Episode #311: Radio Show: Valuation Update…Bond Returns….Meb’s Startup Investing
Guest: Episode 311 has no guest but is co-hosted by Justin Bosch.
Date Recorded: 5/3/2021
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Summary: Episode 311 has a radio show format. We cover a variety of topics, including:
- The importance of having an investment plan
- Valuations update
- How Meb approaches startup investing
- Listener questions!
There’s this and plenty more in episode 311.
Links from the Episode:
- 0:39 – Intro
- 1:17 – Welcome to our co-host, Justin Bosch
- 2:11 – A year in review living through the Coronavirus pandemic
- 2:47 – Get Rich Portfolio (Faber), Stay Rich Portfolio (Faber), IInvesting in the Time of Corona (Faber), How I Invest My Money (Faber)
- 4:32 – A bull case and a bear case for the US stock market
- 7:34 – Potentially finding and claiming your unclaimed assets via org
- 10:06 – Claiming government rebates via com and Episode #268: Best Idea Show – Dug Ludlow, Mainstreet
- 12:38 – Sidewalk Money (Faber)
- 16:52 – Thoughts on the current US stock market valuations
- 23:29 – Distinguishing between the broad index and potentially attractive value stocks
- 26:08 – The Case for Global Investing (Faber)
- 29:33 – What we can expect from bonds and portfolio adjustments going forward
- 31:29 – The Ivy Portfolio, Episode #231: Julian Klymochko, Accelerate Financial Technologies
- 35:11 – Meb’s methodology when picking companies for his AngelList investing
- 38:38 – 100 Baggers: Stocks that Return 100-to-1
- 40:56 – AngelList, Republic, SeedInvest, WeFunder
43:32 – The sectors Meb’s most interested in when angel investing
- 45:23 – Episode #224: Eric Kinariwala, Capsule
- 47:09 – What effect do interest rates have on intrinsic value, and what the effects of low interest rates are
- 48:54 – Stocks Are Allowed To Be Expensive Since Bonds Yields Are Low… Right? (Faber)
- 49:09 – Carter Malloy Podcast Episode (coming soon)
Transcript of Episode 311:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria investment management or its affiliates. For more information, visit cambriainvestments.com
Meb: What’s up, everybody? After a long, long, break, today we’re back with a radio show. In today’s episode, we review the crazy last 12 months and discuss the importance of having an investment plan. Most don’t, by the way. We take a look at valuations around the globe and see which countries look cheap, which countries look expensive. We talk about value versus growth and how to handle portfolio construction in a world with bonds return almost zippo. As we wind down, we get into my process for investing in startups and some of the lessons learned putting money to work in over 200 companies. Please enjoy today’s radio show. Welcome, listeners. It’s time for a radio show. My goodness, we haven’t done these in forever and a day. Joining me on the show today, Justin. Welcome back.
Justin: Howdy, good to be back. It’s been over a year now. I think we had sat down last time right before we went into lockdown, so a pretty dark and scary time.
Meb: I give us an excuse for putting it aside, but I’m going to commit, I’m forcing you to commit to doing this monthly going forward. We could do it more if people like it, and miss it. But I say let’s start with monthly but listeners will have to do an ask. You guys go subscribe to the show on iTunes, give us a review. We love it. We need the feedback plus, minus, everything in between. Shoot us an email, firstname.lastname@example.org. Send us questions. We’ll ask them live on air. Give us suggestions for we got some new sponsors these days, which we’ll talk about. What’s been going on? What should we start with?
Justin: Since it’s been so long and there’s been so much happening from last time we talked, let’s get into it because I think the period of Coronavirus, this…since lockdown to now, is a great case study on what can happen over a certain period of time, and a perfect example of why investors have lots of options including doing nothing and why that’s perfectly okay.
Meb: This is one of the features of markets we’ve talked a lot about. And longtime listeners probably hear bits and pieces of this from other podcast, yes, but we wrote a whole series of blog posts during the pandemic. The first one was called “The Get Rich Portfolio,” “The Stay Rich Portfolio,” which really weren’t pandemic-related. But as that sort of progressed, we wrote the “Investing in the Time of Coronavirus,” and lastly, followed by “How I Invest My Own Money.” And listeners, if you haven’t seen it, we’ll put it in the show note link: so mebfaber.com/podcast.
And the “Investing in the Time of Coronavirus,” I’m proud of that piece because what we talked about…we said, “Look, you’ve prepared for something like this, maybe not this specifically, but something like this. You’ve understood and studied history of market returns. All sorts of left-tail or right-tail outcomes are possible. And so for the years, we’ve talked about getting an investment plan, writing it down, the zero-budget portfolio, all of these things, to get prepared for the crazy times.
You know, it’s like the quarterback analogy we always use. You say, “Oh, wait, you’re Peyton Manning.” Now I can say, “I don’t know,” by the time this publishes, “Drew Lock or Aaron Rodgers, for the Broncos,” we’ll see who. They come prepared to the line of scrimmage meaning they don’t just show up and look around and say, “Oh, geez, I’ve never seen this defense before,” right? They spend millions of hours studying tape and running through reps. And so the same thing with investing concepts is hopefully, you build a portfolio that had a plan with the knowledge that at some point, you’ll see things you’ve never seen before. The example that happened in Coronavirus certainly was the fastest ever from an all-time high to bear market and back.
So if you go look back at our old posts, this was in the depths of March. We said something along the lines of, “Look, markets are uncertain. Most investors are probably better off trying to emulate Rip Van Winkle than Nostradamus meaning predicting the future. But let me lay out a scenario for a bull case for the U.S. stocks and also a bear case. And depending on who you’re presenting them to, they both sounded plausible. Now at that time, the bear case sounded much more likely. The bull case sounded so farfetched.
We were talking about markets hitting all-time highs by year-end and people were like, “That’s crazy.” Well, sure enough, that’s what happened. And if you kind of scroll down, we said a few things. We said a few things you can do, you can re-balance. And we hinted towards this concept of over rebalancing that we’ve talked about with Robert Knott and Howard Marks, this concept of if something moves too far and it’s really cheap, you could add a little more. You don’t have to think in terms of all in or all out, binary, good/bad. The concept of having the portfolio strategies that automatically reacts to something like trend following.
And trend following strategies had a pretty wide spectrum of returns last year, so all the way from exceptional to okay. And some were probably bad, but mostly, they did a good job. And of course, things like tail risk had spectacular returns during that period. When we talked about things like the big discounts, the Bill Ackman Fund closed in, fund traded, I think at like a 40 and maybe even hit a 50% discount. And that was a monster winner for a number of reasons. But I’m kind of proud of what we talked about during that period because it was crazy, not just with markets, but everything else going on in the real world and all the struggle that people went through. It also illustrates the challenge with buy-and-hold investing, which is so much of your risk is specifically correlated to what’s going on in the real world.
So stock risk is in the U.S. is so correlated to your human capital, to what’s going on with the economy, to what’s going on with employment, unemployment, you’re kind of end up quadrupling down on the same risk. Anyway, hopefully, this nice move up where we are in 2021, incredibly strong. I mean, just when 2020 left us, we said, “Okay, good. Let’s put that year behind us. That was insane. Let’s move back to the more normal times.” The year 2021, GameStop, Dogecoin, everything else going on just gets weirder and weirder, “Hold my beer, 2020.”
Justin: Lots of SPACs popping up here and there for different reasons, going after different targets and…
Meb: We have a pin, my current pinned tweet, my old pinned tweet was about global valuations. My current pin tweet is about…it just lays out all of the top charts that kind of demonstrate the craziness that’s going on. And so it references my grandmother who is Southern, and she used to say, “What in tarnation?” And if you’re not from the south, it means like what in the world is going on? And if you looked at any one of these charts in isolation, you’d say, “Okay, that’s kind of crazy.” But then it just goes on, and on, and on.
And it’s hard to get through this pin tweet and not feel a little bit nervous, particularly about U.S. stocks. And we’ll get into some of the specifics on that. But it’s weird times, as always, but we’re right around…before we get into it, we’re right around tax day, which used to be April 15th, is now I think May 15th. And longtime listeners will probably sick of this, but I have to mention it. It’s my favorite thing to mention, because I like giving value to our listeners. And so we got to mention, we mention every tax day, the best way to find hundreds of thousands. We have a Twitter follower report back. They had found a couple $100,000, which is the biggest find, I think yet. But this concept of unclaimed assets.
Listeners, you can go to unclaimed.org. It’s a clearing hub for all of the state unclaimed assets sites. And what is that? It’s if you live somewhere, so I used to live in Colorado, North Carolina, Virginia, all over the place. And let’s say you had some dividends checks coming in the mail, people use to do that. Not anymore. Or let’s say you had a long lost grandfather who left you a trust that you didn’t know about or there’s companies too, by the way, if you have a defunct company that got a tax refund, all of these things, on and on and on, cable bills, insurance. The state doesn’t try that hard to find you. So they amass these war chests of money that no one has claimed. And again, they’re not looking for you.
And so you can go on to these websites. And let me be very clear, this is for free. You should not ever pay someone to do this. And each state does it different. And there is billions sitting there. And we’ll add some links because if you don’t believe me, you can go look these up. But we’ve found millions of dollars for our followers thus far. So you go to unclaimed.org, put in your state, put in states you used to live in, type in your name. Some of them list the dollar amount and maybe like, “You have $1,500.” Some will be like, “It’s below $100, above $100.”
You claim it. And we joked on Twitter. We said, “If you find 100 bucks or more, you owe me some beers, 1,000 bucks or more, you owe me some…what came next? I can’t remember. Some whiskey. Maybe $10,000 is Pappy, I don’t know.” But you can look for your family members. Don’t get too creepy. If you’re at work, mentioned it to your co-workers and they can look it up. But you can find all sorts of people: Britney Spears, Donald Trump, Kanye, they all are owed money by the government.
Anyway, that’s my gift to you listeners. If you find something, shoot us an email email@example.com. Tag us on Twitter. Let us know what you find. But it’s a really fun way. There’s nothing people like more than found money other than found money from the government.
Justin: I want you to add this going forward to your unclaimed property mentioned as Main Street, a company, startup you’ve had CEO, Doug Ludlow, on before, I think an amazing concept to actually put a business plan in action and help companies and startups really attack this from a pretty official standpoint.
Meb: One of my favorite Munger quotes talks about kind of how the world is driven by incentives. And there are certain startups that when you see the idea, it’s so obvious, but it’s under this concept of sort of frustration arbitrage, meaning it’s just a pain in the booty to go do it on your own. So if you have someone that does it for you, finds you money, why would you not do it? So listeners, if you haven’t listened, Doug has been a rare two-time guests because I think that story is so awesome.
And their company has been an absolute rocket ship. If they’re not a unicorn already… I mean, they’re like one of the fastest companies, unicorn status. If they’re not there already, they’re close. They’re just crushing it. But what they do at their core, and its mainstreet.com is they have companies, you send them a summary of financials, I think, or tax returns, and they’ll do a quick for-free audit. And to the extent there’s any sort of government rebates, they’ll work with you to apply for all of them. And the average company’s savings has been $75,000, not like 7 or 7,500, 75,000, which means there’s probably some that…
And I’ve had plenty of friends who’ve gone through this, and have saved a bunch of money. They also have a program where they straight up will advance you the money ahead of time. And you’ll listen to the podcasts. We don’t have to get into deep in here. But the takeaway is that if you don’t do this, you’re lazy if you’re a CEO, or CFO. If you’re an employee at a company that has less than 500 people, I would go into your office tomorrow. Don’t even reference me. You don’t have to give me any credit. Go into your office tomorrow, to the CFO and say, “Hey, have you seen this website? I think this might be able to save us some real money.”
Sure enough, it does. And then you save them hundred thousand, a million dollars a year, guess what? You’ll probably get a promotion, or at least a pat on the back. Maybe a bonus. I don’t know. If you get a big bonus, again, Pappy. We’re talking about it. But this concept is such a no-brainer. And it’s such a cool idea. And it’s so clearly found this magical product market fit. They even announced on Twitter, they’re starting to do it…apply it to employees too. So lots of fun stuff coming down the pike for them.
But again, it’s a really fun… and we summarized actually a couple of these ideas. I totally forgot about it on this concept of a blog post we did called Sidewalk Money. And I can’t remember what the other ideas were. I’ll look them up while you’re talking. But Sidewalk Money, we’ll add a link in the show notes. But it was kind of concepts where like if you’re too lazy to do these, they had to be totally free and require no effort. Oh, yeah. So one was like cash yield on your checking account. Most people earned zero or don’t even know what they earn.
Justin: I remember that one. I’ve used that. It works. That’s a great one.
Meb: And there were some more esoteric ones like reducing your fees on your portfolio. A totally off-the-wall topic, which I don’t know if we want to get into today, but it was the concept of how you invest your safe money. So most people assume that the best thing to do with your safe money is put it in T-Bills as do companies on their corporate balance sheet. And we kind of did a blog post in the stay rich portfolio that demonstrated actually it was much safer by volatility and draw-down measures to invest like half of your money in a global market portfolio, stocks, bonds, real assets versus just T bills.
The funny thing about that conversation is it’s now been co-opted by the crypto community with Michael Saylor at MicroStrategy and others that say, “No, no, you shouldn’t put your corporate Treasury in T-bills,” similar argument as mine, but they take it to a totally different conclusion, which is, “You should put it all in Bitcoin,” which is not the way we ended up going down the path, but kudos to them because that’s been a great trade.
Justin: I actually love that concept. So let’s touch on that for just a minute because what it forces you to do when you read that is to throw out all your preconceived notions out the window, and kind of start with a clean sheet of paper and say, “Okay, how am I defining risk? How am I defining safe money?” You’ve mentioned it several times before. If you take T-bill returns, Treasury returns, and you look at the real returns, so include inflation into that calculus, it’s a completely different picture than kind of the nominal return that we tend to think of when we think of T-bills, and bonds, as safe assets. So I think really illustrate have a really good thing to kind of exercise or walk through, at least it was for me. It was a little bit of a…you know, it changed my mind about how to look at sort of money that’s supposed to be there but you want it to grow at least to a minor degree, I suppose, depending on risk tolerance.
Meb: It’s a little blue pill/red pill once you think about investing in terms of real returns after inflation, it’s hard to go back. I mean, the challenge I think for a lot of people is they think in nominal returns, partially because inflation is a non-stationary concept. It’s 2%-ish, but at times has been much higher in the U.S. and in other places, it’s been deflationary as it has in the U.S. before, too, as well as hyperinflationary. It also depends on exactly what inflation you’re measuring. So each person’s basket of goods and services will be different.
Certain people and certain items like technology and TVs are obviously massively deflationary over time, whereas other things like education, and health care, have only been going up in cost. Anyway, but the whole point being is that a lot of people view something like T-bills in terms of nominal returns…and my favorite thing to do is poll people on Twitter and ask them what sort of returns have bonds had historically as far as the biggest drawdown after inflation? And most people assume it’s 0 to 10, when in reality, it’s over 50.
So you’ve lost half your money at one point. And that’s again, higher inflationary times, but it’s that long erosion of inflation, whereas stocks is much more tangible because it’s like a crash, where it goes…the price is all over the place although bonds have been doing a good job over the last year of going down. Traditionally, something like the 10-year you don’t see a nominal decline much more than 10%, which is kind of where we are right about now. Real drawdown can be bigger, but historically, at least on a short-term basis, you don’t see them much more than they have now. But we’re also starting from a pretty low level as well on bonds. But bonds are easy to forecast because you just look at their starting yield. And that’s almost always what you end up getting nominally after 10 years. Real returns, different story.
Justin: Well, let’s get into it. Markets, valuation update. U.S. stocks, you know, you’re a big CAPE guy, and we talk a lot about that around the office here. U.S. stocks looking expensive, but there is sort of another side of the coin here internationally. A lot of opportunity out there. Why don’t you walk us through it.
Meb: Longtime listeners are probably sick of me talking about valuations. But it’s something to be very aware of. I had tweeted like a bear market checklist. And I said, “Stock valuations, expensive, unrealistic expectations,” people were expecting in the most recent survey, 15% in the U.S. stocks, highest in the world. Lots of new IPOs back supply, some of the highest we’ve ever seen. And I had another tweet where I was like, “The thing that’s going to eventually kill this bull market is econ 101, so boring, it’s just supply, all these companies going public, public, public.”
Short interest is one of the lowest it’s ever been in history. Investors’ allocation to stocks is the highest it’s ever been in history. Retail, trading options in risky assets. I mean, you saw the Reddit, the Wall Street bets, all that going on, that’s well established. The volumes are through the roof. Interest rates going up. Taxes potentially going up. I said, “The only thing left is for the trend to turn.” But the valuation were up around 37-ish, on the CAPE ratio. And again, before everyone loses their mind about CAPE ratio, it’s not even the most bearish. There’s many other indicators that are already at all time highs.
So for reference, CAPE, historically, down around 17, low inflationary periods down around 22. It’s been as low as 5 in the U.S., as high as 45. But it’s at 37 now, which by any standard is high. But if you look at a lot of other valuation metrics, it’s not even the worst. So there’s many that are worse. And it’s interesting, because, you know, I asked people on Twitter, I said, “Do you own U.S. stocks?” It’s like everyone said, “Yes,” 90-something percent said yes. I said, “Would you still continue owning them if the CAPE ratio hit 50?” so higher than it’s ever been in the U.S. ever. And remember, in 1999, we then had an absolutely horrific decade of two drawdowns of 50%. And half the people said they would still own stocks.
And I said, “Would you still own stocks at a cap ratio of 100?” higher than any country that’s ever been in history. Japan in the ’80s hit almost 100. It was like 95. And a third of people said, “Yes.” And that’s such a strange disconnect to me, because everywhere else in people’s lives, they think in terms of fundamentals. Well, maybe not with housing right now. That’s going bananas too. But usually with buying things like housing, if you say, “Hey, you got to go buy the pizza place down the street,” you would ask about revenues, and profits, and all those sorts of things.
But there’s a certain cohort that believes in this buy-and-hold story so much that you are willing to avoid all concept of fundamentals. And the recollection, remember, market cap weighted indices don’t include fundamentals and valuations. So many people don’t understand that. So if you have an index or a manager that is doing it, and incorporates valuations, that’s one thing. My buddy Barry Ritholtz had a tweet. It was referencing a study. I think it was in Barrons, he said, “Price to sales, multiples of 15-plus in stocks,” which is insane, “from 1970 to 2020. Spent the next three and five-year periods with average relative returns of minus 18% and minus 28%.”
Right, they’re horrible. Like, that’s the worst possible thing you can do. And so I was trying to drill this in on the index level, I said, “The U.S. recently just hit 37, 38 in the CAPE ratio.” I said, “On the calendar year end, this has only happened for the major indices going back to the last 40, 50 years like six times, and the U.S. had happened in ’98, ’99, 2000. Not a good time to invest. EFA, it happened in ’88, and ’89, largely due to Japan, again, in ’99. Again, horrific investing points. And emerging markets, 2007. And that was due to India and China being in the ’40s and ’60s of the CAPE ratio.”
So then I tweeted later I said, “Can anyone point out when the CAPE ratio has ended the year at 35. And future 10-year returns after inflation, were even positive?” And eventually, Charlie Biello found a couple. And so then I went and ran all the numbers. And it turns out there’s about 55 times in history that’s happened. A bunch of those are just Japan, because Japan again went crazy, and then had zero returns for 30 years. Not 5 or 10 years, imagine zero returns for 30 years. Looks amazing now, but a different story.
So we looked at all the times in history CAPE ratio closed a year above 35. Again, that hasn’t happened yet. We’re still six months plus left in the year. The average real returns was zero for those markets. About a third were positive, but essentially none had historical market-like returns, right? They may have been positive, like 1%, or 2%, or even 5% per year, but on the average, and the median was zero. So the expectation in my mind going forward U.S. stocks, you have to at least consider the possibility for the large cap market-weighted indices to be zero.
Now, let me be clear. Recall that a stock market is not one single thing. So if you have a value approach in the U.S. or you tilt towards small cap value, whatever, mid-cap, values have been terrible for a decade, that’s different. The valuation of those stocks is less than half of the market cap weighting. Totally different and it reminds me so much in 99, where from 2000, 2003 depending where you put your money, you didn’t even really have a bear market. You know, the large cap stuff got cut in half. I mean, NASDAQ was down over 80. But a lot of things were okay.
And so I think you’re seeing very similar rhymes right now. Historically, SPACs have just been an incinerator. We can get into foreign. Obviously, I think foreign is better. But the U.S. stock market is getting into nosebleed territory. And a great indicator to me about sentiment, and you can go back listen to the Grantham episode who talks about this, he said is the second most bullish people are is the day after the peak, right? People are still euphoric. But people get angry when I talk about this topic now. They’re starting, like, to get a little personal on this topic, despite the fact most of our funds are long-only equities. But it’s a time for…I think it’s the yellow flashing light. Red is when the trend turns, baby. But we’re in serious yellow flashing territory.
Justin: I want to be clear. When you talk about the market being expensive, you are talking about the market cap weighted group index, group of stocks. But I do want to dig into the value a little bit because I think that’s really important to sort of be able to reconcile the two and talk about how the broad market is expensive historically and relative to the rest of the world. There are segments of stocks that still look attractive. So it isn’t one of these you need to be in U.S. stocks or out or in U.S stocks and in other markets. There are still ways to be involved in U.S. markets, but it takes, you know, looking at fundamentals, looking for value. And I want to hear your take on this. Is value here to stay for a little while or is this sort of a head fake and growth is still going to start cranking higher again?
Meb: Value got two historic spreads. My favorite chart on this was one of the guys from Robeco tweeted out a chart and said it looked at the French Fama value high minus low back to the 1920s. And it showed all the paths for the calendar year. At the time, he was talking about 2020. And it said, “Up till then, the worst performing year for value was 1999.” No surprise. Guess what the best was. 2000. Things went crazy and then reverted. And he said, “Until 2020.” 2020 is now the worst year for value, including 1999.
And then what do we have so far in 2021? It was such a beautiful tweet because it was like, “Here we go. What’s going to happen? And we had an absolute just face ripper value in Q1. But the funny thing is if you look at the value growth chart, it’s barely even budged. It’s like this huge cliff, and then just like a little bounce. So I mean, who knows? Maybe it keeps going down forever. But my theory is it has a long way to go. And to me, like you mentioned, if you look at the metrics of a lot of these companies, they’re great companies that are cheap, that have high cash-flow, returning it to shareholders, benefiting from the reopening.
And so to me, that seems like such a great place to be if you’re going to choose stocks. Now, of course, my idea that I drone about ad nauseam is there’s no reason to focus just in the U.S. If you look at any given year, on average, 75% of the best performing stocks are outside the U.S. My favorite piece on this was a summary we did about a year ago. We called it “The Case for Global Investing,” we’ll link too in the show notes that had about five of my favorite pieces about investing in international. And this is a good example, is I don’t think you can read that piece and conclude you still want to put 80% in the U.S., which is what everyone does in the U.S. It seems absolutely insane to me.
And a great example…I mean, the last 10 years have just been U.S., U.S., U.S., U.S., which is great, but it’s not normal. The last time the U.S. outperformed GDP emerging weights was ’90s. And before that, it was 1910. So the U.S. having this sort of run is not typical. And there’s a, I think it’s AQR who talked about this, and they said, “Our performance, U.S. versus foreign is almost entirely attributed to the valuation, multiple expansion.”
So the CAPE ratio, which after their financial crisis was like low teens, is now 38 while the rest of world is at 22, foreign developed, maybe 23 now. Foreign emerging, mid-teens, call it 15. And then the cheapest bucket is like 12. The cheapest countries in the world, we’re talking Poland, Russia. It’s a lot of Eastern Europe. Czech Republic, UK is in there now. My goodness, it surprises people. Again, we tweeted about this. I said, “Russia has a CAPE ratio of eight. U.S. is at 38. And guess what, they’ve had the same stock performance the last five years. I think that would surprise a lot of people.
And so you don’t have to make a lot of assumptions with particularly something like Russia and emerging markets where interest rates are doing well, or going up, financials are doing well. Commodity prices, dollar has been declining. A lot of people haven’t talked a lot about that. That’s sort of a trifecta of tailwinds for emerging markets. But particularly the cheap stuff like the Russia, Poland, etc., it’s not a stretch, I think, to see the fact that they could double pretty quickly. And that takes Russia from 8 to 16. Like, that’s not even…its average valuations. You don’t even have to say Russia. You could put in UK again, and still have a huge valuation discount to the U.S.
So anyway, I mean, this is Meb’s hill I’m going to die on for the past 10 years about…broken record talking about valuations elsewhere. I think the story is finally changed in the last year. And you guys can quote me on that. This is Meb happy hour talk. But usually, we should have broken out the beer of the month club subscription we now have. Shout out to Mike for signing Cambria up. However, one was like a pineapple strawberry Belgian, which I just don’t think I can do, particularly right now. But anyway, this is happy hour talk to where I think we’ve seen a big regime change in the last year. And you can date it to one of three dates. Either pandemic low, so let’s call it a year ago, March, interest rate low, summer, and you could tie the dollar into that too, or the election.
And certain things have happened since then. So value, the biggest story just face ripper across the board. But foreign I think has made the turn and interest rate cycle could have changed. So we’ll see how that plays out. But as the U.S. has led sort of the reopening of the world and doing well with, at least, knock on wood, a lot of the pandemic vaccines, I think that trade could rotate around the rest of the world. And then you could see value rip in foreign and emerging too. We’ll see. But that seems to be the playbook thus far in 2021.
Justin: So far, so good on the value side. I hope it sticks with us. But anyway, talking about things that have been hammered, you know, we had a steep, what I’d say, a fairly rapid increase in interest rates this year a little bit and bonds got hammered. It spooked a lot of people, but we also have to remember we were coming off like yields at a half a percent on the 10-year here in the U.S. And that’s also you got to compare that to, you know, you got yields around the world are negative. So I mean, we’re coming off like a super low interest rate there.
But the rate of change was rather startling, or at least it seemed to be that way when you started reading headlines. So you wrote about this a while back, and I think it’d be good to revisit your thoughts on…and you talked a little bit about it earlier. But what we can expect from bonds when they have these kind of periods, you know what we’ve seen historically, and what we might be able to see going forward. And you hear the calls for the 60/40 portfolio and the 40% bucket of that being dead and needing to have some type of tweak. But let’s get into it.
Meb: The simplest part about bonds is 10 years, easy to forecast, 2% being an optimist because they’re not 2%. But let’s call it 2% to make the math easy. And all these corporate pension funds expect 7%, 8% returns. Investors expect 15%, whatever. So I said, “Look, if you have bonds as 80% of the portfolio, you need the other, the 20%, stocks return almost 30%. Never going to happen, right? If bonds are only 20% of the portfolio, you still need everything else to be 80%. So the old 60/40, you need stocks to 15%, something crazy per year, when…we mentioned the U.S. stocks potentially doing zero is tough.
And so this is one of the reasons I think you’ve seen people move out the risk spectrum to doing all sorts of crazy stuff. You know, we mentioned SPACs. And look, maybe this time is different. SPACs are nothing new. They’ve been around for 300 years. We wrote about them in our very first book, “The Ivy Portfolio,” where this was going on, and the concept of blank check companies. Obviously, they’re a little different now. We’ve done a few interviews with a great SPAC arb, Julian Klymochko out of Accelerate up in Canada. So listen to those, listeners.
And depending on how you trade them, they can be a great low-risk investment. But historically, post deal consummation, so post-IPO, they’ve historically been a dumpster fire. So Leuthold did some research on this. Others have done research. The average return post-IPO is like minus 70. And a lot of the ones that already, I think there was a stat in Barron’s or something recently that showed from the peak, many of the billion-dollar-plus ones are down by like half. So we’ll see how that plays out. I don’t know.
But a lot of this people understanding saying, “Look, I have a poor opportunity set, U.S. stocks and bonds. Where do I go?” Well, I don’t know how but it leads some people to hanging out in Dogecoin. And part of this is this concept that drives me nuts, which we wrote an article about it. We’ll link in the show notes in January, which was this concept of people saying, “Look, Meb, you don’t understand. I get stocks are expensive, but they’re allowed to be expensive because bond yields are low.” And we walked through this and I’m not going to get into it right now too long, because you can go read the piece, but it basically lays out that that’s just not true. And historically speaking, yes, low bond yields have historically led to high stock returns.
But that was entirely because when bond yields were low stock valuations were low. So the average stock valuation was like 12 when bond yields were low. And so that’s what led to the outperformance, not where we are currently, which is at 38. So it had really nothing to do with bonds, but people extrapolate this concept and they misquote the Schiller study in paper… I did a recent Schiller webinar with DoubleLine and talked a little bit about this, about his paper, all his new Schiller papers showing says they do like a yield adjusted CAPE.
But the only takeaway is stocks, on an absolute level with CAPE, expensive or cheap. And then it says, “Our bonds are relatively attractive.” And so it says like, “99, stocks, expensive, bonds, relatively attractive,” they yielded like 4% or 5%.” And 2020, stocks, expensive, bonds, not attractive. So you’ll still have a stock, bond, spread. But both are terrible. And the media, for some ungodly reason, has totally misinterpreted that paper as, “Oh, bond yields are low. Stocks are allowed to be expensive,” which is not true.
So go read my piece listeners, maybe I’ll do a Meb episode and read it out loud. It’s hard to read this and still believe that statement. And when you hear in the media, it’ll be like nails on the chalkboard. But as far as bonds, look, the weird part is, U.S. bonds are one of the higher yielding bonds in the world, which is a little crazy. You know, the rest of the world got negative pretty hard. And by the way, the bonds did not help in many of the countries when we had the pandemic. So they weren’t the counterbalancing factor they were in the U.S. It doesn’t mean bonds can’t be a good short-term trade.
So historically, when the tenure starts to get into that 10% to 15% drawdown, it has a nice bounce. We’ll link to the piece in the show note we wrote. I mean, we wrote this like a decade ago. I’m starting to get embarrassed because the blog turns 15 this year, listeners. And the podcast I think is five years old. My God. How’s that possible? We’re starting to be the adults in the room who’ve been around the longest. I don’t like it. I like a few generations between me and the grave. Anyway, we’ll link to the bond piece too. There could be a bond bounce, and certainly they’re higher than they were down at 50 bits. Will that be low? I don’t know.
Justin: Let’s get into some listener Q&A while I still have you here. So Meb for you, what’s your methodology or process for choosing startups to fund in your Angel investing endeavors? Do you follow syndicates on AngelList? Choose your own founders companies to invest in, anything else?
Meb: We should probably do a whole episode on this, I think, at some point. You know, we’ve done maybe a dozen Angel investor episodes and VCs, Jason Calacanis, Fabrice Grinda, on, and on, and on. I’ve been Angel investing since 2015, 2013? My God, I can’t even remember. It’s late in the day, but for a while. Let’s call it seven years. Yeah, I think it is 2013. And we’ve talked about it before, and the longtime listeners have heard the entire progression of why and how. I’ll give the quick summary now.
And it’s important because we’re near tax time. This is one of the most important takeaways from the tax review other than obviously, get rid of your mutual funds and put them into ETFs, which are almost universally better. Is there’s a little rule that passed during the Obama administration that is not a lot talked about. We talked about it on The Rubalcaba Show, who Alex has had a big win with his place where you go back a few years ago. There’s a little tiny startup he referenced in the show, just did like a $50 million raise. It’s called QSBS, Qualified Small Business Stock, I think.
But it’s an amazing tax benefit, which is if you invest in companies under 50 million, they call it gross assets, both let’s just call it market cap to summarize, and you hold it for five years, your gain is completely exempt from capital gains for 10 million or 10x, whichever is greater. Which, look, I think it’s going to be one of the most impactful piece of legislation because it incentivizes startups. These companies, by definition, are small, under 50 million, but it’s a massive tax benefit. And so the ability to invest in these startups, even if you match the S&P, should outperform the S&P on an after tax basis.
And so I’ve invested in…it’s going to be closing in on 250 companies. I actually tweeted about it recently. I was curious, you know, who would have been the most prolific angel investors. I know Fabrice is over 500, Jason’s up at 300. And I think my check size is quite a bit smaller, but concept is still there which is it’s not a particularly profound or new insight. But once you understand it and really think about it, it’s important because most people don’t really apply it. And that is the concept of power laws, investing in a company and allowing it the breathing room, and the time, and the space, to appreciate.
So not just double, or not just 10x, but 100x, or even potentially 1000 times your money. I mean, think about that. That is life changing wealth for really almost anyone on the planet. And most people, if you make an investment, let’s say you go buy Google, or Apple, or some stock, or crypto. Let’s say you buy Bitcoin at 50,000. It goes to 100,000. Oh, my God, the world would just lose its mind. Everyone is so excited. Thinking about the vacations you’re going to go on, thinking about the cars you’re going to buy, all these things that people think about when they have life-changing instant wealth. But you got to remember the things that go 100x or 1,000x had to go to 2x and 10x first.
And in the meantime, this is why public markets are so hard is…Chris Mayer, we’ve mentioned many times. He’s been on the podcast. His book, “100 Baggers,” has this concept that it takes often a decade or more for these companies to go 100x. And it’s not a smooth line. Like, you will have multiple 50% losses, and in some cases, Amazon and others, 90%-plus losses. So imagine putting money into a company and it goes 10x. Oh, my God, amazing. And then it loses 90%. And the stock market, like, that’s why it’s so hard. So the beauty of the privates is a feature, not a bug, which is you can’t do anything with them. You’re stuck. And so if you go back to my early days, and you can check the old transcripts, I said, “Look, here are my goals. One, I’m going to start to make a lot of little bets. I want to learn. I want to follow these companies.”
In many cases have found world changing ideas in my mind, I think incredible founders applied…so, like, MainStreet applied some of them and I was a seed investor on MainStreet, applied some of them to my own life, or to my own company, or to other areas of my world. So I want to learn. It’s incredibly optimistic and inspirational. So as dour and Debbie Downer as I sound about large cap weighted public stocks, the amount of innovation, and entrepreneurship, and optimism, about the future in the private startup space is the complete opposite. Like, every day, it’s so exciting to see what people are doing.
So I said I want to learn. If I break even great, I’ll consider it tuition. If I make money, if I match the S&P, even better, that’s gravy, because remember the tax benefits. But this concept of the power laws is I need to put 100, 200 investments to work because if only a couple of those go 100x or more, that drives the returns of the entire portfolio. This happens in public markets too. People forget this. But all the research shows that the vast majority of the return in public markets is driven by 5% to 10% of stocks, McDonald’s, Wal-Mart, Apple, Amazon. They don’t see it because it’s part of an index, most people will market cap weighted, S&P, whatever it may be. But on the private side, the same is true.
And so you have to place enough bets to be able to capture those. And so in my mind, I was looking at the other day…and AngelList is my favorite spot. I have my qualms and complaints about it. And I track the others. It just seems that the incentives and the deal structure on AngelList is the best of the group. But the new crowdfunding rules, there’s Republic and SeedInvest, and Wefunder, and others. And so I’ve done a sprinkling off the platforms because they charge carry and fees as well. So if you’re a startup, hit me up. I don’t lead rounds, by the way, but hit me up. We’re interested. And so we’ve also had a lot of entrepreneurs on the podcast, but I’ve reviewed something like 3000 deals.
And it’s funny because the AngelList has sort of, like, an activity insights tab, and it shows you compared to everyone else. And it’s like the number of people…syndicates you follow. And it’s like the average is like three and I’m like 200 or something. And it’s like the number of deals you review per month is like 200. And everyone else is like five, but I want to see that. I want to see all of it because it gives you a pulse of what’s going on, what people are up to. You see the good behavior, the bad. I think a lot of the syndicate leads, and we’ve had a lot of them on here, the ones we really like, we love, we certainly see some people taking…it’s like the SPACs, taking a little bit of liberty at this point in the market cycle with some of their optimism and projections to be kind.
I had also some early wins, which I think gave me some more confidence to continue. I don’t know if I struck out 30 times in a row investing in breweries and restaurants. And I guess the LA equivalent would be movies and theater without getting a Hamilton. I probably would have quit. But I went into it with a plan. And so far, we should do like sort of an OkCupid analytics breakdown on this. I’ve invested in about 250 companies. There have been about 20 exits. I think the highest multiples on a cash-on-cash exit have been about a 20x. There’s been some that have been in between there. And then on paper and, of course, there’s many that are in TBD, but certainly, a number that have gone to zero as well. But it’s been fun. And I encourage everyone. I say, “Look, if you haven’t done this, go sign up on AngelList in particular, but also the others we mentioned.” Jason has moved off onto his own platform, and has something like almost 10,000 syndicate members.
And so he’s created essentially his own VC company with just individuals. It’s a pretty cool idea. So you’ve got to follow him on his own site. But just follow along. And the biggest mistake anyone can make, I think, is to go into it and think, “I got to put all my money in the first deal.” The takeaway is it should be 95% no, no, no. And you should write down your criteria. I mean, for me, there’s like five areas in particular, I take a second look at no matter what. It’s like aerospace space, we talked a lot about that, and biotech, my old background. I love the frustration arbitrage.
So industries where the NPS or just the customer experience just sucks or is just awful and you can see how software just solves it. I love emerging in frontier markets that are just inefficient and they don’t have certain business models applied yet. One of the biggest for me is mental health and loneliness, attacking that from both sides, trying to introduce happiness and optimism but also trying to treat all the various…and this has obviously come to even more of the forefront last year with everything that’s going on. And kind of food 2.0. To me, that’s obviously a big one.
Most for me, the market cap size ranges… I mean, it’s been as low as I think 2 million. The sweet spot is really 5 to 20 millions, which would be considered seed series A. A big filter for me, I think helped a lot is I don’t really do pre-product. So the service or the idea has to already be generating revenue, usually around a million bucks per year ARR which equates…most of these deals target 10 times revenue. It’s almost like it doesn’t matter what it is, 10 times revenue. But you want to see it have something tangible.
I think the biggest mistake people can make, and it’s harder for me, look some people can do it is the pure pre-seed, where it’s not even built yet. Because I feel like there’s such a high failure rate, that it’s tough for me. I don’t want to fail 99% of the time. I want to see real products that are actually out there. And as you know, this, we’ve had a lot of the guests on the podcast. They’re awesome. We just had Capsule. That was a seed investment. They just got bought for half a billion dollars. Congrats, Ryan, if you’re listening.
A lot of listeners, by the way, are people that get seduced. And media always gets this wrong, by the way. They’ll do something like, “Hey, so and so invested in Uber at $10 million and it went to a billion.” I mean, it’s way higher than a billion now. But just for math’s sake, “They got 100x return.” And you say, “Well, no hold on a second. There were massive amounts of dilution. So instead of 100x, it’s really 10x or 20x.” But just a reminder to the listeners, and commentators who seem to always get this wrong, when they’re talking about valuations in actual outcomes.
But the agony and ecstasy of being an entrepreneur, look, we’ve done it on the Cambria side, is a thousand times harder than being an investor. An investor, you don’t do anything. You’re just writing a check for the most part. Anyway, sum total, it’s been a lot of fun. I’ve done really well. We’ll continue to do it. If you’re a company that I’ve invested in, we’ve offered every one of them some free ads on the podcast. They don’t take us up on it as much as I think they would. But if you’re listeners, hit me up as well as come on the show. Talk to us about what you’re up to. There are some really cool ones we have in the queue that I’m excited to share. That was a really long-winded short summary. I was like, “We should do a whole show on this.” That was basically a whole show. So sorry, listeners.
Justin: Let’s do a whole show. I think it’s important. And we’ll walk through kind of the process, do some case studies. That’s always a fun way to do it. So we’ll do it.
Meb: So listeners, hit us up with some questions. Well, include in what you want to know, firstname.lastname@example.org and we’ll certainly include those in the upcoming episode as well as just questions for the mailbag to include in future episodes. We’ll do more than once a year, once a month, committing to it. You can keep me on this.
Justin: Next question, what effect do interest rates have on intrinsic value? In particular, what is the effect of low interest rates? Why? Now, you already got into this a little bit. But this is coming from the standpoint of equity investing, discount and cash-flow, intrinsic value of stocks. Similar takeaways, I’m sure, but that’s just the context of this question.
Meb: The one thing I’ll add to the comments earlier is that interest rates and inflation are tied at the hip. And it’s inflation in my mind, that’s the big driver of the price earnings multiple that people are willing to pay. So if you look at Robert Arnott Research Affiliates, calls it, like, king of the mountaintop. So they show valuation multiples for the last 120-plus years. It applies to foreign markets too. But essentially, when there’s a sort of sweet spot of inflation of, like, 1% to 4%, people are willing to pay the most on the multiples because the future is a little more certain. That’s my belief. And interest rates are also low, usually, but not always. It’s when inflation gets high, because people are worried it’s going to be out of control. So above four. Or you start to get into deflation and that creates all sorts of other problems, not always the case, but often.
So to me, that’s the bigger driver, it’s less the… I get all the inflation arguments. I just don’t think there’s as much historical evidence for what people mean when they’re talking about interest rates and how their effects are. And I get the cost of capital. I get all the arguments people make. I don’t know as a quant that it actually translate. So please before you harass me on IM, DM, email, Twitter, everything else, listeners, take a look at the post we did, which we’ll link in the show notes called “Stocks are Allowed to be Expensive Because Bond Yields are Low.” But I’d love your feedback. I value it. You can critique it all you want, but at least take it for a spin first.
Justin: Well, that’s all I got today.
Meb: One or two more things before we go, listeners, I got some news I got to update. I got to update my annual “How I Invest My Money” because we may have already talked about it in an episode that will have dropped by now or maybe not, Carter Malloy talking about farmland. But you can listen to that one, listeners. And we got a few others I should probably update as we’re talking about farmland. It’s going to be interesting to see the biggest farmland owner in the U.S. is getting a divorce this week. Bill and Melinda, sorry to hear that.
Coronavirus seems to be taking its toll across the board. We used to joke, one of my favorite unused domains that I have, I have about 50 terrible domains. But my favorite is not a business model yet. So, listeners, if you’re going to build it, let me know. I’ll give you the domain, or if you want to buy it. One click divorce, I think is my favorite domain for a business model that hasn’t been translated. I’m guessing the Gates’ won’t use that simple checkout process. It’s going to be a lot more complicated. But I imagine it’s got to be one of the biggest divorce settlements. My goodness. Who knows how they deal with that. They can handle it. Other than that, listeners, Justin, thanks for joining us today.
Justin: Thank you. It’s been a pleasure.
Meb: Listeners, shoot us feedback at email@example.com. Thanks for listening friends. Good investing. Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show. Anywhere good podcasts are found. Thanks for listening friends and good investing.