Episode #202: Joe Davis, Vanguard, “The Idea Multiplier…We Believe It’s One Of The First Leading Indicators Of Commercial Innovation”

Episode #202: Joe Davis, Vanguard, “The Idea Multiplier…We Believe It’s One Of The First Leading Indicators Of Commercial Innovation”








Guest: Joe Davis is Vanguard’s global chief economist and the global head of Vanguard Investment Strategy Group, whose research and client-facing team develops asset allocation strategies and conducts research on capital markets and global economies. Joe also chairs the Strategic Asset Allocation Committee for multi-asset-class investment solutions. As Vanguard’s global chief economist, Joe is a member of the senior portfolio management team for Vanguard Fixed Income Group.

Date Recorded: 02/12/2020     |     Run-Time: 1:24:44

Summary: Meb and Joe get into the broad framework of Vanguard’s research, and some depth on the thinking and process involved. They walk through some current thoughts on a few different asset classes and the Vanguard Capital Markets Model.

The pair cover Vanguard’s most recent outlook, and their projections that offer an average return differential for non-US equities of roughly 3-4% vs. US equities.

Stay tuned to the end of this great conversation as Joe discusses the concept of the “Idea multiplier,” a fresh way of thinking about the evolution of knowledge and innovation.

Sponsor: AcreTrader



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Interested in sponsoring an episode? Email Justin at jb@cambriainvestments.com

 Links from the Episode:


Transcript of Episode 202:

Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

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Meb: Welcome, podcast listeners. We have a monster show for you today. It’s almost two hours long. It might be our longest ever, and I promise you it is well worth it. Our guest serves as the principal and global chief economist at none other than Vanguard. He is a prolific researcher and investment writer. Also head of the Vanguard Investment Strategy Group, whose research team is responsible for helping to oversee the firm’s investment methodologies and asset allocation strategies for both institutional and individual investors.

In addition, he’s a member of the Senior Portfolio Management Team for Vanguard Fixed Income Group, which oversees more than $500 billion in assets under management. In today’s episode, we get into the broad framework of Vanguard’s research and some depth on the thinking and process involved. We walk through some current thoughts on a few different asset classes and their Vanguard capital markets model.

We’ve uncovered Vanguard’s most recent 2020 outlook and their projections for global stocks, global bonds, what looks good, and what to avoid. Stay tuned to the end of this conversation as we discuss the concept of the idea multiplier, a fresh way of thinking about the evolution of knowledge and innovation. The research effort was an incredible undertaking and you don’t want to miss their findings. Please enjoy this episode with Vanguard’s Joe Davis. Welcome to the show, Joe Davis.

Joe: Thanks, man, for having me.

Meb: Joe, it’s gonna be a lot of fun. We’re gonna get into all sorts of stuff today. First, you’re calling in from Pennsylvania, I assume. Are you on the Vanguard campus or are you at home? Because I hear that’s almost the same thing.

Joe: Yeah. I grew up 10 minutes from Vanguard’s building, but I am on our campus, somewhere about, for those that don’t know, Vanguard, we’re outside of Philadelphia…where the Philadelphia suburbs. Probably about 20 minutes from the airport, western suburbs along, what some call here, the main line. So, born and raised here, and now working here.

Meb: Out of curiosity before we get started, were you aware of Vanguard growing up? Were you aware of investing in general? What age did you sort of aware of this just enormous growing amoeba taking over the asset management world?

Joe: Well, I was aware, high school I was interested in economics. Actually, one of the first books I read was “Random Walk Down Wall Street,” the Malkiel classic, who I didn’t know at the time, eventually served on Vanguard’s Board of Directors. But my dad got me interested in Vanguard. My first exposure to investing.

And I had summer money from working construction and cutting grass. And I said, “What do I do with this money?” He said, “Why don’t you put it in a mutual fund?” So I didn’t know what a mutual fund was. So it was my first lesson in investing. It was around 1990, 1991.

Of course, I will admit the first mutual fund I bought was…because at that time you recall, still the massive run up in Japanese equity. So I bought the Vanguard Asian mutual fund. So I learned a good hard lesson of valuations, but that was probably my first introduction to the investing world.

Meb: That’s funny, that just generated a random memory I don’t think I’ve ever told anyone. I was interning at Lockheed Martin in the late ’90s, in a cubicle with three other engineers and they were older. And, of course, in late ’90s, everyone’s talking about their 401(k). And one of the guys was very smugly bragging about his investment in Wellington. And I was like, “What is Wellington?”

I’d joke. I’d finished my duties as an intern because you can’t do a whole lot at aerospace companies when you’re a freshman in college. I’d finished my duties by 10:00 a.m. and didn’t just spend the rest of day on the internet looking up tech internet stocks. So I had the same experience as you but a different bubble. So I was…you know.

Joe: But I did it again. Meb, here’s the thing. I’ll admit I did it again. Because, no, that was a diversified basket of securities, at least, in the early 1990s. Now I go back to graduate school, my PhD. I’m down in North Carolina, down Duke University in the late ’90s. You can imagine that environment with the NASDAQ and tech. And I had a little bit of money. And so I had a small… I was just in graduate school, my wife, I had a little brokerage account.

So I bought the first stock, individual stock I ever bought my life was in 1997. The ticker was AMZN, Amazon. And I was an early adopter of Amazon. I didn’t really know. I was just buying books there, books and CDs, update myself with the music. And so I bought a number of shares. And so I was both lucky. Some would say I was smart. I was also dumb because I sold it in 2001.

And I tell that to students perhaps in a classroom setting. That’s the story they’re most interested in. They look at me like, “How could you have sold it?” And I said, “Of course, had I known.” And it’s actually a great lesson of bubble investing, because everyone says it’s so easy to spot. I said, “Let’s be careful, because many said Amazon was a bubble in the late ’90s.”

But that’s a whole topic in and of itself. But, I’m not afraid to admit it. I think you learn from your mistakes more than your successes. And that was clearly an investment mistake longer term, which has cost me a pretty penny.

Meb: Yeah. You can do the math on that from ’99. Today, I mean, I think it’s what? Probably $10,000 to $10 million or at least $1 million or something like that.

Joe: It is.

Meb: You speak to a couple things. One, the challenge is also… I mean, Amazon went through a 95% drawdown during the internet winter, as well as multiple 50% ones after. And the challenge of holding something like that is so difficult. Many investors, it’s beyond comprehension. But you also talked to the very real benefit and a lot of the younger investors probably scratch their head at this.

But almost every successful investor we’ve had on this podcast has the same stories, about losing a lot of money when you’re young, making dumb decisions. But those are the scars that keep you behaving better in the future.

Joe: Yeah, I think what it made me do is sharpen my pencil. I mean, in terms of just thinking about investing, active decisions, asset allocation decisions, was I still view as a form of active in some philosophical sense. But what are the assumptions one is making? What are the characteristics that those theses or does the data still hold in that framework?

All those things I actually go back to even those events and replay the tape, “What would I have done differently?” It was, though, a lesson of emotion in some sense and the fear loss. But if I stuck to a purely quantitative way, I would have been more likely to stay the course. But that’s where I think sometimes forgetting the reason why you bought an investment or had that strategy to begin with and just revisiting that in a more systematic way. That’s something…

I had that in one sense, but to be more concrete about it would have been helpful. Which is, why in my current role, we spend a lot of time in Vanguard. I like to think we’re very quantitatively oriented. Not that any model is infallible, and certainly won’t solve many problems, but to have a numerical framework that you continually both challenge the assumptions, but come back to, and let the data help inform to make decisions, I think, is a really important framework.

Meb: Yeah. I spend a lot of time thinking about these mistakes and challenges of investing. The older I get, the more I think about the behavioral side. But not even optimal structures and outcomes, but even areas where it’s suboptimal, actually, if it helps you stay the course is a much better investment.

I used to scratch my head for the longest time about private investments. And I said, “Why would want someone want all this liquidity?” But then it’s thought about it long enough and said, “Well, it’s because you can’t pull up the Amazon quote on your phone every day.” If you were locked in ’99 and said, “You can’t sell this for 10, 20 years,” it’s a different framework.

Joe: Yeah.

Meb: We’re actually recording this during the Charlie Munger is holding court in Los Angeles at his chairman on…is it the Dow. God, what is it? Dow Software Company? I’m blanking on it anyway. So those guys talk a lot about Mr. Market and showing up on a daily basis makes it a lot harder to behave, for sure. All right, so let’s start with the depressing and then move to the optimistic.

You’re a prolific writer. I had a lot of fun last couple of weeks reading, not just Vanguard publications, but a lot of your academic literature. But, let’s start, as we turn the page, on the last decade in getting to a new one. And you guys put out a nice 2020 outlook with the headline “Subdued Returns.” I don’t know how many people just stopped reading after that. But walk us through your thesis, walk us through kind of how you all look at the world in the beginning of 2020.

Joe: There’s three points I’d like to make. One is our approach. And for those that have read our outlook, I mean, we’ll talk a lot about the near-term economic risks and the environment. But I think the broad framework of our market outlook is to really look in a distributional sense.

I mean, I’m proud of us as a firm. Our first publication, this annual publication was 2009-2010. And some will criticize us because they want shorter-term market prognostications, point forecasts, as we call them. We refuse to do it but that’s because I think we’re just honoring the predictability that…the modest predictability I think that we have. And so that’s the framework that we’ve been living under.

And then within that framework, that the second point is that initial conditions, we know for asset returns, initial conditions don’t really tell you much about equity returns over the next year. This gets to the whole literature that your podcast has talked around. Academically, they call it return predictability.

But we look out…we tend to focus on the next 5 or 10 years because that’s where there is some modest predictability in equities. So I think it’s also more important that horizon allows you to try to look through some of this noise and assess risk on a more asset allocation perspective.

And when we do that, given the initial conditions that they do matter, where valuations are in the equity market, at least in the U.S. and where interest rate and the term structure is, risk premiums are…they’re not suggesting that the world will end but it’s just…it is one of subdued returns are more likely than not.

I’d hope that…at least what I believe is that our outlook is not pessimistic. We believe we’re being reasonable. Now, the recent returns have been very strong. In one sense, they maybe laughing at our outlook, which the market may be right. I just think the odds are stacked against it on a 5 or 10-year basis.

And then the third point that we would make is that, from an investment perspective, it’s actually gonna be a challenging environment. Because if we’re right of a period of subdued returns, it means that for many investors they’re gonna have to stay invested, yet they may not be rewarded for taking on aggressive risk positions. But for me, I’m not a very patient person, so that sounds frustrating to me.

It’s actually a little bit of frustrating environment. I think, if you’re an active manager or willing to take on tracking error with your portfolio because you look at most parts of the financial markets, now the coronavirus that’s hitting now is starting to disrupt a little things, but it isn’t like there’s compelling risk premiums like there were 10 years ago.

And for the record, 10 years ago in our first publication we actually had faced a lot on our valuations in our approach. We had a 10-year annualized return for global equity. So we’re roughly not… The Central Tennessee was roughly 9%. It turned out to be that was pretty much right on the mark. Now, year-to-year, who knows? And that’s why we wish we had that sort of precision we never will have. But we were pretty much on the mark.

The more narrow the market segment, the less information content we have, and the strength of the signal dissipates. So, the past three years, we become more and more guarded. But since this past year, we put a little bit more finer point on it, just as equity, particularly in the U.S. have just exceeded the fundamentals.

Meb: So as you kind of walk us through around the world, I mean, I’m looking at your outlook and it’s got U.S. equities range is three and a half to five and a half, let’s call it four and a half. And in my head, that would have been a great real return historically but that’s nominal.

Joe: Yeah, it’s nominal.

Meb: You know, and not too far different for reads, global equities, few percentage points higher, and then, of course, bonds. Maybe just walk us around the main asset classes. You guys put out a really nice publication called the “Vanguard Capital Markets Model” that a lot of these assumptions and inputs are based on. Maybe just walk us through it how you guys think about actually coming up with these numbers in general.

Joe: Yeah. So I give a little sense, everyone on your webcast. So it’s funny, it’s one of the first research projects I was involved with when I started at Vanguard. Now, that’s, oh my goodness, 17 years ago. But this capital markets model, it is a global model where we model in the technical parlance in endogenous system, which means all these variables interact with each other.

We look at core variables. I would call them risk factors. Call them inflation, growth valuation, the term structure of interest rates, and we do this for all the markets, all the primary markets around the world. And then you use that there are some persistence in those variables. And, of course, they interact with each other.

And so when you move them forward, recursively or effectively, you forecast them through time, that gives you over time, a distribution of outcomes. So, in one sense, it’s like taking for those in the money management industry, if they’re managing portfolios, they still have a risk factor model, their attribute performance. It’s based upon…the portfolio is going up because of factor X is going up and value factor is going down, and blah, blah.

Just think about that in a risk factor space. But we’re evolving that in a time series basis through time. So there’s a lot of cross sectional variables that we evolved through time, and where we’re able to harness two full two things that I think are important. And certainly, that’s more important than what I think the financial planning community has generally used for years.

And I fair on that research almost two decades ago, it tends to just use Monte Carlo simulation, just throw the distribution around the historical mean. But we all know just even from fixed income returns alone, that’s unlikely to get the historical average where the interest rates are today, which is a simple way for saying that returns are actually somewhat predictable on intermediate settings.

And so we’re able to harness that literature. But you still get ranges of outcomes, despite us using valuation measures such as the CAPE for equities all around the world, the term structure of interest rates, they’re still in precision. And then we’re, of course, we’re drawing very rich tales based upon historical as well as our own sort of belief that in the future the range of outcomes is always gonna be potentially wider than what has happened.

Because things could always have been modestly better and modestly worse than what has realised in history. That’s a general operating principle we have, but we do honor the initial conditions in the marketplace. And then, we as a team in the Investment Strategy Group, we will take a stance, and this was I think sometimes losses, that the model’s never left on its own because there’s two primary decisions we have to make regardless of the math and the computers.

And that one is, for what historical time period do you estimate these models? There’s regime changes historical. We try to use as much history as possible unless we believe the historical record, there’s a big reason why the past is not necessarily a prologue. And then the second one is we have to make a stance.

And we have done that on occasion. We’re doing that today, that the historical average level of outcomes, so that bell curve, the average outcome will be different than what the long-run average and the data has been. Because any model will converge to that long-run historical data.

We’ve done that for 10 years that we believe that because of our research, inflation, for example, the historical average, historical inflation rate has been roughly 3% to 3.5%, if you define the world as having started in 1960, which quite honestly, is a pet peeve of mine. I think a lot of the investment world tends to define all of history as starting in 1960 because the data is clean at that point.

Based on our research, we thought that the central tendency was closer to 1.5%, below 2%, which is where central bank’s aim in large part because of technology. And so, even though we get a range of inflation outcomes, that in and of itself, we’re making a decision of where future inflation will go as a central mass.

That’s been important, that’s actually helped us in terms of accuracy of our forecast because that has that all sequel. We also had a view that our star, the real base rate, the real riskless rate in the major developed markets was certainly below the 1960 plus record that we thought actually in the 1960s and ’70s and the ’80s were biased upward. When one looked over 200 years, the average real short rate is around 50 basis points.

So, we generally tended to converge there. Now, the central banks have kind of come down to that. And not to say we haven’t…we’ve revised modestly those projections that mean down a little bit. But I say that because there is subjective. I mean, you could argue that’s either subjective. I think it’s informed by research and/or reading history, but that’s still an active decision, whether you use blindly history or you kind of override it.

And that’s sometimes not talked about a lot. Even if one had our capital markets model, was able to use it to create our outlook, I think there’s also decisions that they have to be aware of that they would have to make. And I’m not saying ours are the right one. They’ve generally been accurate thus far. And even with that, year-to-year, we’re certainly not getting the investment outcomes in any one year.

I mean, last year, we had the same 5 or 10-year outlook, generally speaking. Everyone knows what U.S. equities did last year, very strong. But again, that’s not the forecast horizon we’re focusing on. We’re trying to really nail the next 5 or 10 years.

Meb: It’s funny you mentioned that, about everyone knows what U.S. equities did last year because there’s like…they do these polls consistently and ask people if they thought the stock market was up, flat, or down. And it’s like, last year, I mean it was up, I think, 30%, was ridiculous amount of people. I think the majority of people said flat or negative because of the geopolitical news flow.

And I’ll find it and send it to you and we’ll post it to the show notes. Because the consistent amount of just negative media commentary on everything in the world, whether it’s coronavirus, whether it’s tariffs, whether it’s politics, yada yada, I think, tends to have effect on people.

Most pros know, obviously, because you’re involved in every day. But I think the general populace, it doesn’t translate even in a monster you’re like… Anyway, we’ll post to the show notes for listeners.

Joe: Yeah. That’d be interesting.

Meb: So I got lots of follow-on questions. And I figured we’ll kind of go one by one. You guys put out a great paper on the CAPE ratio. Some thoughts on it? Would love to hear kind of a short summary on that paper, the concepts, how that makes its way into an of you all’s valuation models in general?

Joe: Yeah. Well, I think if everyone on this podcast is familiar with the CAPE, or the Cyclically Adjusted PE Ratio, really, from John Campbell and Bob Shiller going back years, the one thing that’s been perplexing is that, I mean, ultimately our research shows that there’s nothing wrong with the CAPE ratio per se.

I think it’s generally though, how it’s applied. In our mind how at least I’ve seen it applied in the industry could be improved. And why I say that, I’ve seen charts where you’ll look at the CAPE ratio, which is a good measure of long-term expensiveness or cheapness in the stock market.

And people will say, “Well, the CAPE ratio is elevated.” And they’ll do that because they’ll draw the historical average at the CAPE, let’s say, around ’16 or ’17 and compare that to today where it’s elevated. And say, “Oh, based upon that, the market is grossly overvalued, and we’re due for a significant correction.”

I’m being crude in my sort of characterization there but that’s the general gist, at least in the direct application of it. One of the things that our research has long showed in that we’ve put in our capital markets model and that we published, and we’ve disclosed this so that others can read our methodology is that, I believe that mean reversion is the most powerful force in finances. It’s also can be the most dangerous.

We believe mean reversion is conditional in other things. And so, we don’t think there’s anything wrong with the CAPE ratio per se. And again, some are wondering if the CAPE ratio bias, in other words, is E, P over E is the earnings? Jeremy Siegel’s got a CAPE ratio out, saying, “Well, we’ve got to use different accrual earnings.”

Someone say, “Well, do you look back 10 years? Maybe the earnings are different. Maybe we should have looked at shorter windows. Looked at forward earnings.” Our research shows it really doesn’t matter what earnings you use. The more important thing is to acknowledge that that means that…what is average valuation? What is the average PE, that we should be comparing to, that that in itself, the “fair value” so-to-speak, I’ll put air quotes around fair value, of any fund of valuation metric.

In this case, the CAPE, the fair value in and of itself can vary through time, because then in and of itself is related to other key macroeconomic risk factors. And so, for example, what we would say is that the fair value CAPE that we should be comparing to the actual CAPE, which is elevated, that equilibrium level is higher than average because interest rates, particularly real interest rates, not nominal, real interest rates are lower than historical average and are at least expected to remain at that level.

And so that’s a double-edged sword. That means that the base rate, cash rate, and fixed income, those sort of rates are not gonna provide the sort of nominal and real return, which is an ingredient in an equity risk premium that’s on top of it. So that’s negative.

But it also means that equities are not necessarily, certainly aren’t screaming overvalued territory, because we shouldn’t be comparing to the long-run average CAPE, which is alarming. Because if you just look blindly at the long-run average, to CAPE ratio right now is in unwelcome territory.

Because any another time, we’ve been…and only two times we are higher than that, it was the late ’20s in the late ’90s. And that’s always not a good peer group if one is looking out 5 or 10 years.

We’d say let’s be a little careful of that. And that’s the sort of corrections that we’re making for in our capital markets model. In our fair value CAPE, when you are able to control for the level of interest rates, the real rates and inflation and deflation volatility, you can actually improve these intermediate-term or medium-run equity forecasts relative to the traditional Shiller CAPE, almost double.

I mean, literally out of sample predictability across many markets goes from roughly 30% to 40%, which is not bad. We’re talking about 5 or 10-year returns, average returns, it goes to about 50%. And again, we’ll see. I mean, things could change. But that’s why we still believe that there’s a subdued return environment, but that’s when we talk about valuations.

That’s the sort of controls that we’re doing. And it’s because there’s a fundamental linkage between earnings yield, which is E over P, the earnings yield, and then real bond yields, not the nominal yield, but the real yield. And when people say to me, “We’re in a somewhat lower growth environment globally and a low interest rate environment.”

But then, some will then say…well, then they’re very concerned about the CAPE ratio. I said, “Well, no. If you just said that if we’re low-growth and low-real yield, that means by definition, then we’re gonna have lower earnings yields going for, which means the equilibrium P/E ratio is higher than the historical average.”

Meb: I think it makes intuitive sense. I mean, you see a lot of research out, and some of this translates to what inflation is up to as well. When you have these sort of moderate inflation environments, it makes sense for people to wanna pay a higher multiple, because they’re not at risk at either the dual problems of outright deflation or high inflation. And some of that translates to, as you mentioned, real interest rates and etc. But I feel like it’s really hard for investors to think in terms of real versus nominal.

Joe: Oh, totally. In fact, the first year, Meb, the first year we did our capital markets outlook in 2009, and we presented, the quant in me, the academic in me said, “Well, we got to get out inflation or get out the cash rate to talk about risk premiums.” But then I found that people were saying, “What do you mean by talking about real returns?”

So, I got to add inflation back in. Why am I doing that? Can you just tell me what the nominal return was? So, that was the last time we just solely showed real return, even though I think that’s a natural thing to do, and generally how we model it inside the capital markets model.

And again, I still just want to underscore, it’s funny is that even with our, I think, improved framework, and history will tell if it surely is improved. But from all the evidence we know, it is, but we’re living the out of sample as we speak. But even with all that improved predictability, we still have wide outcomes. But this is the best that we do.

I think we are doing a justice to smart investors to say, “Here’s the full range of outcomes,” because…and I think even firms or asset allocators, or strategists that don’t do that and show a point forecast, when you really ask them, they’d have a distribution in their head. What we’re trying to do is show investors who are trying to make decisions under uncertainty.

I think if we’re really successful, we’d have to do three things. We have to show the full range of the distribution, we have to give them the methodology, or where is this bell curve coming from, right, qualitative or quantitative or some combo? And then third, in certain scenarios that they’re interested in, show them both.

What are the payoffs, and then the probability that happened in the past that being right, but also the downside risk is the probability that they’re wrong, and then let them make informed decisions. And I think that that third component that we’ve been doing, focusing more and more, and you see that towards the end of our outlook this year because…that’s where active management comes in.

If one door feels very strongly about a scenario A, I don’t know, high inflation scenario, playing out more than a global recession scenario, that’s where the active management comes in. I think our group is responsible for saying, “Okay. If you care about the state of the world, what matters and what doesn’t in those scenarios?”

Because sometimes they’re surprising. And then secondly, what are the probabilities of those, and what are the tradeoffs if they go wrong? And then at that point, it’s up to the advisor, strategist, investment committee, whomever it is to make the decisions as they see fit.

Meb: Well, I laughed because somebody was talking about all of the strategists’ expectations for the stock market next year. And let’s call it…or it was like a range of minus 2% to 10%, somewhere in there, for stocks next year. And I said, if you really wanted to be the number one strategist every year, all you have to do is predict either stocks are gonna do higher than 10%, or less than minus 2% because that’s the vast majority of outcomes.

That’s like 60% plus, because any given one year, the returns are extreme over time. Ten, 20 years, they usually call us to the numbers we’re talking about. But any given year, anything can happen. And so, I always say if I was in that prediction for all the Baron stuff I would just name a really high or really no number and chances are you’re gonna win.

Joe: I would do the same thing. In fact, when you were talking about I was going back to my workdays growing up. I remember the game show. Some may not know I’m talking about “The Price is Right.” And to get on the show, you either guess $1 when that product was up and everyone else is $700, $800 for that washer and dryer. Either you bet the highest bid plus one, or you bet it was $1.

Because most of the times it was well outside that tight range. And I think people do anchor. I feel that in the economics world if you hear the consensus outlook for growth, I don’t know for the U.S. if it’s two, you already start thinking, “Oh, is it gonna be slightly higher than two or slightly lower than two?” And so there’s that behavioral finance, that anchoring that’s powerful.

Which is why I think that’s where the analytics is really important. I never would want to throw out human judgment because we can’t model everything. But I think that’s where that process keeps us honest.

I know for us, we have internal growth forecasts, our capital markets forecast because we ourselves are…we’re not immune in any way, shape, or form to the market sentiment, and concerns, positive or negative. And so that at least keeps us honest in terms of, we are much less likely to be swayed by the data flow because we use as much big data as possible.

We still know that we have a large imprecision in our projections. But at least if we’re gonna make a change in our outlook or material shift on either the economic or the market front, we know it’s effectively gotten over some hurdle that’s bigger than any one person at Vanguard and it’s bigger than any one data point.

I think that’s at least a good thing because then we’re less likely to be swayed. Because even economic growth projections or market earnings projections or estimates, they tend to move in a six-month cyclical fashion. So we’re trying to minimise the influence we will feel on that. We know we will still feel it, but we’re trying to minimise that influence.

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Meb: So you guys put out last year and consistently some of my favorite pieces on international investing. And Vanguard has long beat the drum of having a global perspective, which humorously differed a little bit from your founders’ perspective. So, according to the outlook, stuff across our borders looks a little bit better.

Maybe talk about is the opportunity set in foreign stocks and how you guys think about incorporating that into a portfolio because, according to Vanguard, most of our listeners here in the U.S., they want to put it all in in the U.S. stock market.

Joe: Yeah. I wanted to be fair for your listeners. I mean, that scene relative to U.S. large-cap the past two or three years has just underperformed. I mean, you almost don’t even need a terminal or an access to internet to make that statement. I mean, it’s just been eye-opening at how strong the U.S. has done.

And I did…you mentioned Jack Bogle. Rest in peace, our founder passed away. Jack and I, we agreed to disagree, let’s put it that way. I have the most respect for Jack. He just was not as big of a fan on international investing. Thought he got most of the exposure, the benefits from a global portfolio invested here in the U.S. large corporations.

Our data would say, “Jack you’re missing some extra free lunch from the diversity angle.” And so I’d say just two things I’d say. One is from a strategic perspective. I think we are in fairly safe ground saying that the global portfolio is the most efficient portfolio.

Now, that does not necessarily mean, and that’s just the highest ratio of return for risk, expected. That does not mean however, it will be the best performing portfolio. And I think going forward our projections, the average differential over the next 10 years for international equities, non-U.S. equities is roughly 300, 400 basis points average return higher than the U.S. which is a sizable.

I mean, that’s like what? Half the historical risk premium? I mean, it’s pretty sizable. There’s two primary ingredients for that. One, I have more confidence than the other. The first one is and, again, it’s all being driven from our capital market models model. But the one one is just the valuation differentials. So, we’re outside the U.S., haven’t seen as much of move to the upper end of the fair value band.

So that’s generally speaking, a modest tail wind. And then the other tail when is the expected depreciation in the U.S. dollar on a secular basis. Now, we will be the first to say, we don’t have a strong qualitative sense on the dollar on a 5 or 10-year basis. We’re not bearish on the U.S. economy.

Where that signal is generally coming from is the intermediate-term predictability of modest carry returns or performance of various currencies relative to some purchasing power parity, which are all being reflected in the yield curves.

So, part of the reason for U.S. are projecting of non-U.S. equities, some portion of that, not the full portion, but some portion of that is because of an expected depreciation in the U.S. dollar. Which, again, being currently reflected in U.S. and international interest rates.

Again, I have a little bit more confidence based upon our research, a little bit more confidence in valuation tailwind than I do, just on us having precision on the currency effects, but it is there, and it is showing up in the projection. So, I mean that’s where we will start most investors, as a starting point, is significant exposure.

Roughly almost 40% of their equity portfolio to non-U.S. securities as a starting point and then go from there based upon their sort of risk preferences, or their active views. But again, it’s still in the past few years international equities have clearly underperformed U.S. I do say there’s a limit to that outperformance. But it could happen this year, of course, it could.

Meb: Yeah. So, I always reference and I’m curious because in 2020 if you look at the global market portfolio that you’ve referenced a few times, you can get pretty darn close with a couple of Vanguard ETFs. And I think it’s down to two now. And I think that you guys got a global market-cap-weighted equity in a global market-cap-weighted bond. When are you guys just gonna put it all into one and just do the global market portfolio and be done with it?

Joe: I mean, it’s kind of amazing that you couldn’t even…and I remember learning in school, the whole CAPM portfolio. And of course, it’s been extended multi-factors ever since. But I mean that’s how… I think, as an industry and we’re certainly not alone in this, but I look at the asset management industry, which at times gets criticised for a number of things or concerns about different things.

And the one thing that’s been lost at times is all of us as investment professionals, and asset management companies, how we’ve been able to provide investors with a wonderful piece of technology, which is a portfolio of thousands of securities, whether they’re fixed income or equity at fraction of the cost it would have taken to assemble that portfolio even 20 or 30 years ago.

Sometimes, personally, I take it for granted. But being at Vanguard and the amount of skill and effort and technology it takes to do that, I think is a… It’s a wonderful consumer surplus. We had a paper on this last year that came out from our team, we called it “What does a mutual fund worth?”

And try to quantify that it’s been billions and billions of dollars because it’s allowed investors theoretically they get closest than they’ve ever been able to get to the efficient frontier of broad-based beta, at least as a starting point for their portfolio.

Meb: As we’ve been saying last year, there’s never been a better time to be an investor. It’s a kind of a good segue to talking about the U.S. dollar. I thought it was interesting talking about the purchasing power parity, which to the listeners if you’re not a big forex person is, goes back to the days the old Big Mac index the economists used to put out.

But that kind of leads us into a segue about bonds. And I imagine, and you can correct me otherwise. But when you were doing your grad school down in Durham, I imagine the textbooks weren’t filled with a world of negative-yielding sovereign interest rates.

Talk to me a little bit about how an economist thinks about this development over the past 20 years. Where maybe in places in history you’ve had patches of negative-yielding bonds, but never on the scale that we do now? When you have your economist hat on, how do you think about that?

Joe: That’s just been amazing. And that’s something that no, it was never talked about. In one sense. It was never said explosive that it could happen. But it was almost because it was on no one’s radar set or experience set, why would you even talk about it? And it’s funny, and even for me, I’m a big fan of economic history. It’s actually what my dissertation was on.

And, I’ve long looked at charts, you can go look at interest rates back to almost the Roman Empire. And there’s a lot of bad stuff that happens now and then throughout world history, and you don’t see the yields of those interest rates going below the zero line. If anything, they were hired during bad times, not lower. So, I think two things, one is, I think the…and again, part of this is us now being able to have some experience in this situation.

I’d say one, economic. I have a personal view from a monetary policy perspective. And then I also have what I think is being an underappreciated factor, although it has been talked about in terms of why we have negative interest rates. I think just as a monetary policy-making framework, I personally have been of the view, and I’ll be stubborn to get off this view, that, I think negative interest rates your mistake.

Why I say that is, the whole rationale or logic to take interest rates negative is that it assumes that inflation economical yields are our real yields plus the inflation, expected inflation, and there’s risk premium there too. But, the assumption is when you take the nominal rate negative, that the real rate will go then negative, which is why stimulatory, which was central bank does it.

And that inflation expectations will either stay constant in that formula, or what, if anything, go modestly up. And I have long worried about when you have negative nominal interest rates, it’s not necessarily clear to me why inflation expectations wouldn’t come down. And we’ve even started to look at how inflation expectations are formed.

And so that’s why I had concerns about it. Because if one can answer that definitively, “No, Joe, it will not drive down inflation expectations,” then I would be very reluctant to use that as a means for monetary policy stimulus. And, again, this whole debate isn’t ended, we still have the ECB. They’re starting to get a little bit more defensive in their movements there, trying to defend it more.

I think there’s behind the scenes. It could be IAAS, it could be IS and certainly, the Fed is very reluctant to do it. But I think that’s a good thing. So I think that’s one. I think, secondly, one of the reasons and we’ve been able to quantify it to some extent, one of the reasons why we have such negative interest rates besides secular forces, which we have long focus on.

We focus on three big secular forces to try to get a sense of what we call paradoxes that can emerge in the world only when you account for these paradoxes. And there’s technology, there’s globalization, and there’s demographics. All of those point to lower…to at least the present time, lower real-rates and some lower inflation that can get you closer to the zero bound.

The other thing I think that’s been underappreciated is that I think the irony of… There’s two things I think have been underestimated, which is why I think we have a little bit more negative interest yielding debt, then I’d certainly have thought 5 or 10 years ago. One is the diversification power, effectively the utility of fixed income.

The irony of the low interest rate environment is that the utility of fixed income has actually gone up, not down, because of the correlation at least on a rolling basis. The past 10 to 20 years have been the most diversifying high quality fixed income relative to equity when equities do sell off. I think there’s a greater appreciation of that.

Effectively, that’s another fancy way for saying that the market is not too worried about inflation risk premium in the ’70s coming back. But regardless, that can explain roughly 50 basis points reduction in long-term interest rates, is the powerful diversification. In fact a negative correlation to high data assets such as equities.

So that’s been, I think, and that’s been really important. The other thing is the irony here is, and I’ve got to be careful with this statement because somebody throw the phone at me since I’m on the phone here. And that is, the irony of the global financial crisis is that today, we may have a shortage of debt in the world.

And why I say that is I think I can make the argument. We have a shortage of high-quality safe collateral, which is why you have a big-time pressure on short duration, high-quality assets that has pushed some into negative territory. But there are academics who’ve made that argument.

And I think all of these forces are working at the same time. We haven’t been able to triangulate to the basis points how all of them are working, but some of them are not permanent. Some of them, though, will stick with us for several more years, which is why our fair value estimate, certainly for the 10-year treasury, which is kind of a benchmark interest rate, ironically, we’re 11th year into the expansion, our fair value estimate for the 10 year hasn’t changed in 4 or 5 years.

And that was with the expectation that the Fed would raise rates off the zero pound five years ago, it’s because these other forces that are more than all setting our high level of debt, which is continuing to grow on a trend basis.

Meb: So you putting on your crystal ball, take it out of your desk, from under your desk, U.S. interest rates, ever a possibility they go negative? Is that a scenario that is fathomable?

Joe: I think it would be more likely to see intermediate or long-term interest rates go negative than the short rate, which sounds really crazy. But, I just think the Fed will be very reluctant to take it. I mean, I could see the two-year, for example, getting negative. If a recession comes and the market really starts to price it, I could see it really prices just skyrocketing if equities were down 30%, 40%, 50%.

I think the Fed will be reluctant to take it into negative territory because of two things. One is the Heisenberg principle, which means just the very fact of observing Europe and Japan, and seeing the mix record may alter your own decision. And that secondly, just how the capital markets and I think the capital market system in the U.S. and the importance of money market funds and other short-term funding markets where that’s our biggest benefit had negative rates.

I don’t think we’ll see it. I think what we would see is a much greater likelihood of a pairing of the Fed with the Treasury, either formally or implicitly to get us out of the next downturn if the strike was very significant. I mean, clearly, quantitative easing would occur, but I think that would be the next stop, it would be quicker.

It still could be delayed and lead to another lay down in the markets to coordinate that, but that is what we would see before, I think, the Fed would start taking it down 50 or 100 basis points. The only thing would change that, I think, Ben Bernanke has talked about this and a few others.

If we do, I think we will live in a world at some point, it’s just not going to be next five years is my best rate of technology. But until we have digital currency as the baseline across the world, you’re unlikely to see negative interest rates multiply in significant fashion, certainly not to the level that in theory, you would say would really start to jumpstart spending. So, I don’t think we’ll see it.

Meb: All right. So as I kind of flip through your outlook and projections, I mean, we’re talking four and a half U.S. Global X, seven and a half bonds, somewhere in like the twos for most of them. You guys manage in the trillions. You talk to a lot of institutions that also manage in the billions. The average pension fund in the U.S., whether it’s public or private, still expects 6.5%, 7.5%, some 8%, 9%.

The average investor, if you survey around the world, always, always says they expect 10% returns. What do you say to them? What’s the general takeaway commentary? Are there any solutions? Is it just everyone lever that puppy up? What’s the general conversation you have with all this big money and even people listening to this, that have much higher expectations?

Joe: The conversation usually hits on one of three topics, and usually all three of them. One is, Meb, is like, listen, we will honor the fact and show the probability of their return projections if they have them, and some do and spend a lot of time focusing. It’s not impossible. I mean, they get a 5% real return. There’s a…and I have to look at this, echo with the numbers today for an 80-20 portfolio.

It’s like, “Oh, okay. That could be 30 some percent.” It’s not like it’s some return expectations. Seven percent on a high quality fixed income before, that’s close to zero. And I only say close to zero is because there’s usually legal disclaimers we have so you can’t say something completely without any…that has zero probability having but it’s extremely low. And so I think we show them distribution.

They could be right just saying that, as best we can tell, we go through all of our framework, it’s just it acts so much against you. And so that’s why we’re trying to be realistic and see what the most likely outcome is, and saying that now you can. You can then think if you have that as a central tendency, that’s important because…

And for some investors, I said, “Listen, if they have very unrealistic, and our judgment, unrealistic return expectations on the secular horizon, walking them through, A, what we need to happen for that to materialise or, B, quite honestly saying, ‘Listen, I don’t believe respectfully that hope is a strategy. I just think the odds are stacked against you. And just know eyes wide open the sort of downside risk that you may be exposed to there.'”

And maybe there’s some other levers that one could pull one’s portfolio to help close that gap. The biggest thing we’ve been saying is it’s not great. I mean, sometimes this will feel to some maybe like my family feels a conversation of, “Well, I was growing up of eat your vegetables.” You told me that I have to save more, I’m gonna have lower returns.

It’s not a conversation that gets you excited. Sometimes it’s not a conversation that gets you on TV. And I think both of those are fine because I think that’s a conversation that I think is a good starting point to have. I would love to see the returns over the next 5 or 10 years being the top quarter of our projections. That would be great for my retirement plan. And I imagine for everyone else’s who’s listening to this.

Again, I am not saying it’s not possible. I am not a curmudgeon by nature. We are just showing where the math and the framework is. And we’ve again, where I think we do have some credibility is that 2009 and ’10, when quite frankly, I got tired of hearing the phrase “new normal” being displayed that there was no hope for a decent return in a balanced portfolio.

I said, “Listen, the market is priced in a fairly somber economic environment. We were projecting actually above historical average returns.” And I remember getting a lot of pushback for that, Meb. And having some doubts on some of those jury days myself. And if anything, we were too low in our projections for some parts of the market.

And so I kind of pulled that lesson in that environment back because here we are in the…I think on the part of the other end of the spectrum where you wanna have… I tend to find more investors who were saying our return projections are too low or a little bit too pessimistic than I do find saying that we’re too optimistic.

The contrarian in me and the fundamentalist in me tells me actually, we’re probably more likely to be right than wrong because the sentiment tends to be countercyclical. But that’s the conversation we’re generally having. I have not seen return projections out there for the most part that are wildly off other than few and they start to hit the 9%, 10% range for 80-20 like portfolio.

So I have seen some institutions have that. But most institutions, most investors have ratcheted down. I think what the fixed income markets have done and seen dividend yield, and nominal yield come down, I think people have been marking down their return expectations a little bit.

Meb: Well, it’ll be interesting to see how a lot of these underfunded pension funds, you would think, given the returns of this past decade that everyone would be in great shape but consistently. A lot of these funds are, and it’ll be curious to see how a lot of these guys resolve any potential subpar return environment with their already sort of chronic underfunding, I don’t know.

Joe: That’s funny, Meb, you talk about that because it’s discount rate, that the academics on your show, it’s what John Cochran always talks about, the power in discount rate. But I tell you, that’s done some damage to savers, to pensions, have lost in others. There’s winners and losers in every battle. They’ve clearly been on the short end here.

I think that would cure… I said, the best thing that could happen to the world would be a 200 basis point rise in real yields across the board. It’d be great for our long-term return projections. It would raise the efficient frontier across the board by 200, it would help savers as well as investors.

Now, getting from path A to path B, even if that occurs, it’s probably gonna be uncomfortable, but for a time, but that’s the biggest challenge, is can we live in a world where we have higher real rates?

Meb: Yeah. Interesting. All right. Let’s start to transition a little bit to some other topics. I really wanna chat with you about as we move, as I mentioned, from a little bit of the more somber part of the conversation to some ideas that you’ve published over the past couple of years that I think are pretty unique.

The one that you and I had been conversing about online for a while was culminated in a new paper you’ve published recently called “The Idea Multiplier.” I would love to hear you walk us through that, and also the whole process on compiling the data and the framework, and the inspiration for the idea on this paper.

Joe: Yeah. Thanks, Meb. I mean, so the grand…so what we got is also “The Idea Multiplier.” So we got on this project because we, as a team, I think the entire industry is struggling to explain why and then sort of dichotomy in the world that we have…

I think with technological disruption all around us, we don’t have measures of commercial innovation rising, which means, economists say productivity. I think commercial innovation, GDP per person, revenue per worker, whatever it is, those measures on a term basis have certainly been lower than historical averages. They’ve been low for 10 years, which that’s why we have lower economic growth, lower growth world, and that’s why we have a low-interest-rate environment.

And when someone says, “Well, why is growth low? Or why interest rates are lower?” I said, we have to answer that question if we’re going to get a diagnosis of where the world economy and where the financial market’s gonna be 5 or 10 years from now. I was struggling to answer that question, Meb, of explaining why commercial innovation is low.

And so that took us on a path. We didn’t anticipate coming here. And so what we believe we have found, and we believe it’s robust, and we disclose all the empirical methodology in this paper, “The Idea Multiplier,” we believe it’s one of the first leading indicators of commercial innovation that has been sort of formulated.

I mean, I grew up in graduate school, the so-called personal innovation is what drives economic growth over the long run, output per person. And I was taught in graduate school, it’s pretty much a residual. Now, Paul Romer won a Nobel Prize years ago. It’s called Growth Theory, Endogenous Growth Theory, that ultimately is a function of human capital.

Really, what he was saying is it’s a function of how ideas form. And that’s where the motivation of this study where my sort of motivation or intuition grew. And my intuition was, in a world where we’re concerned about globalization peaking with respect to trade, it was purely intuition. My intuition was that globalization in terms of the exchange in knowledge and the building of ideas could be accelerating to competition as well as collaboration around the world.

And if that was true that we could be seen, that we could see a pickup in commercial innovation, and hence even growth and even real rates, I’m talking like our star. But that was just a hypothesis. So, we started doing some digging, and we throw a challenge to ourselves. Could we measure the creation of ideas in real-time going on around the world?

And so we access a database that pretty much only libraries use. It’s a database of all published research in the world across all languages and all topics, all disciplines. A library uses… So, when you go into a library and say, “Okay. I’m trying to find an article or a book on something,” Not only that’s useful, but it’s all they use it to even rank academics in terms of their impact on the profession, how well-cited are they?

And so, that’s what we did. We effectively traced the evolution of knowledge of idea networks and how they’re spreading in real-time, and do this historically all the way up to today. And so, we created this measure called an idea multiplier. So based upon…so what we did is we access 2 billion records.

So, of those 2 billion records, we not only downloaded all the ideas, these were all published research. We not only downloaded all the ideas, we downloaded all the citations of all of those articles. So you can imagine the massive amount of data this was. So we use big data techniques and analytics on the cloud, and it was a monster exercise.

And why that was important is that then we were able to screen the data and look at two things. We were able to only trace the evolution of the spreading of influential ideas because these are ideas if they’re influential and they’re being cited by others. Either in agreement or disagreement leading to new further ideas. And we did that across all industries and over time, and we did that…

That end result is what we call our idea multiplier, which has been…and it turns out that that leads to actual productivity, like GDP per person, the stuff that I thought was a residual, it predicts it five years out. It’s robust, it’s robust other controls, and we show in the paper. And so I encourage the readers if they really wanna read all the details, it’s been stagnant for 15 years.

The ideas have been multiplying at a ratio of 200 ideas for every influential one. And in the past 18 months, to our surprise, it’s really started to rise. And I think it’s rising for two reasons. One is, particularly China’s human capital contributions to innovation is starting to move the dial more than it ever has. And secondly, is building block technologies.

You can think of things like the cell phone, or digital, or cloud and big data, they’re starting to what I call smash together, which are starting to lead to new insights in fields that have nothing to do with technology per se. So that’s encouraging. We were not expected to find it, Meb. It tells us…we believe we found the first upside risk to global growth because we’ve been on the lookout for it and haven’t found it.

There’s a lot of that on the negative side. We haven’t found something on the positive side. It truly is. I’m not kidding, it leads growth. We’re not gonna see this the next year. It leads at four or five years out. Again, we were not looking to find this, but the cool thing is is that it gives some sense of where the next great ideas will come from. Like what fields, what industry they’ll come from, because our idea multiplier really pops.

It tends to pop before you see the commercial innovation rise in those sectors where growth takes off. For example, our idea multiplier really popped in the field of computers and technology in 1988, 1989, early 1990s long before the commercialization of the internet. Now again, we can…this has no idea what company will come out, what actual idea, but it gives us at least some sense of if we are gonna see a pickup in genuine.

I talk about organic global growth, not some sort of stimulus fueled temporary fix. It has to come from a genuine rise in commercial innovation. Think of the late ’90s. And this says it, that is at least possible. And certainly more likely than what I’ve been given it credit for, or a sign of the probability to I’ve been assigned in a fairly low probability to it.

And we have more work to do on it. But it is encouraging and it starts to identify the three or four fields that could, in theory, have as big of impact on growth as the internet did in the 1990s. So I think this is important contribution out there.

We would hope others take this methodology. Hopefully, they could improve from what we’ve done. I mean, I know they could, but I’ll pause there. It was a cool thing. And we did not anticipate finding this result, but it is robust to our sort of testing.

Meb: Well, I love reading. I’ve been through it four or five times now. And, listeners, will post obviously the link on the show notes, mebfaber.com/podcast. And it’s funny because, over the past handful years, I’ve been talking about valuation and chatting with investors and talking about what we were talking about earlier with mean reversion and valuations.

And often I would say, look, the future is a spectrum of future probabilities. And I said, there’s plenty of ways these resolve themselves. Obviously, the market could crash, it could go nowhere. Valuations could go up. You could have growth, just be a massive renaissance and go to the moon. I said that, people would say, “What could cause this, Meb?” And say, “I don’t know. Elon Musk invents free energy, or find something in the crust of the moon. I have no idea.”

But the interesting part about what you guys talk about is exactly what you just outlined. Maybe talk to us a little bit because this was a bit of a surprise to me. I mean, it’s not a surprise, but it is a surprise. Maybe about the industries that this was kicking out as having the big potential you guys found?

Joe: I think there’s three takeaways to this. And one is, where the ideas, the game-changing ideas could come from. Again, so we screened for it. We looked at as a team, we said “Are there any fields today that have…is at least sizable Idea multiplier as the computer and telecom industry headed around 1990?” And that was important because that was five years ahead of commercialization like the build-out of the Internet.

The internet was around long before that. They actually see that in company revenues and the stock market. So, we actually found as many as five, which shocked me. One was, you’re seeing things around materials. I think particularly it has to do with battery technology. But there’s things around polymers and carbon fiber.

I don’t know exactly what that means. I think battery, though, it’s particularly a highly charged state. That’s where the idea multipliers picking up. Transportation and energy, I think this is related somewhat to sustainability. We probed down deeper. It’s a lot of ideas in the engineering field.

And again, Meb, just for your readers, these are ideas in the research lab during the medical laboratory, they may be any university or company lab. These have not been commercialised. So by definition, they’re gonna be leading over the actual economy. These are products. They may be in patent form but they haven’t been commercially operationalised.

That’s the signals we’re picking up. So it’s tough to know exactly how it’s gonna play out. But we can tell the high energy state in these fields because of the citations going. There’s something there around energy. The third big one is particularly around health care. And if I had to just pick one field and say, “If there’s something that’s gonna be bigger than the internet, what is it?”

It tends to focus on genetics, where the idea multiplier, the overall one has jumped from 200 to 400 to 1. That’s well over 3000. I mean, it is… And I don’t know exactly what that means over the next 5 or 10 years, but genetics and genome research, starting to show some applications, other parts of the healthcare delivery system.

So again, I am not a medical doctor. I don’t know exactly what that means. But that field is ripe for additional new products, or services, or something’s gonna happen there, which is actually kind of exciting. The funny thing is when I mentioned that, Meb, I said this at a recent conference. I said the irony is I just didn’t mention… I didn’t see the field of AI.

And I didn’t see machine learning or big data. Now the irony is, is I think that’s where one of the reasons the idea multiplier is jumping, those are the sort of what I call building block technologies, AI, machine learning, big data, they’re smashing together that are starting to lead to new insights in, say, genetics research, or in energy research, or I don’t know, new material creation on a computer simulation.

So it’s not that those technologies aren’t valuable but it was funny to me when I started looking in the fields is that some of these industries sound like value companies today or the value sector, which I wasn’t looking for either. So I said, “Maybe I think it has a shot of happiness.”

That the irony would be is if we have a genuine pickup and growth that’s driven by…let’s call it technology. At the end it always is, but it’s picked up by technology. The irony is that could be actually a tell into the value factor, which has gotten absolutely decimated over the past 5 to 10 years.

I don’t know if that’ll play out but that’s what I think would be ironic, is that this sort of technological disruption, which is a knee-jerk reaction, I associate with tech and growth, like growth companies. This says two things are coming. One it says the value premium could very well come back because this is where the technology could be most commercially applied, is in some spaces, which may be more value-oriented.

Secondly, it also means if I’m large-cap companies, we’ve struggled with seeing a number of startups create. There’s been some handwriting over that. This says that there’s been a delay, but there could be more startups coming because more ideas mean more new companies. It’s not on a one-for-one basis, but it does have some leading predictability there. Anyway, that’s it in a nutshell. And I encourage people to say. But full disclosure, we did not know what we were gonna find.

We stumbled upon this. We got on this project because we were worrying about globalization and trade. And we started looking at… The funny thing is, is that the globalization, I think, is accelerating when we define globalization in its most powerful dimension, which is the exchange of knowledge or ideas, twin cities across people, between people and across countries. And that is accelerating, which I think is ironic what they were speaking at Davos a few weeks ago.

Meb: Yeah, well, you start to just get the just basic concept of everyone being connected, and the concept of knowledge compounding, where it has power-law effects in my mind. And it would make sense that as the internet’s coming online and so much of the developing world, simple knowledge share going on that it would sort of lead to some of these conclusions, but it’s wonderful because it’s an optimistic outcome.

How much of a bear was data collection on this project? Did the partners you guys worked with take care of a lot of that or was this like…? This sounds like the world’s worst Ph.D. project to me.

Joe: I have the pleasure of leading the Investment Strategy Group here. We’re ultimately a research group and we’re roughly 65 people globally. The whole 65 global team was not on this project. It was several of us but we started that almost two summers ago. It was a lot of work. We didn’t know exactly where we were going. We talked to the data provider, which is Clarivate, which is sort of a library database.

They were helpful with some web queries, but we’re pretty comfortable looking at large data sets. So this is big. I mean, 2 billion data points is massive. You can’t download it into Excel, no matter how many rows and columns it has. You can’t handle that. But that’s the irony. And so I said, in fact, our whole research insight is in and of itself a manifestation what we’re talking about.

That was not possible without big data analytics and some of the cloud computing. That’s why I said, I’m not dismissive of these new technologies. In fact, they’re key enablers to different insights and other industries. And if we are gonna see a pickup in growth, it’s got to be outside of one small part of the technology field.

Like cloud computing, the spread out, that, yeah, we’re in the early stages of that and that’s going to be positive, I suppose, for growth but that’s basis point effects. How you get percentage point effects is you start to see whole unlocking and the need for increasing and capital stock or completely new unmet needs met, new services, new products, new industries.

And that’s been…you talk to a lot of smart people. They’re very pessimistic on global growth because they struggle to see that. And these are individuals I highly admire. But I’ve been of the camp that we’re in a low growth environment and we weren’t gonna be in it. But it’s not necessarily permanent because that assumes that commercial innovation never picks up.

And that’s where I disagree with like a Bob Gordon who says the best days of global growth and U.S. growth are well behind us. I respectfully… He’s a legend in economic history but I’ve also told Bob, I said, “You’re underestimating the… We’ve been here 10 times as a country before, having very low rates of commercial innovation.”

I think we’re in one of these periods where the economy is trying to adapt and figure out how to use these new technologies. So, longer-term, I’m more optimistic. And so I think I still believe in the next year to two, if there’s a risk of the marketing economy from the downside.

And longer-term, I think the risks of the upside. I think the general narrative has been, quite frankly, just the opposite. That if there are risks the next year or two, it’s reflation, it’s better than expected growth and markets, and all good stuff. But that the longer out the horizon you look, the more pessimistic people become. Low rates, low growth, secular stagnation, and they point to Europe, they point to Japan, and they say, “Well, that’s the future we have to look forward.”

And then, of course, we’re not helping matters when we have lower expected returns. I think what we’re starting to find is that I’m least asking the question. What if the risk in those horizons are exactly the opposite? That the near term risks are a little bit on the downside, in part, because so much as being priced into perfection. But longer-term, maybe we’re all a little too pessimistic.

And maybe if our return projections are too low, I don’t think it’s so much for our handling valuations, Meb. I think it’s that the earning growth themselves, like the true fundamentals are underestimated. And now we don’t get historical 3% or 4% real earnings growth. So maybe that we get the five or six. And maybe that’s what we have underestimated, which we kind of take as historical averages.

Maybe that’s if there is the positive surprises next 5 or 10 years. And I think if returns are much stronger next 5 or 10 years, it’s gonna be because of that. It’s not gonna be because of some sentiment valuation further extension. I think it’s going to be because of the fundamentals were better than expected.

Meb: Well, that’s usually what drives it in the long run.

Joe: Yeah, in the long run.

Meb: You’ve also written a little bit about looking out to the future. A lot of people have the topic of the future of work, and how this is very quickly starting to play out in real life in many, many, many industries of software eating the world but automation, robotics, labor market. We’re now at one of the lowest unemployment rates in the U.S. Talk to us a little bit about your piece on the future work in general thoughts?

Joe: Yeah. I mean, what we found is, I mean, you’ve heard the stories, and I think everyone has that there’s some estimates as much as 50% of the jobs even today, current technology could be automated next 10 years. You talk about sobering, that there’s trouble and then there’s, “Well, what if we lived in that world?” One study estimated several years ago, 70% of the jobs in China could be automated away.

I mean, I don’t think we’re debating the Fed cutting rates or raising rates once. Or if that’s the world we’re headed for, whatever we’re talking about, the economics profession today, that’s not the right one. It’s that we looked at it because it’s really an important issue. What is the future of work?

What we found, though, is that general conversation, those estimates are two barriers, are too high, and there’s a reason for it. Our research finds that most of those frameworks confuse a job with tasks that ultimately it’s important to look at how technology will impact all industries and jobs by looking at the past profile of every job.

And we did that. We looked at…we got data that looked at the time span and the relative importance of all tasks for every occupation in the United States, and how that’s changed through time. And each one of those tasks, its intensity to…or it’s either it’s a substitute or complement to computer technology, in fact.

And by all that data crunching, what we’re able to find is that for more…well, more than half the occupations, there’s gonna be a significant change in time spent and the task emphasis on the jobs, but those jobs aren’t gonna go away. In fact, more jobs are more likely to evolve than they are to get automated way.

So I think that’s the biggest ones. That’s the good news. I mean, roughly 20% of the occupations we estimate, there will be significant downward pressure on the number of jobs. And what are those industries? Those are industries that have very few critically important tasks, and the critically important tasks that they do have going direct competition with technology.

So, there’s probably some professions that jump to mind. But the important contribution of our work and why we got to a little bit more optimistic conclusions at least for the next decade, and now come to the challenge as well, but it’s because we were able to look at the actual task profile of all jobs.

Most professions have anywhere from between 12 to 15 critically important tasks that they do day-to-day. So even if you automate one of those tests, such as, I don’t know, accessing certain information or processing some information that there’s other critical components of anyone’s job that actually can make them more efficient.

Now the challenge, I think, of companies of the workforce and the workers is technology changes so quickly, the ability to adapt. Our analytics show that most jobs have changed their test profile by 50% over the past decade, 50%. Think about 50% of one’s job time has changed over the past 10 to 15 years.

So it does say people are capable of change, it doesn’t mean though it’s not gonna be uncomfortable. And it does mean that there’s gonna be an incredible amount of change in the type of skills that are rewarded over the next 5 or 10 years. And so, I think that’s a challenge for workers, for companies. We’re thinking through, what does the average task profile or job profile of a portfolio manager look like 10 years from now or a salesperson?

We don’t have all the full answers on that but we’re thinking about all that as we go forward. So I think there was good news and challenges as well. I think what that led us to the conclusion four or five years ago when we did this study, Meb, was one of the several paradoxes that I believe will exist in this world.

And the paradox is, we will continue to see advances in automation and continue to see more headlines on automation. And yet, the irony will be that we will continue to have job shortages. And that’s because of the demographic profile the world and the fact that most jobs are more changing rather than disappearing for, again, roughly 60% to 70% of the occupations.

For 20%, there will be significant downward pressure when we try to identify those occupations. It’s not line-by-line but at a high level going time. So, we’re not as [inaudible 01:13:14], I’d say, or pessimistic as… I think we’re trying to be techno realists. Well, I don’t think we were blindly…we’re certainly not blindly optimistic, we identify some of the challenges ahead.

And we also identify the three key skill areas that in most professions are gonna be increasing value. We identify these skills in the paper and competencies. But we’re not techno pessimists that everyone’s pretty much doom to technology. It’s just past profile, most jobs is not consistent with that.

Meb: So, we can only hold you for a few more minutes, I wanna ask a couple of pretty quick questions. But I’d be really remiss if I went through this whole podcast and didn’t get to ask you about a fun paper because, I say to a lot of the listeners, that to really have perspective, you need to be in many ways a historian when it comes to investing. And so you wrote a fun paper on “America’s First Great Moderation” not 10 years ago, not 20 years ago. What did you learn from that paper?

Joe: Yes. Well, it’s funny that paper spun out my dissertation when I was down at Duke. And I did my dissertation, what I did is I created effectively a high-frequency index, an annual index of the cyclical industrial production, or the cyclicality of the U.S. economy going back, all the way back before World War I, all the way back to right around the signing of the Constitution. So it’s going way back to 1790s.

And the funny thing is, is I was not a historian by trade. I got into that because I wanted to do simulations, and I thought the data was available. Turned out, for those listeners, there’s really no effectively GDP or GDP equivalents that are reliable before the early 20th century, before like the 1920s, ’30s, and ’40s. And so had I known how much effort that was to get into that I would never have done it. But that data collection never became my dissertation.

And one of that insights is when you are able to create new data, which is something I really tell researchers, if you can create a data set or get access to a data set, that by definition will give you new insights because no one else knows that. Whatever it yields, whether it’s something you thought was gonna happen or not.

And so this data, one of the papers I did with a colleague several years ago, is when we looked at the annual growth in the U.S. economy, early U.S. economy, I’m talking a little bit the 19th century, 1800s, it turns out that there was a 17-year period before the Civil War that had no recessions. And so, I just think it’s funny. Not many people, thank you for at least reciting that paper or talking about it, Meb.

Most don’t even know it exists. But I think it’s funny today because I stopped chuckling when I see the press report saying, “Oh, we’re in the longest U.S. expansion.” I say, “Well, technically, we’re not.” And so that, yes, for those who think the stock market has gotten well more to go. And, you know, I think there’s clearly a risk that we could wake up six years from now, and we’re still in recovery phase.

And I got to be careful how I say that because I’m not just blindly immune to some of the downside risk. But yeah, I mean, nothing magical about an expansion dying just because of old age. And this says that even in our own history the irony about this great moderation, that 17-year period when we had no recession, is that that was a period when we had no central bank.

We didn’t have a Federal Reserve then. And it was a period when it was undergoing profound technological disruption. So you had to build out of the railroad, of the telegraph, and so forth. Again, and the history never repeats. There’s some similarities with today. There’s a lot of stuff that’s different and a lot of things that could alter that trajectory, but it does says it is possible.

The one thing that also a lot of times you also need luck, and what we talk about in that academic papers that long expansion that was 17 years. And again, for context, we’re in, what, 11th year now? It would have ended in only 9 or 10 years. The economy was starting to slow down. There was overbuilding in some areas, but it was actually all lucky event that kind of kept the…expansion got a second wind.

And that was the discovery of gold in California. But it was effectively, it was a fancy way of saying the money supply increases dramatically. So, we didn’t have a central bank. Discovery of gold in California was affected like a massive Fed rate cut, which also led to a significant increase in demand. So it was fortuitous that that occurred right around 1850, 1849. And that gave a second wind to the expansion.

I don’t think that the Fed’s recent rate cuts in 2019 were that powerful, nor will they intend it to be. But it does say that expansions can go on. Let’s put it this way. If we can get through the next two years, Meb, without a significant downturn, I would hope we can. Maybe that’s when our idea multiplier for right on that kicks in. And that’s the second leg.

So you’re the first time I’m talking publicly about that scenario. It’s not my sort of baseline. Because if I say that’s my baseline, that we’re only midway through the expansion, they’re gonna throw me out in the street as being crazy. It sounds pretty crazy, but it is possible.

I still think that’s more of a just upside risk to the outlook. I think the equity market at some days seems to think that’s already a foregone conclusion, but it is possible and we do have historical precedent for it.

Meb: Good. We’ll have to have you back on in a few years to see how this is playing out. So, question, you’ve completed some big research projects as you’re looking out to the new decade. Anything burning, searing on your brain right now? Or anything that you’re working on that’s particularly interesting or curious? Or any unsolved questions you have at the front your head?

Joe: I think the thing that will come back to, again, is I think there’s three. One is just always continuing to challenge or to improve and enhance our capital markets model sort of framework. I mean, we have a… I think we have a good framework, we can always improve it, both the signals we use and how we process the data.

So that’s one, because we turn our distributions, and we turn our predictability can impact to have conversation with clients and the advice we may give them. So that’s why that in and of itself is important. I think, secondly, down the line is still…again, 11 years since the GFC by some dates, and we have more debt in the world than we did 10, 11 years ago.

So the high level of debt and how do we play that? How do we get out of QE and yet still stuck with this high debt level? So this sort of interplay of monetary and fiscal policy that ties into debt, it ties into the negative rates and quantitative easing and what’s the exit strategy if there is one, that’s a big, sometimes a big mess, to think through that. But we’ve got to think through it even more than we have.

And then something that our risk factor that we haven’t been too concerned about and that is…we’ll always come back to, and that is consumer inflation, not just asset allocation but I think we’ve done a good job there. We’ve generally been on point but that doesn’t mean we should be complacent on it.

So, there are the three really big areas I think right now. I think the fourth one, too, is globalization. Coming back to the trade, though, is I think we’re just stalling in terms of a trade perspective globalization. And we’ll still modestly increase prove over time, but that could be wrong.

So, what does a world we’re going from globalisation to regionalisation? What does that really look like? And I think the second-order effects, the second half of the chessboard, maybe we’ve underestimated some things, so they’re the topics that come to my mind right now, Meb, that we have to think about. We have to sharpen our pencil for sure.

Meb: Last question, we always ask people, what’s been their most memorable investment? Is that the AMZN you’re talking about earlier? If it is, you’ve got to come up with something else.

Joe: Yeah. Well, most memorable investment for me, it was actually having the fortitude to both stay the course and then with my discretionary. Effectively, my savings account, it increased exposure to equities in 2009. I’ve only made very few discretionary changes to my asset allocation over the past 10 or 15 years. That was one of them.

It wasn’t right before the turn. It was over the course of that whole year. But that in my mind, because it was going right against the gut where it just seemed like every day there was something more negative on the economy.

Yet at the same time, our math was saying, “Listen, unless the world ends, and there’s a non de minimis risk that it does economically, that the market is pricing in a pretty sober economic scenario.” And so having the personal fortitude to not only maintain my equity allocation, but to tell clients that if anything you’re gonna do with this environment. I’m more inclined to take more risk, not take less.

But that’s me, I can’t speak for you. But that was a memorable environment the whole…it’s a little bit like kind of like the fog of war, the whole late 2008, 2009 trying to figure out what the heck tarp was. And trying to talk about purchasing of assets. In one sense, it’s receipted part from memory.

But I do remember our conversation with investors and they were good conversations of trying to walk them through, why are expected returns were at least at historical averages. And, that’s memorable because I was feeling the same tensions or fears that I think some investors had, being very open and honest with them.

But they’ve also been able to draw on my experience of history as well as the math and the quantitative, the sort of thing, the valuations. “Hey, this is…” you know what I mean? To have that whole rich conversation, that was very memorable to me. It was unfortunate we had to go through a global financial crisis to have those conversations but anyone of the listeners, many of them, they experienced the same environment. I’ve always told investors, they should really be applauded because… But those sort of periods that were rewarded for the long run returns we expect half, but those were trying days. So that’s my biggest memory.

Meb: It’s so hard to think in those how emotionally charged those years were back in 2008, 2009. To the younger cohort of investors who haven’t been through that sort of market yet, it’s hard to relate that in verbal recollections. But living through it is a different story. Joe, you’ve got a lot of writings, a lot of great ideas, republishing. Where should listeners…what’s the best place for them to keep up-to-date with all your thoughts?

Joe: I’m trying to be better putting all of our team’s research on LinkedIn. You could go to my LinkedIn profile or Vanguard’s LinkedIn. I mean, clearly our website, we have portals for it. If you’re an individual investor or if you’re an advisor that you clearly go to it. And if you don’t know where to go, they’re on our website. I mean, on the retail website. Just go on to…there’s a click always press room where now I have our papers, but you have a lot of different sort of really important announcements for Vanguard.

I go our press room sometimes, and I’ll try to put things that…certainly topics that we touched upon today, Meb. I would be at least, in addition to that, putting it on my LinkedIn profile and Vanguard would be putting on there as well.

Meb: Joe, thanks so much for joining us today.

Joe: No, thank you for having me. It’s been a pleasure.

Meb: Listeners, we’ll post all the links to all the papers we talked about today on the show notes, mebfaber.com/podcast. Shoot us a feedback. We love hearing it, feedback@themebfabershow.com. Subscribe to the show, leave us review, let us know what you think. Thanks for listening, friends, and good investing.