Episode #141: Radio Show: 34 of 40 Countries Have Negative 52 Week Momentum…Big Tax Bills for Mutual Fund Investors…and Listener Q&A
Guest: Episode 141 has no guest but is co-hosted by Justin Bosch.
Date Recorded: 2/5/19
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Summary: Episode 141 has a radio show format. We cover tweets of the month from Meb as well as listener Q&A.
For Tweets of the Month, a few topics we cover include:
We then get into listener Q&A, a few questions we touch on include:
There’s this and plenty more in episode 141.
Links from the Episode:
- 0:50 – Welcome to the show
- 1:07 – Steve Romick podcast episode
- 1:33 – Meb’s travel schedule
- 2:53 – Remembering Jack Bogle
- 3:42 – Feex.com
- 3:53 – Meb’s latest writing binge and the markets fast start to the new year
- 4:06 – On Writing Better (Zweig), Jason Zweig
- 6:50 – Valuation vs equity returns
- 7:00 – Charlie Bilello – Chart
- 9:06 – The Biggest Valuation Spread in 40 Years? (Faber)
- 16:54 – Behavioral biases
- 18:24 – Finding Yield in a 2% World (Faber)
- 19:08 – Trend following and momentum
- 19:18 – Star Capital Research Update
- 20:40 – Where the Black Swans Hide & The 10 Best Days Myth (Faber)
- 21:45 – Mean Reversion After Bad Months (Faber)
- 23:16 – Implementing trend following into the portfolio
- 27:46 – Buybacks
- 28:03 – Please Repurchase Responsibly (Marciscano)
- 31:50 – NYU Professor Aswath Damodaran on Buybacks
- 36:06 – The Dividend Challenge (Faber)
- 37:08 – Effectiveness of dollar-cost averaging
- 37:26 – Buy Low, Buy High (Batnick)
- 37:57 – Top Traders Unplugged
- 39:35 – The Stay Rich Portfolio (or, How to Add 2% Yield to Your Savings Account) (Faber)
- 40:46 – Taxes and capital gains
- 40:56 – Here Come Some Big Tax Bills for Fund Investors (Zweig)
- 46:15 – Listener Question: How can potential MBA and finance students find a good mentor
- 48:43 – Listener Question: What does Meb wish he knew when he was an engineer considering a career in finance?
- 50:35 – Listener Question: Building a network
- 53:09 – Listener Question: Certifications and skills young workers should focus on
Transcript of Episode 141:
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 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. It is Tuesday, February 5th. Happy 2019. We haven’t done a radio show yet this year. We’ve had so many guests just squashed in. We don’t know what to do. We’ve got a great backlog. I hope you guys are listening to a lot of them. One of my favourites at the end of the year, Steve Romick. There’s been a lot of really fun…we’ve got a lot of fun guests coming up. And today, joining, one of our coworkers on the podcast, Justin Bosch, welcome to the show.
Justin: Thanks, Meb. Great to be here.
Meb: Justin is from the Pacific Northwest. He’s gonna sub in for the old Remsburg who’s on a short-term or permanent sabbatical. We’re not sure yet. But this is gonna be a lot of fun. We have a lot to talk about. Lot’s have happened since we did the last radio show, I think in November or December. What should we talk about first?
Justin: Well, let’s get into a…you’ve got a little bit of busy travel schedule coming up. Let us know what’s going on there.
Meb: Yeah, man. After the birth of my son, I said I’m not travelling for a while. I’m gonna stay at home. But 2019 is a different year. So, we may bring him along on some of these. But I’m gonna be on the road a bit starting with Japan later this week. So, Tokyo listeners, if you’re there or in Hokkaido, reach out, I’d love to meet up. And then a whole bunch of other cities, giving speeches, doing meetings. If you’re in any of these, please drop us a line.
We’ll be in Dublin, Ireland and probably in London as well coming up in March. We’ll be in Texas, Toronto, North Carolina, Cleveland, Detroit, Nor Cal, Italy, Mexico, and Virginia. Phew. May be worn out, but it should be a lot of fun. And listeners, if you’re in one of those cities, please reach out. And if not, you want us to come and give a talk in your town or say hello, please reach out. Have you ever been to Japan?
Justin: No, never been. I need to put it on the list here coming up soon. I hear they get a ton of snow.
Meb: Yeah. Shout out to podcast sponsor Mountain Collective. We’ll be trying out the first two free days of the ski pass in Niseko, which should be pretty great. But, yeah, looking forward to it. I’m a little ill-prepared. I haven’t done any skiing yet this year. But we’ll hopefully be a-okay. What else is on the list?
Justin: I think an important note here, listeners already probably know this, but I wanted to touch on it. We lost one of our investing greats, Jack Bogle.
Meb: You know, I mean, he’s definitely on the Mount Rushmore of investors. I think probably no one has done more, certainly for individual investors but also changing the industry, putting pressure on institutions to lower fees, consistently really living the fiduciary standards. So, I mean, he’s certainly a titan. Probably no better person to emulate as far as asset management companies.
So, we tweeted. We said, “There’s probably no better way to honour him than to look up your portfolio. Pick out a bunch of crappy, super expensive, tax-inefficient funds. Sell them. Buy some cheap funds. And then probably forget about it for the next decade.” So, great website, we used to always tell people, it’s FeeX, feex.com where you can type in funds and they’ll spit out cheaper alternatives. So, that’s a fun one to go take a look at. So, RIP, Jack.
Justin: So, I can attest to this. Meb, you’ve been busy writing. So, talk to us a little bit about what you have going on, if you can.
Meb: My favourite hack, writing hack, you always see a lot of great articles, Jason Zweig recently did a few on, you know, the writing process and how to be a better writer and thinking about it. We’ll link to him. But my hack for productivity in general but mainly at writing is to have something you really, really don’t wanna do and avoid doing. That way you can do something else. I mean, I could put a thousand things in that category, certainly avoiding going to the gym. But within that three days of notice, I’ve been putting out quite a bit more writing recently than in quite some time, so a few articles. We may read for you as some podcast shorts and some we’ll talk a little bit today.
We have another one coming up that’s revisiting some of the older articles but one about cloning the largest hedge fund of the world, that I think it’s pretty interesting. But, you know, it’s been an interesting time where certainly 2017, we had the first time in history when markets were just up every single month. And then 2018 seemed to be more the same, pretty mellow, and then bam. People start to get woken up by it being the first time, I think since 1930, where essentially every major asset class was down except for cash.
We did a post on this and said, you know, “It’s incredibly rare for that to happen.” And it depends how many asset classes you included and what you consider to be an asset class. But it’s pretty rare for everything to be down. And the caveat, of course, is those are nominal return. So, if you look at real returns, which is after inflation, it happens a little more prominently, and the frequency has been more…I think it’s been five times since 1930 because of the inflation and relative returns…inflation’s pretty mellow now. But it was a pretty unique year.
And the funny thing as we said, 2017 was really the outlier. You don’t really see markets where for the first time in history, stock market, it went up like 15 or 16 months in a row. But volatility is actually the norm. And so, Q4 reminded everyone of that as we had one of the worst quarters ever for U.S. stocks. And then guess what, 2019 is starting to look like the opposite of 2018, which will look like the opposite of 2017.
So, we had one of the best Januaries ever for U.S. stocks. So, it’s been interesting to see people wake up. Oddly enough, the sentiment, I was at the gym the other day, and out of the nine TVs on, zero were on financial news. It’s just so funny to see how times have changed from 10 years ago, certainly with financial crisis. But the late ’90s, internet boom, when at least half of those TVs, maybe all of them would’ve been on CNBC and other Bloomberg news channels, but none of them are anymore.
So, interesting times we’re living in. It’s been pretty interesting to see people kind of, you know, last summer, I’d chat with other wealth managers and they’d say, you know, they get emails from clients say, “Why are we in anything besides S&P 500?” This is crazy because everything else was going down. And then by the end of the year, people said, “Why are we in the S&P 500? Why aren’t we in more cash?” So, it’s funny to see a quick return to risk.
Justin: You make some great points there. And that’s actually a great lead into a topic, I think, that’s important to cover here on equity returns and valuation. So, Charlie Balelo tweeted a chart of equity returns over the past 11 years, noting that in the U.S., the return has been 125%. The next closest is Japan at 17%. And Italy and Russia came in, let’s call it down, 47 and 48 respectively. So, price is one thing but valuation is entirely something different. So, talk to us about that. I mean, it’s a huge spread, and what do you see in terms of valuation?
Meb: You know, it’s funny because markets zig and zag, and it’s so easy for people to have a very short-term focus. And any of the 45 investible stock markets around the world, in any point in time, some were outperforming the others. You know, and I was trying to give some people some perspective because this topic consistently sort of tweaks me or it triggers me. But we did a tweet, and it’s funny the tweets that become most popular, by the way, because they’re almost always co-opted by people.
I often will tweet facts. They then get co-opted by people on both sides of the aisle or both sides of a discussion. And they almost always end up ranting about the FED or something else. But I said, you know, “Over the past 70 years, the U.S. stock market has been a darling, outperforming foreign stocks by 1% per year.” And that’s a huge difference over 70 years. That’s since 1950. Ten thousand dollars invested in U.S. stocks in 1950 would’ve turned into 14 million versus only 8 if you invested in foreign stocks. And I said, “Want to know how much would that outperformance has come since the global financial crisis?” And the answer was all of it.
And that’s a really surprising conclusion for a lot of people. And the argument we were making is a lot of people extrapolate recent returns. And in this case, I’m talking about for the past 10 years since the crisis where the U.S. has outperformed really everything else in the world. And the challenge for that is people assume that that is the norm. And yes, going back to 1900, U.S. has been one of the best performing stock markets, but it wasn’t the best, and there certainly were worse ones. But over time, it kind of waxes and wanes.
You know, we extrapolated this a bit to an article we wrote, called “The Biggest Valuation Spread in 40 Years?” And what we were talking about in the analogy that we gave was, you know, one of being at a local coffee shop. I love Two Guns but Peet’s is another great one. And, you know, there being some Los Angeles moms talking about their child and saying this child is so gifted. He’s so smart. He’s counting already. And then made the joke. They looked over at the child and he was looking in the glass on the display case for the pastries.
And so, everyone has their own biases, and obviously, these parents think their child is exceptional as every parent would do. And so, a lot of U.S. investors certainly think that the U.S. deserves a valuation premium. And I was chatting with my good friend, Josh Brown, on this, and we disagreed a little bit. But I made the argument. I said, you know, “The U.S. trades have a valuation premium to most of the rest of the world. It’s one of the most expensive countries in the world. It’s not crazy but it’s in the high 20s. And certainly that’s down from…it’s probably back in the 30s now but down from the low 30s at the end of Q3, but one of the most expensive in the world.”
And a lot of people say, “Well, the U.S. deserves to be more expensive, the rule of law, GAAP accounting, stable government,” which I always laugh at given how the rest of the world would probably perceive our geopolitics. But they say the U.S. deserves to be more expensive. And then my counter is always that, “Okay. Then let’s look at the data.” And when you look at a chart of U.S. valuations going back to 1980 for CAPE ratio, you know what the historical valuation premium has been, and it’s been zero. And the U.S. and foreign global markets outside the U.S. have traded on average at the same exact valuation.
Now, there’s been times when there’s a huge spread. So, in the ’80s, it was actually the opposite. So, Japan was the largest stock market in the world. And it had a massive, massive bubble traded at a valuation ratio of almost 100. But that distorted most of the rest of the world. And the U.S. was cheap back then. And then most of the rest of the time ensuing, they’ve been kind of going back and forth. But since the financial crisis, the U.S. stock market has gone up much more than the rest of the world. And people list all the reasons they were listing earlier.
They say, “Now U.S.’s economy,” and this, that, and the other. But one of the biggest tailwinds and simply the valuations of both U.S. stocks and foreign stocks were in the low teens at the bottom in 2009. I think they were both around 12. Granted, nobody was buying stocks in March 2009, but they were really cheap. And guess what’s happened? Well, the U.S. has essentially almost tripled its valuation. So, you have a massive tailwind, a multiple expansion. But in the rest of the world, it hasn’t changed that much.
So, a lot of the foreign developed and emerging markets are still in the mid to low teens. And if you have a basket of the cheapest stocks that trades at a CAPE ratio of around 11. So, we wrote an article “The Biggest Valuation Spread in 40 Years?” And it’s funny because people, their brains go a little crazy about this. And my argument is less about you have to invest all your money in cheap stocks around the world, outside the U.S. and more that you need to be thoughtful about it. So, I did a Twitter poll as I want to do. And the Twitter pool said, for U.S. investors and our global listeners can extrapolate this to their own market…it’s pretty interesting to see who the podcast top countries are. Do you know Sweden is in the top five?
Justin: I didn’t know that.
Meb: That’s interesting to me. It’s a lot of the English-speaking countries you would expect, Canada, U.K., etc. But Sweden was top five. India is top 10. We may have to do a podcast tour in some of these countries. So, what’s up, you guys? But, say, all right, so, I said this to U.S. investors but extrapolate it to your own country, I said, “How much of your portfolio is in foreign stocks and bonds outside the U.S.?” And so, a third said less than 15%. Thirty per cent said 15% to 30%. Twenty-one per cent said 30% to 45%. And only 16 said over 45%.
So, going back to our great Bogle, you know, if you did the global market portfolio around the world, that means you have over half. You should have over half outside the U.S. But according to this poll, 84% of people have a massive bet…on an active bet overweighting the U.S. Now, you could argue that’s correct. You could argue that’s silly, but it’s a fact. So, they’re making a very active bet that the U.S. is better. And the funny thing is is everyone will then go and justify that for all the reasons we talked about earlier. This is why I have this much in the U.S.
The number one reason we always hear is people say, “Well, the U.S. has a high per cent of foreign sales abroad. Therefore, I don’t need to diversify globally.” And my reaction to that is always, you can go look up all the other countries in the world and they have a high percentage of sales abroad, too. That’s called globalisation. That’s obvious. And so, in a world of being global, you should be agnostic as to where you invest.
The funny thing is this happens everywhere. We’ve talked about this many times on the podcast. So, sorry if I’m belabouring the point. But every country around the world has the same country bias. If you look at Canada, they put 60% of their equity market in their own country, Australia, Japan, etc. I saw some stat at JPMorgan had that said Latin America had, like, 90% in their own region. And it’s even funnier where you can actually break it down in the U.S., for example, by sector, where people in California have more in the tech sector, where people in Texas have more in energy, and people in the Northeast have more in financials.
So, the bias kind of works its fingers in everywhere because everyone thinks their child is special. They think that they have a false sense of security about, “I understand my local market.” But it’s particularly problematic when it comes to valuations, because if you’re an American citizen and you’re putting 80% of your money into U.S. stocks, you’re also putting them right now into one of the most expensive countries in the world. Again, it’s not terrible but it makes a lot more sense to be valuation-thoughtful.
So, the example we give on this tweet was that Vanguard recently upped their equity exposure to 40%. So, it’s close to the 50 of what the world is. And one of my little birdies inside of Vanguard said they actually wanted to do 50, but they thought there’d be too much blow-back from advisors, which is pretty funny.
But you could easily make an argument that 75% should be outside the U.S. U.S.’s per cent of the world GDP is only a quarter. And so, a lot of people, they want to place this huge bet on something local. And to be clear, the funniest part of the tweet is that everyone is like, “Well, the U.S. has outperformed in the past 10 years.” And what you said, that’s exactly backwards-looking. That’s exactly 180% wrong. What you want going forward is what looks good in the future.
So, this is one of my biggest struggles in this topic that I really think if you would’ve put a gun to my head, global stocks X U.S. particularly the cheapest, which have been outperforming for the past going on one, three, four, five years now. It’s really since…2014 was a stinker for global cheap stocks. But since then, they’ve beaten pretty much anything else. A lot of people don’t know that. So, anyway, that was a long, long-winded answer of saying that, yeah, what’s happening…and by the way, fourth quarter, U.S. was one of the worst-performing countries. And this goes back to an old chart we have that the GMO and others have replicated, which is when you have an expensive investment, particularly a country, you have a much bigger chance of a big, fat draw-down. So, when you’re expensive, you’re much more fragile towards future return.
So, that was my long-winded rant about valuations, about the…people putting way too much in the U.S. My piece of advice to all the listeners would…start with a global portfolio, which is half in the U.S, and then I would tilt even further towards valuation from there. But certainly putting 80% in one country, I think, is very foolish.
Justin: Well, I think those are great points. One question I have for you, you know, as an investor, someone comes to you and says, “Hey, Meb, that’s all great. It looks great on paper. But all that cheap stuff is really scary.” How do we get over the behavioural biases that we face when we’re looking at allocating our portfolio and hopefully toward those areas of the world that look a little better on the valuation standpoint?
Meb: It’s why being systematic is so necessary. You know, I think waking up and calling your clients and saying, “Hey, we’re gonna go buy,” whatever it may be is kind of a hard way to do it. But say, “Look, we have a process that tilts.” I mean, and it doesn’t have to be you’re all in on Brazil and Russia. You know, it could be that you simply tilt towards value and whatever that may mean. It could be the way we do it, where we’re picking some of the cheapest countries in the world. But you certainly need to diversify. You never wanna just own one or two countries. But even at a minimum when we’re talking about the global market portfolio, like, that should be the starting point. And that’s what’s so hard for people.
So, when you buy that, you get 45 countries. You know, it’s not just the U.S. You get tens of thousands of securities around the world. And don’t even get me started on bonds because bonds is actually, foreign bonds are the largest asset class in the world. And it’s something like the U.S. investors put, you know, 98% in the U.S. bonds. They almost never put anything in foreign bonds, which I think is really foolish.
By the way, we’re updating our old global value approach to government bonds where we did an old white paper saying, you know, it’s totally insane to be a global sovereign bond investor in a world of 0% yields. And, you know, I think the G5 still, U.S., France, Germany, Japan, and U.K., maybe, yields less than 100 basis points. And the U.S. is the outlier. The U.S. is the high-yield. But if you were to do a carry approach to sovereign bonds, which is similar to a value approach, I think, in equities, you end up with a yield north of 5, 6%.
Anyway, that’s a departure. But I think foreign bonds is necessarily not the point of what we’re talking about. But there’s a lot of hacks around it. You can use certainly funds that don’t concentrate on just one country but have a much more broad exposure.
Justin: I wanna use that as a chance to shift into something related to value, but something you’ve done a lot of work on, trend falling and momentum. So, Norbert Keimling tweeted an update to some charts. He and his team have updated. And he noted all country and sector valuation and momentum indicators that have been updated, 34 of the 40 countries had a negative 52-week momentum. That map on their chart is rarely seen so red. What are we looking at here?
Meb: So, you had a shift this year where for the longest time, a global buy and hold approach was very similar to a global trend approach. Most markets have been going up over the past number of years. The last time you really started to see some significant gyrations, maybe back early 2015. But 2018, you saw a lot of markets after Yuan started to roll over. I think foreign stocks as well as parts of the commodity space had already started declining early in the year. And then really, the U.S. was the only man left standing coming into the end of the year, and then very quickly fell out a bit.
So, by the time 2018 was over, you had many of the markets around the world in down trends. And you started to see the volatility pick up. And we talked about this on Twitter certainly, but where it always surprises, I think, a lot of the commentators where you start to have this big and up and down days. But we’ve shown in the old white paper called “Where the Black Swans Hide” that the vast majority of the up-and-down days it’s something like 70% occur when the market is already declining. And so, below something like a 200-day moving average or 10-month moving average. But so, you had an interesting scenario where trend falling type of systems started to de-risk.
And so, depending on the system, it could’ve started de-risk as early as Q1. But certainly, very heavily by the end of the year. So, a lot of traditional trend strategies would’ve been at near or max risk off, or if they’re in the managed future space would’ve been shorting certainly a lot of these markets by the end of the year. What’s interesting to note about that is that because markets go up most of the time, 60%, 70% time they’re going up, it’s pretty rare to have the scenarios where the buy and hold in trend diverges. And it’s extremely rare when everything is kind of going down. And so, you have what we call this sort of hero or zero moment for strategies to start to diverge.
So, for better or worse, a lot of the trend strategies will diverge going forward. We saw this somewhat in January where you had this big bounce, which is funny because we have a 10-year-old study. We’ve been at this too long. But if you look it up, we tweeted it, it looked what happens after really bad months, the really bad outlier months in traditional asset classes. And so, equities in particular is something like if you have like an 8% or worse down month, what happened in the ensuring three months. It’s pretty strong, outperformance, so the balance in January is not particularly surprising.
Anyway, you have a scenario where a lot of markets are still in a down trend. It’s changed a little bit. There’s a few that are starting to see some green shoots. But that’s when you see the divergences. So, will the market start ramping back up just like in 2015, or will they continue on down like in ’08 or 2000? I mean, who knows? Of course, no one knows the future. But that’s when you start to see some of the benefits or drawbacks or trends that’s either the whipsaw drawback or it’s the protection of things continue south. But it will be interesting to see going forward, for sure.
Justin: And some of the markets that were in an uptrend are not ones that exactly give you a lot of confidence. I mean, precious metals are starting to pick up. You know, a lot of those are in sort of uptrending buy-signals. But that’s not something you would really traditionally want when you’re in an uptrend. And along the same lines, I mean, I think 2017, 2018 was a great showcase for how something like a tailored strategy works, you know, in real time. We have some ideas to track that as well.
And so, for investors, especially those who might not have considered trend following as an allocation in their portfolio, how should they be looking at this? Is it a way they can protect downside? Is it a way to curve behaviour? What are the virtues of trend falling and how can they, you know, look at their portfolios today and start implementing, you know, some of these ideas?
Meb: There’s kind of two main ways. And then we’re probably the biggest outlier in the entire country as far as investment advisors that utilise trend following in their portfolios including institutions as well. I think that the biggest institution we’ve ever heard of that uses traditional, what most people would consider trend following, you can have me go off of my rant talking about market cap weighted indexing is essentially trend following. But referring to traditional tactical trend following sort of strategies, either long, flat, or long short, you know, you never almost never hear of an institution or an investment advisor utilising that for more than, say, 10%, 15% of their portfolio.
I mean, most people are zero and some people are five. But with a lot of Trinity research, the starting point is usually half. And what we tell people is say, “Look, nothing wrong with asset allocation or buy-and-hold approach, it’s certainly totally fine.” The challenge of buy-and-hold often is that it coincides the drawdowns of that portfolio, if you think about ’08, ’09 coincides these bear markets with recessions, which is when people are losing their jobs. It coincides with bad geopolitical news, economic news. But it all kind of happens at once. And the biggest challenge of that portfolio historically has just been being able to sit on your hands not doing anything dumb, and just being able to endure. And for a lot of people, that’s really hard. That having been said, it’s a great investment approach. We have one of the lowest cost asset allocation strategies out there.
And on the flip side, trend following, which we’ve been writing about for over a decade, the way we do it which is moving to cash and bonds as markets decline has been a great strategy where you traditionally have lower volatility, lower drawdowns. You’re not gonna be invested in a market as it goes usually down 20%, 40%, 60%, 80%. And so, the whole goal is to miss the big ones. But the big ones don’t happen all that much. You know, you may get one a decade. You may get none. You may get two. So, they’re pretty rare but they do happen in markets everywhere. In some cases, they get really bad and really big. You know, if you ask any of our friends in Brazil, or Russia, or China, or India, or Greece, those that are a lot more recent memories, Italy, than the U.S., but it’s funny how people forgot something as quick as 10 years ago.
So, trend following has its own challenges. One is certainly you look different, which usually looking different is not a problem when you look better. It’s a problem when you look worse, and that’s hard for a lot of people. They’re neighbours in making money, but they’re not is one of the worst possible ways to invest, you know, the old Munger quote where he says, “I’ve heard Warren say a million times, it’s not greed and fear that drive markets, it’s envy.” And so, being not invested when people are making money is tough. And the other one being, of course, whipsaw. So, having a lot of false signals or underperforming a traditional buy and hold. But trend following usually does well when buy and hold is doing poorly.
And so, you have this sort of yin yang and it’s a nice complementary portfolio where they both should do about the same return over time. I think if I had to pick one, I would pick trend of course. But they complement each other. And it goes back to the old Bogle quote where…I mean, granted he would roll over in his grave talking about trend following. But he puts half of his money in stocks and bonds and says that way he spends half the time worrying there’s too much in stocks, and half the time worrying there’s too much in bonds. And this is the same way, I think, about trend falling where, you know, that’s what I do with my portfolio in my money into these Trinity ideas.
And so, for most of the time, I’m happy I have a bunch in buy and hold. And the other times, I’m super happy I have a bunch in trend following, handling sort of last quarter and beginning of this year, it helps to smooth things out. So, we didn’t really talk into managed futures which is more of a traditional long-short approach to trend following. And the short side is traditionally, I don’t think a huge alpha generator. But I think it’s a wonderful diversifier when everything is kind of going to hell or you have a deflation rate sort of shock, not much really helps other than bonds, obviously tail risk or being short. So, that works as a great diversifier to a traditional portfolio. So, you know, we tend to be an outlier but we’re a very happy and content outlier.
Justin: I do wanna shift into the topic of buybacks. It’s hotly debated. There seems to be no clear consensus here, which is probably a good thing for investors using this as a factor. Jeremy Schwartz tweeted about buybacks recently and linked to a piece titled “Please Repurchase Responsibly.” So, he says, “Buyback haters will not like this note. If net buybacks were used on top of dividends alone as a value factor over the last decade, performance impact was substantial: over 300 basis points a year increase over dividends alone in the top quintile.” What I think was really important or equally as important was that the study also mentioned that the bottom quintile of shareholder yield underperformed the market by 342 basis point. So, talk about the takeaways here. I think there’s a lot of good points in there.
Meb: It’s simple, man. And you’re hitting on all my trigger points so far. We’ve got CAPE ratio. We’re now on the buybacks. These are the things that I lose my mind about. The buyback discussion is interesting because it’s getting partially co-opted by politicians. And so, despite the fact that I’ve muted every political phrase I can possibly think of on Twitter, they seem to all still get through. I think you need to separate this into two buckets. There’s the corporate operational structure side and societal justice, and we can talk about that. And then there’s also the pure investment side.
Let’s talk about pure investment side first because it’s really simple. There’s only five things a company can do with its money. It can reinvest in the business, which is the sexy part. Build new iPhones, build new plants, all that good stuff. It can pay down debt if it has any. It can go acquire another company or merge. And then the last two are it can pay out its cash through dividends or buybacks. And if I didn’t say, and pay down debt, too. That’s it. There’s only five things, literally, only five things a company can do with its money.
And so, historically speaking, as an investor, you want a company that has high cash flows that in this case distributes the cash flows. And the research shows that stockholders don’t care about how they distribute the cash flows. It’s just the holistic total amount, which correlates very highly with how much cash flows they have in the first place. And to pay a low valuation for that portfolio. And research shows…we call that shareholder yield. Other people call it different things, net payout yield, etc. But if you include dividends and buybacks into the equation and in an additional benefit, I think, target value, it outperforms historically any dividend measure you can come up with in for something like nine decades or more that we have research for, and in almost every decade.
And it’s really strange to still see all the focus on income investing through dividends because it’s totally nonsensical. You’re ignoring over half now of how companies distribute their cash. I would also argue it’s totally as nonsensical to look at just buybacks. An additional caveat you need to use is, of course, net buybacks because what you hinted on in this piece where the bottom quartile of shareholder yield, which is essentially those companies that don’t pay dividends that are issuing shares, traditionally, that’s through management, paying themselves a lot of options and diluting shareholders. That’s the last thing you want, right? That’s people that are diluting you as a shareholder and you’re getting no yield. You would expect that underperforming market and it has.
So, shareholder yield strategies have done fantastic. I would continue to expect them to outperform any given strategy you can possibly come up with, particularly the ones that ignore buybacks, and particularly the ones that ignore value as an input as well. Let’s talk about the political side real quick.
You know, there’s some very clear challenges in our economic environment where there’s been this massive spread in between what workers have made, real wages, and what a lot of top executives and the super wealthy have made, right? And so, it’s really simple for politicians to find a, you know, a bogeyman. And buybacks sound good on paper, but I was reading an old article by Damodaran, professor from NYU where he’s like, “Look, it’s a great scapegoat, but there’s no basis for this.”
And let me explain why. So, first of all, so, Elizabeth Warren has done it. And I’m as, listeners know, I’m politically independent. So, this isn’t a Republican-Democrat thing. Elizabeth Warren, Bernie Sanders, and Chuck Schumer have all taken to the news headlines to say buybacks are terrible. The first part is usually, people don’t understand that buybacks and dividends are the exact same thing. It’s just simply a way to return cash to shareholders. And so, that trips up 90% already.
The interesting part was that Bernie Sanders and Schumer seemed to understand that they are the same thing. They mentioned in the article, they said, “We wanna limit the ability to which companies can buy back stock and also limit to the extent that they can pay out dividends.” And that they had some criteria. But the funny part about that is, you know, if you have the assumption that CEOs are self-absorbed, empire-building, these kind of egomaniacs that wanna go spend a ton of money on giving themselves high salaries, what’s the last thing you wanna do? Give them more cash.
So, if you limit or get rid of buybacks and dividends, CEO now says, “Okay, well, I can’t return to the shareholders. I’m gonna go spend it on a new building or sponsoring, I don’t know, the Bronco Stadium, or paying myself more salary and a new jet.” Like, it’s the last thing you want is to give the CEO more money to light on fire. That’s one of the best checks against CEOs is the ability to give cash-back to shareholders because shareholders complain about the CEO. The big problem with all this, I’ve been seeing this for a long time, is if you wanna check on CEO compensation, it’s a board issue.
So, the board is supposed to be on the hook for regulating how the CEOs get paid. And if you’re an idiotic board that pays the CEO based on short-term returns or stock price or EPS, then you’re just an idiot and you should be fired. And you’re not doing your fiduciary duty. And so, you know, the key with all of this is that incentives matter.
And so, coming up with this system that would align shareholders, align employees, align management so that you’re not rewarding management at the expense of employees makes a lot of sense. But it’s not dividends and buybacks. And in fact, if you started to limit dividends and buybacks, you very easily could have the exact opposite outcome. And it’s irrelevant to us. I mean, let’s say, if for example, dividends and buybacks became illegal somehow. First of all, you would have every company on the planet just go private. There’s no point being a public company. But second, you know, the whole point of investing is you wanna tilt towards value and be a value investor anyway.
So, it’s frustrating. I joked on Twitter. I said, “I need to write an article called “Buyback FAQ for Journalists and Politicians.” But I don’t know if I need any more fights to pick on Twitter. I have enough arguments. So, look, as a shareholder, remember you want cash flowing companies. You want good companies that are trading for low valuations. And if they’re paying out a lot of it in cash and dividends and buybacks, even better.
Justin: Great points. But I do wanna circle back to sort of the evidence we’re seeing in studies and research. That point that sends out to me is that not only is it important to consider shareholder yield for potential returns, but it’s equally important to make sure you’re avoiding things that could potentially drag on you.
Meb: The classic example we give is, we say people…here’s the other thing about the dividends that most people get wrong. They say, “No, no. I love the dividend approach. It’s all I care about.” I say, “Well, you could also have a company that’s paying a 4% dividend. And if they’re issuing 5% new shares outstanding ever year, you have a negative yield.”
It’s hard for a lot of people because most websites don’t publish buyback yield like you would see a dividend yield. And by the way, most sites publish like four different versions of dividend yield, by the way. So, it’s a little harder number to come by. And so, it’s harder for people to screen. And it tells a good story. I mean, our old piece, which we’ll link to, that is talking about Coke versus Pepsi and how dividends have a great brand, you know. All the retirees listening to this love getting their dividend cheque in the mail because they think they’re somehow getting paid.
But in reality, you could easily have a company that has dividend yield that’s getting swamped by shares outstanding increasing. And on top of all this, the last thing you want on the planet is any of these variations of companies that are expensive. And so, a lot of dividend funds don’t use valuation as a metric. And so, you guys don’t believe me, go to Morningstar. Type in your favourite dividend fund. Go to the holdings tab. Go look at the valuations. And the vast majority of the biggest dividend ETFs are more expensive than the U.S. stock market. That’s the last thing you want on the planet is a bunch of high-yielding junkie companies in the next bear market because they’re not gonna protect people the way that people would expect them to, and particularly the people that have mentioned they think that dividends represent a substitute for bonds, which we’ve heard in the media a few times, the cycle, which I think is totally insane.
Justin: Well, moving on, so another topic I’d love to get into a little bit is dollar cost averaging. So, this is a little bit more on the side of investors thinking about their portfolios and how they’re implementing their investing strategies over time. Josh Brown retweeted a piece on dollar cost averaging by Michael Batnick. The piece discusses the reality that with dollar cost averaging, you’re buying low and buying high. I think that’s important to keep in mind.
Over the last 20 years, someone who’s systematically invested each month actually beat the S&P 500. That was a little bit of a surprise to me. Is there a hard rule on this? Is it really the best way to go in all time periods? Is there a reason to believe something like lump sum investing can be superior?
Meb: I was actually walking my dog this morning and listening to a podcast called “Top Traders Unplugged,” which is one of my favourite podcast. And they do a systematic investors series where they get a couple well-known investors and do kind of just a roundtable, happy-hour chat. And one of them is Jerry Parker who was on this podcast in the past. I love Jerry. And he approached the same question and I’ve mentioned it many times before, in the same way, which is if you have a positive expected bet or return stream, the algorithmic best time to start is now. There’s no question. The correct answer is you should put all of it in today lump sum.
Now, that ignores the psychology of humans because I guarantee you if I said, “Okay. you just inherited $1 million or you just sold your house, you got a million bucks, what should you do with it?” And I say, “You should put it all in today.” And then the stock market goes down 20% next month. You’re gonna pull your hair out. You’re gonna regret that for the rest of your life, regardless of the randomness of it.
So, we tell people, look, dollar cost averaging is fine. If you wanna invest one-twelfth every month for the next 12 months so you don’t have any hindsight regret and bias, that’s fine. If you wanna do it over the next five years, that’s totally fine. It’s whatever you come up with the system. The problem is most people shoot from the hip. They don’t have a plan. They say, “Well, let’s see how it goes.” Like, I can’t tell you how many times I’ve heard this. “Hey, Meb. I think markets are expensive. I think they’ve gone too far. I wanna invest how much ever money. But I’m gonna wait until the market pulls back.”
And then 100%, 200%, 300% later, they’re still waiting. And, you know, the big problem with that is that over time, markets go up. And we’ll read a piece coming up on the podcast. You guys should listen to it. It’s a short piece I wrote called the “Stay Rich Portfolio,” which talks a little bit about this. But the simple algorithmic answer is immediate and all. But I think the real answer is it’s totally fine if you spread it across time. And in the spreading across time, what the article about Josh, and Batnick was referring to is that it means the timing matters really not at all, if you’re spreading it out over time.
Justin: So, it’s really about knowing yourself, knowing your plan, and knowing what suits you better?
Meb: Yes. I don’t wanna give away the whole piece, which I’m gonna read later. But, you know, I think one of the most important things as I get older is a lot of the framing about investing. I think if people thought of investing and just replaced everything about the word “investing” with just “saving” and thinking about it as savings and not investing. But almost like they just have more volatile savings account, I think that’s a really useful construct. Because savings aren’t risk-free either. And we’ll talk about the Stay Rich piece. But in general, if you think about all this with an umbrella of savings rather than investing, it changes how you think about a few things.
Justin: Little behavioural hack. I like it. A big thing on investor’s minds coming up, you know, this time of the year is taxes. So, Jason Zweig had a piece in “The Wall Street Journal” that he talked about the tax games and the tax bills that mutual fund investors are, like, they’re gonna be facing from 2018. There’s a big difference between ETFs and mutual funds as far as the structure goes and a potential capital gains consequences.
So, the article talked about some issues including how there are 517 mutual funds that announce single payout at least 10% of net assets as capital gains. So, talk to us a little bit about what the mechanics are that get us here, what the problems are that investors are potentially facing…
Meb: This is important because it’s very poorly understood. And so, in my opinion, there’s almost no reason to justify investing in a mutual fund today. Now, there’s obviously departures for that. And I joke because I have plenty of mutual fund friends. There’s plenty of great mutual funds out there. But as far as the base case, so let’s talk about it. The only thing, 99% of people think about is management fee. So already, the average mutual fund is 1.25%. The average ETF is half that, so around 0.6. Granted, if their index are low-cost funds, you know, we’ve said this a million times, Bogle echoes this, says it’s not about active and passive. It’s about high-fee, low-fee.
You have some in both cases that are 0.1%. But on average, ETFs are half the cost. So, that becomes your default. But taxes are where there’s a huge difference. And no one really cares. And I say no on average because 90% of people I talk to don’t care or they don’t know. But the very simple takeaway in the stat, I think, you cited was that mutual funds on average 60% plus of them are paying out capital gains every year.
In ETFs, it’s 5%, 6% order of magnitude, less. And ETFs in general almost never pay out a capital gain. And it’s just part of the structure. And we’ve talked about this. We can go down the rabbit hole about the why. But in general, most ETFs like the SPDR since the late ’90s have never paid a meaningful capital gain ever.
And so, that works out to, I think, Robert Knott was the one that did the math. It’s like an 80 basis point difference in net returns over time. And so, all of a sudden, not only do you have a 60 basis point advantage on ETFs for fees. But it’s actually swamped by the amount you’d save on taxes, which is arguably equal to the amount you’d save on management fees.
And so, you have a mutual fund now that has to outperform by, what is that, over 100 basis points just to break even with a similar ETF. And so, it’s a structural thing. Look, some people have figured it out better. Vanguard has a pattern that allows them to sort of lay off some of their mutual fund taxes on their ETFs, which doesn’t benefit the ETF but benefits their mutual fund customers. But in general, the default is most of your mutual funds are gonna be taxed.
But again, people don’t care because they don’t see it until they pay the IRS. And it’s not something they see when they would be buying the fund. So, it’s unfortunate because it’s probably a bigger determinant of performance than management fees are. And the last thing I will comment that just so you don’t think I’m totally biassed because I’m an ETF manager, there’s actual cost in trading ETF, which is the bid/ask spread. And many are very small. But at the average, I think, it was like 20 basis point. So, you know, for the people out there that are trading ETFs every other day, that can be a very real cost, too. But as you all know, I think most people should be buying their allocation and then doing nothing for 10 years if they can help it.
But it’s a great example. I mean, the dividend one is another great example. But these are just things that to me are so obvious but goes to show that people aren’t totally rational investors, not totally logical. And some of these, by the way, the worst-case scenario with a mutual fund is you have these guys that lost money in 2018, you could’ve bought the fund in 2018, lost money, and then have to pay a capital gains tax because the mutual fund did trading. And then that is just like the most horrific outcome. It’s really terrible. And some of these were monster, like 20% capital gains tax. I mean, it’s really terrible anyway.
Justin: So, what do you do? Wipe it clean…
Meb: Selling mutual bonds and buy a bunch of ETFs. I mean, the challenge, of course, is a lot of people to have, if you’ve owned mutual funds for 10, 20 years and you have big, fat capital gains, I can sympathise with why you might not want to sell and pay the taxes. But you’re gonna have to weigh the amount that you’re getting eroded each year by the management fee and the drag on taxes versus an ETF. I mean, most people, I’d say, rip off the bandage.
And a somewhat related example, a lot of people say the same thing with individual stocks and say, “Oh, man, you know, I’ve own GE for 10, 20 years. I can’t sell it now. I have a huge capital gain.” And then what’s the next thing that happens? It goes down 50%, 70% or something and you’ve lost all the capital gains, solved that problem. So, almost always, you know, the better answer is just be done with it, sell. You don’t have to sell all of it but sell some and balance your portfolio. But pay attention to your taxes, people. It’s really important.
Justin: Why don’t we get into some listener Q&A?
Meb: Let’s do it. Listeners, by the way, send Q&A questions. We’ve depleted most of them because we haven’t been doing too many radio shows, but we’re gonna pick them back up. So, feedback at themebfabershow.com. Send them in and we’ll read them live on air. What do you go?
Justin: So, this is coming from the perspective of students that are looking to get into quant finance. So, think MBA finance students, you know, even finance students in general, I think this applies, how can I find a good mentor in this field?
Meb: You can have a good mentor without it being a personal relationship. I mean, you could consider listening to this podcast as me mentoring you for 150 episodes. So, right now, you have a mentorship. We wrote an article about this that says, basically like how to get a master’s in investing. I mean, if you go listen to the top four, five investment podcasts, I guarantee you, you’re gonna be exponentially light years ahead of any grad student that completes coursework that didn’t listen to them.
So, if you listen to all the interviews, because I mean, if you think about it, who are you listening to and it’s being able to sit in on conversation between multiple billion dollar money managers just shooting shit, right? Like, what better way to learn than listening to some of the people we’ve had on the podcast, but also some of the other top podcasts as well. I don’t think the mentor has to be a personal one that you’re necessarily working with, if that question was more referring to that, then the question is really more how do I find a job, which is a totally different question. But if you’re really just concerned about learning, I think podcasts have been one of the biggest positives for investors in decades.
Justin: To pile onto that one, how do you feel about learning through managing your own money?
Meb: There are some good and bad lessons. And I wanna do a book on this at some point, but I think the incentives matter. You know, we talked a lot about in the past in some of the podcasts about how a lot of traditional parents try to teach their children about investing as kind of backwards. Certainly, I think investing, almost everyone you talk to, they learn by investing their own money. You know, and until you feel the very real pain of doing dumb stuff over and over, it’s not a reality, you know.
We talked to a lot of people who say, “Yeah, I can take on tons of risk. Bring it on. I’m just looking to compound as high as I can.” And then their portfolio goes down 20% or 50% that they expect to go down. And they say, “Oh my God. I can’t deal with this,” you know. So, certainly, I think getting real-world experiences is important, whatever that may be. Does that mean trading a bunch of crypto and, you know, trading day-trading stocks and buying message board securities and listening to your neighbour? Maybe, if that’s what, you know, you learn all things not to do. But you’ve got to start at some point. And the younger you are, you have by far the biggest advantage of anyone else for compounding and that’s certainly time.
Justin: What do you wish you knew when you were working as an engineer and you’re considering a career switch to quant finance?
Meb: Man, working as an engineer, I would’ve been an intern at Lockheed back in the day learning about stocks in the late ’90s because I think I was finishing… There’s only so much you can do as an engineer at an aerospace company when you’re 20 years old, except playing on the softball team.
You know, I mean, look, the people that give advice on this sort of thing, it’s tough because, you know, the way that I went about it is one of the most atypical ways that anyone can go about it because it was a lot of it was self-taught. And that’s good in a way because I came with no preconceived notions. It was bad in a way because I spent many hundreds and thousands of hours kind of reinventing the wheel.
You know, so I think, find… Like, I mean, again, if I could’ve had podcasts back then, my God, what a wonderful thing. But back in the ’90s, we had something called books. So, I simply just read a lot. And, you know, obviously, I wish I could go back and tell myself, “Don’t read these hundreds of books and these terrible things. But that’s a part of how you find your own style.” You know, Buffett talks about being inoculated as a value investor. And other people are trend followers. And other people who emerge…and yada, yada, whatever you may be. But, you know, finding your own style, I think, is important because, you know, a lot of people are trying to fit them into a hole that’s not comfortable for them it’s not gonna work out. And then that probably is career in general.
Justin: By the way, how did you find your own style? I mean, what was it that morphed? You know, how did it morph in time?
Meb: I mean, some of it was intentional. Some of it was decided for you. You know, I think probably if any dozens of job opportunities had risen in my 20s, I certainly would’ve taken them, you know. Many of these jobs I probably would’ve been the most intolerable person if I got many of them. But that’s the randomness and beauty of life is that it’s a bit of a ping-pong. You don’t necessarily get to make the decisions on a lot of those choices either.
Justin: How can I build a network without Ivy League or Silicon Valley connections?
Meb: I don’t have either of those as most don’t. I think it’s common sense advice, it’s certainly going to as many events as possible, you know, CFA, CAIA, all these organisations, local, QWAFAFEWs, or AAI, whatever the organisations are or whatever you’re interested in, that’s the best way to learn and make friends and find people with common interest. I mentioned podcast enough already. You know, and then I think if the question was more angled towards finding a job and it goes back to the comments we’ve made on…all of these questions, it’s funny from students because they’re all about them. It says, how can I find a good mentor? How can I build a network?
And what the question really needs to be and they learn eventually is reversed, how can I deliver value to someone? Because no one gives a shit about you as a 20-year-old student furthering your career. I mean, they might. But in general, you know, it’s really how can you a benefit to someone in their life? And then the best example we’ve talked about was the Theo Epstein from baseball where he said, “Go up to someone, a job you want or your current superior and say, ‘What’s 20% of this job you hate the most and let me take it over?'” That way you learn part of that job. It may be miserable. But you also endear yourself to your superior, which is a wonderful situation to be in.
You know, so, a lot of that is just showing up. I can’t tell you how many times people have put themselves in situations where all they had to do was ask or all they had to do was make the effort and they don’t often because they’re scared, you know. We’ve had a number of times where we’ve done events or talks, and I’ll get an email later and say, “Hey, man. Like, I’d really wanted to say hi, but I just, you know, I think you’re busy,” or whatever it may be.
A good example is one of the podcast guests, Steve Sjuggerud was talking about Jim Rogers, famous hedge fund manager, partner with Soros back in the day and ran one of the most successful hedge funds of all time. And he was sitting at a table, and the seat next to him was open, and no one would sit there because they were all too scared. And so, he sat down and they’re now good friends. And so, it’s a good example of just trying to, one, showing up and doing the work. But two, be willing to kind of put yourself out there and make the effort.
Justin: Well, I think that’s a great point on making the effort. Another thing I’ll add, it probably teaches you a lot about, you know, whether or not you’re really committed or cut out for the job in question.
Meb: Yeah, yeah.
Justin: So, what knowledge, skills, degrees, or certifications are most important? And how do you recommend I obtain those skills?
Meb: Totally depends on what you’re doing, what area. It’s a super broad question. I almost feel like the same person asked all four of these. Depends, you know. If you wanna be a financial engineer, work on the derivatives desk at Goldman, you should probably get a master’s in financial engineering…or a PhD and learn to code. If you wanna play golf and be a wealth manager and make a million bucks a year and have a cushy lifestyle job, you’d better be good at people skills. It’s not only the basics of I’m getting a CFP maybe, financial planning, learning some tax, trying to figure out, you know, how you can network with people, and also become a good salesman. Totally different skill sets for totally different jobs.
You wanna be a portfolio manager, it seems everyone wants to be Bobby Axelrod from “Billions” and, you know, fly around in jets and helicopters. You know, it’s a different skill set, too. Being a trader, being a portfolio manager, being a quant. You know, there’s a million different roles in our world. And so, it’s hard to pigeonhole one. So, hard to say.
Justin: Well, that’s all I got today. Anything else you wanna cover?
Meb: No. Listeners, it’s been good to be back on the radio show. Send us some suggestions for 2019. We’re open to ideas. And again, if you’re in Japan, Europe, Austin, Toronto, North Carolina, Cleveland, Detroit, Nor Cal, Italy, Mexico, or Virginia, or Los Angeles, any point, come say hello. We love chatting with people here in Manhattan Beach as well. We’ll post show notes to all the things we talked about today. Subscribe to the show. Let us know what you think. By the way, leave us a review. We love reading them, good, bad, in between, everything, always. Thanks for listening, friends and good investing.