think it’s dangerous.
Meb: It murders people.
Jeff: But then it goes back to the idea that we’ve talked about is like at what point does it make sense to kind of wait, keep your money in the side and hold out for a big chunk allocation versus putting it in? We’ve talked about this a million times.
Meb: Like, but that’s like more of a new money, new shift strategies, someone inherits a million dollars sort of thing, right?
Jeff: But still I think that’s a good paper, right?
Meb: But again, that’s why the preface of this conversation, I said it’s a philosophical question because on math you should invest it. There’s no question you should invest it instead of letting it sit in the money market account.
Jeff: But that’s the paper. At some point, I remember us talking about this and you’re like at certain valuations, it does potentially make sense if you have a chunk, not just your sort of daily, you know, monthly 100 bucks, 300 bucks. If you have a big chunk, there might be certain valuations at which you say, “Nah, I’m not gonna put in half a million.”
Meb: You got your dollar cost average because as the market eventually comes down, you know, but I’m talking about a diversified world allocation, not just if you’re gonna invest in U.S. stocks. But anyway, it’s a fun idea. Maybe we’ll drag Dan on here and make him defend himself and talk about it a little bit. A think it’ll be a lot of fun.
Jeff: All right, a few listener Q&As;. We already tackled one on Cape a minute ago. Let’s talk about momentum funds. So we’ve got a question here that says our momentum fund’s just camouflaging another factor. For instance, if value became the end factor, wouldn’t momentum pick it up? So momentum would then just look like a value fund.
Meb: There’s plenty of times when factors overlap. And so, I think a lot of the work currently being done is on a lot of other factors besides value and what their valuation looks like at times. So people will say, “Hey, here’s the low vol factor research.” Philly’s been doing a lot of this and says, but you really only get compensated when the low vol factor is cheap. You shouldn’t be buying it when it’s expensive, which just totally makes sense. Now the implementation I think is a little bit harder.
So there are times where we mentioned dividends stocks are cheap. So there’s overlap there, late 90s. There’s our time when dividend stocks were expensive right now. So there are times when value and momentum intersect and there’s other times when momentum is purely buying the fangs. So who knows? My favorite as we’ve talked about many times is when value and momentum intersect. So then you start to get into should you treat factors individually where you’re buying a value fund than a momentum fund, or should you buy multi-factor funds where you’re buying both and the same? I lean towards the latter. Most of our funds are multi-factor, but I’m somewhat agnostic. So, yes. If you buy a momentum fund, at times, you may end up with a bunch of utilities companies. Other times you may end up a bunch of expensive tack, and sometimes you may end up with a bunch of cheap tech. Who knows?
Jeff: You ever tried to personally sort of rank tilts, like let’s say momentum was cheap, value is cheap, you don’t want… Well, it’s something else that didn’t overlap as well.
Meb: But this is the HQR side of it where they say it’s really hard to time factors. We did this many, like probably a decade ago on the blog back when we used to talk a lot more about currencies. I feel like in a different life, Jeff, you would probably have been really interested in currencies instead of options. Have you ever traded options on currencies? Maybe that’s perfect. Talking about overlap.
Jeff: There’s a rabbit hole we don’t wanna go down right now.
Meb: So, but we looked at, so for example, carry, which is simply yield in bonds or currencies globally, and carry got pummeled in the financial crisis, but the basket of the stuff you’re buying versus the basket of stuff you’re shorting. It was the same analysis. When the basket you were buying was cheap, returns were a lot better in the basket. When the basket you’re buying is expensive, returns are a lot worse. It makes sense. So, anyway, and then the currency is purchasing power parody, but stocks could do price earnings, cash flow, whatever. Same sort of theory. But I think the challenge is not as easy to implement as the theory sounds.
Jeff: All right. So, bottom line is it’s not always gonna pick up something else. It’s not gonna be the camouflage. All right. We just covered the one on Cape a minute ago. So next question, “Regarding your global value strategy, have you ever tested the strategy using relative cape ratios versus absolute to determine country allocations in order to avoid countries with structurally low cape ratios?”
Meb: Yeah, this is one of those consistent questions we get on the podcast. I feel like we need to add a section of the website just called FAQs and we’ll…
Jeff: We already talked about that.
Meb: Did we?
Jeff: We need to do it.
Meb: And that will be the first section is that we’ll need to talk about a section on the podcast that frequently referenced Meb, referencing, doing frequently referenced FAQs. Yeah, so this one is I’m agnostic. We look at it both ways. The problem I have, and Schuller actually does this with sectors is that it will have a huge bias to bubbles in booms. And so, in Japan, you had this massive, the biggest bubble we’ve ever seen. So if you did relative cape, that means Japan is cheap on any cape level below 50, because it spent a ton of time in this bubble above 40, 50, 60, 70, 80, 90, and then backed down for 20 years. So that doesn’t make a whole lot of sense to me.
And then if you have a country that is structurally low, it’s called Russia, and something shifts while then you would always think anything above five is expensive. So I don’t like it one, but it historically hasn’t made a whole lot of difference.
Jeff: Okay. All right, next question. “I’ve never heard of a 401k plan offering ETF options. Is there a reason logistically, legally, etc, that prevents 401k plans from offering ETFs? You’ve discussed a lot about the advantages over mutual funds for long-term savings. So why aren’t more available for 401ks?”
Meb: Let’s back up and say that, you know, a lot of people say once ETF’s finally getting into retirement accounts, that’s gonna be the death now for mutual funds. You know, you lose one of the biggest benefits of ETFs in retirement accounts, and that’s the tax efficiency. I got into a grumpy tweet storm last night where I mentioned, I said reasons to start a mutual fund moves that ETFs. One, on average mutual funds are twice as expensive as ETFs.
So the average expense ratio with mutual funds is 1.25% versus 0.51% for ETFs. Two, mutual funds are vastly more tax inefficient. So there’s a lot of different studies, but it’s approximately extra 0.8% tax drag from owning a mutual fund. So you add those two together and you’re up to, you know, 1.5% spread bar that that fund needs to outperform just to hit the ETF bogey. That’s crazy. And lastly, there’s an article that you sent to me in the financial times that most mutual fund managers have nothing invested in their own fund. And I actually said that’s pretty smart. They shouldn’t have anything invested in their own fund because it’s really stupid because it’s expensive and tax inefficient. That all having been said, I actually don’t think that 401k and retirement accounts is like the killer app for ETFs because they lose that tax issue.
They’re still cheaper, but one of the main benefits is gone. So, yes, would I rather have ETFs in the lottery retirement accounts? Sure. The problem with a lot of the retirement accounts, they can’t handle the intraday trading. It’s the end of day trading. And so ETFs, unless they bundled the orders or do something, they’re not gonna be able to…the structure of the funds aren’t set up to deal with ETFs.
Jeff: All right. So you would then say then for retirement funds that strategy potentially trumps cost and expense ratio?
Meb: What strategy? Well, that’s the point. Stress strategy that’s gonna give you better returns is probably more important to look at than…
Jeff: I think the number one consideration almost always is expense ratio. Like, that’s the bar. So I think you want as cheap as possible in your retirement account. Half of these retirement accounts have absurd management.
Meb: But you’re just saying that the retirement, that the costs and benefits go away in a retirement account.
Jeff: No, no, no. The tax benefits.
Meb: Tax benefits, okay.
Jeff: The cost benefits remain, yeah.
Meb: And the 401Ks in a lot of retirement accounts use it as an excuse to just hose you on fees. It sucks. And so, I will highly encourage people, if you don’t know your retirement plan is charging you to find out, you will probably be shocked. A lot of times there’s crappy fund options as well. So Cambria uses Vanguard just because obviously we love them, but a lot of these companies are predatory. But you can Google. You can like if you do 5-29 plans, Google the best 5-29 plans per state. You don’t even have to use your own states. So, there’s a lot of ways, if you do a little homework, to hopefully find a better one. But they are historically just burdened with a lot of crazy. And so, for example, I had tweeted the other day, there was an article in the journal, and could have been based on, I don’t know, an old article we wrote about how it’s crazy there’s all these S&P 500 index funds that still charge 1%, 1.5%, to 2.2%. And they’re literally based on the same exact index that charges three, three basis points, 0.03%.
And so, all those people, I said, why in the world would you ever pay? It’s literally the exact same thing. And a lot of people emailed in to me, and they said, “Meb, actually, you know, problem is, this is the only option in my 401k. Is this dog shit stock fund that’s S&P 500 that charges 1.5%? So it’s, again, the internet shines a lot of light and disinfectant on these areas. So eventually, hopefully they will go away. People hopefully will vote for the doors, but it is such an awful practice just to fleece people in their retirement accounts because they don’t have any choice.
Jeff: Yeah. It was forced them into it. All right. Next question is actually, we’re gonna combine two, because it’s pretty much the same thing. First one starts off, “I like your shareholder yield strategy, but if I get capital return through buybacks and share appreciation, how do I get monthly income without selling shares and triggering taxes? Do I just leave enough cash in my account to pull from each month or use bond ladders? I don’t see how I can implement a monthly income plan with this strategy.”
Meb: I mean if…
Jeff: Whoa, whoa, whoa. Second question was kind of winding a little bit. So that it really reduces to, how do I structure my portfolio for a 4% yield after tax? Both looking for income.
Meb: I have a hard time with the A and B questions because I have a hard enough time answering one question alone without getting off track. So we’ll try. I mean, here’s the thing I’ve never really understood about the income set, is let’s say you need 5% income this year. We’ll invest 95% of your money, leave 5% in a high-yielding, as we talked about earlier, money market account that’s gonna get you 2% and just spend that over the course of the year and be done with it. Like, why do people have to max out 100% on the investment and look for some sort of yield? Like it’s the craziest thing. I mean, they have these managed payout funds so that you can buy a fund that’s managed payout that every quarter will hit 4%. But half the time those guys have to do capital return as well. So, if you invest in a portfolio that only has a 2% yield, what those funds will do is they will give you your 2% yield, and then they’ll return 2% of your capital. So it’s crazy.
Jeff: [inaudible 01:05:58] almost.
Meb: Right. But you’re gonna be paying taxes. Like they have to then sell it, and you pay taxes. So you have a couple options. One is you create a synthetic, but it’s not like dividends magically, let’s say. Okay, let’s say the question is reframed. Let’s say, “Hey, Meb, I want an 8% yield. I need 8% income.” Let’s make it simpler. “I need 10% income per year.” Well, you’re gonna say, “That’s crazy. Where are you gonna get 10% income?” So what are you gonna do? You can either max it out and sell some down each month or quarter as you need the checks, but that’s totally unrelated to what your actual income is.
Jeff: I think the assumption all these people are asking earlier is they want their cake and they’re gonna have it too. Where, basically I wanna invest 100% of my investible funds and from that, give me my 4%, from that give me…they don’t want the sort of 90% let it ride.
Meb: Just put the amount of income you want in cash and invest the rest so that you achieve the ultimate total return. We showed the mistake of this in our white papers. We said if you’re focusing on dividend yields, in many cases, particularly right now, you have a much more sub-optimal approach that despite the fact that you have a higher yield, you’re gonna have a lower total return. So you’re penny smart pound foolish. So if it was me, I would leave 5% and say, “You want a 5% yield?” I’ll leave 5% of my checking account, optimize it so that it’s getting 2% a year at Goldman or Ally. How do you say it? A-L-L-Y? Ally Bank? maxmyinterest.com. I’d use one of those services to max out my cash interest so that it’s getting 2%. So, it sits in there, and then the next year I’ll do the same thing. That way you don’t have any capital gains. You’re not even paying any dividend taxes.
Jeff: I think theoretically some people would be saying, “Well, I don’t have enough capital base for that percentage to give me what I need.”
Meb: No. It’s because most people magically equate getting a dividend check with getting a check from their company and it’s not the same thing. A company that’s sending you a dividend is just returning some of your cash, the same way they do if they buy back shares. They’re not magically sending you earnings on top of your stock certificate. It’s not the way that it works.
Jeff: All right. Let’s see here. Last question, “Can you explain step by step process of conducting a backtest? I wanna know what you’re doing once you get the data so I can explore my own trading ideas.”
Meb: Jeff’s getting a little sleepy over here. I think it’s because his blood sugar’s getting low because he didn’t have any green Kit Kats. So backtest, I mean, look, this is pretty basic stuff. You come up with an idea, a theory, a hypothesis, a scientific method, you test it. You know, where people get into trouble, of course, is the idea itself is flawed or silly. We said, “Hey, there’s many people, these academics that have come up with backtests where they just buy all stocks starting with the letter Q, or they look at all 26 variables and some of them are gonna vastly outperform because of randomness. But if you do 26 tests, you’re gonna end up with one letter that’s the best.”
Jeff: Are you using Excel to run audio stuff or like which?
Meb: I’ve used dozens of different programs. Some built in-house, some are customs, some we’ve purchased, some are off the shelf. It’s everything.
Jeff: That might be kind of what he’s asking, is like some more rubber meets the road, like how does it actually work? What do you do?
Meb: Well, he said process. So, we’ve done a post on the blog many times called free data sources. It says also under the timing model where there’s a lot of websites now that track our and other models. Allocates Smartly is one, Extragenic or extra something, extra dash is another one, ETF Replay. There’s a bunch of these sites that will track models. We give away a free backtester with our idea farm subscriptions as well that you can play around with and understand how a lot of these backtests work. But again, it all goes back to is this a sensible premise. You know, we’ve talked about indexing with our cheeseburger idea, like, “Do CEOs eat cheeseburgers or hamburgers?” It’s a very recent example because an In-N-Out truck was here in our office yesterday, which is awesome because we have a vegan, a vegetarian, and someone who doesn’t eat bread in the office. So we had a lot of extra tickets. So, I had two In-N-Out burgers yesterday. It was lights out after that.
Jeff: How was your nap?
Meb: Oh, I wish. So, yeah. I mean, look, the biggest problem for a lot of people too is coming up with data. Certainly, if you have a local business school, you can go hit them up for some free data resources. There’s a lot on our blog, we said free data sources. There’s French Pharma, there’s a million others you can download, many years of databases, and play around.
Jeff: All right. That’s it for Q&A, that’s it for tweets. Anything top of mind you wanna talk about before we close up?
Meb: That’s it, man. Hit me up if you’re in Colorado. San Anton, Nashville, Vegas. Is Nashville actually called Nash Vegas?
Jeff: Nash Vegas.
Meb: So Nash Vegas and Vegas. Rhode Island, anywhere else. So you guys want…
Jeff: Rhode Vegas.
Meb: So Meb and Jeff Show to come to your town, so just shoot us an email at email@example.com. And give us an excuse to come to your town. We’d love to come visit, give a speech, hang out, have a beer, have a whiskey high ball, that’s my new drink of the summer.
Jeff: Whiskey highballs?
Meb: Yeah. It’s big in Japan.
Jeff: So I gotta go whiskey, man.
Jeff: Whiskey neet, room temperature.
Meb: Because it has the benefit of being hydrating you with water. It’s a lot of soda water and a little bit of whiskey. It’s lower alcohol content.
Jeff: As you eat your Kit Kats?
Meb: As I eat my Kit Kats. Have my Kit Kats and eat them too.
Thanks for listening, friends. This has been a great podcast. As always, you can find the show notes at mebfaber.com/podcast. Pick up the new copy of the book. Let us know what you think. Leave a review. Ditto for the podcast. Thanks for listening, friends. Have a great summer and good investment.