Episode #472: Morgan Stanley’s Mike Wilson Says the Earnings Recession is Worse Than You Think
Guest: Mike Wilson is Chief U.S. Equity Strategist and Chief Investment Officer for Morgan Stanley.
Date Recorded: 3/8/2023 | Run-Time: 46:39
Summary: In today’s episode, Mike starts by touching on the price action we’ve seen so far in 2023, which he says is driven by global liquidity instead of fundamental factors. Then he gets into his outlook for 2023. He has a non-consensus view that we’re in the early days of an earnings recession and expects earnings for the S&P 500 this year to come in around $195 dollars compared to the Street average of $210-215.
Before we let Mike go, we have him share what he is positive on in the US. He explains why operational efficiency is the factor he likes the most right now, and why areas like industrials, financials, commodities, and even some technology names fit that criteria.
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Links from the Episode:
- 0:39 – Sponsor: YCharts
- 1:45 – Intro
- 2:52 – Welcome to our guest, Mike Wilson
- 2:35 – Mike’s notion that bear markets are like a hall of mirrors designed to confuse investors
- 6:12 – Mike’s framework for evaluating US equity markets
- 8:53 – The non-consensus view he holds on US stock markets
- 13:47 – His focus on operational efficiency and leverage
- 16:12 – His views on inflation and how Morgan Stanley is dealing with inflation spikes
- 20:12 – Corners of the market that remain favorable throughout this inflationary environment, namely “real investments”
- 23:09 – Explaining his optimistic views on foreign and emerging markets going forward
- 30:11 – Looking at China as a rejuvenated investment target
- 31:46 – Quick takes on fixed-income, bonds, real estates, and commodities
- 35:13 – A belief he holds that the majority of his peers don’t
- 35:31 – Twitter thread for Meb’s non-consensus beliefs
- 41:00 – His most memorable investment
- 43:29 – Learn more about Mike and listen to the Morgan Stanley “Thoughts on the Market” podcast
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.
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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Hello, everybody. We got an amazing show today. Our guest is Mike Wilson, Chief US Equity Strategist and Chief Investing Officer for Morgan Stanley and one of the biggest bears on the street today. Today’s episode, Mike starts by touching on the price action we’ve seen so far in 2023, which he says is driven by global liquidity instead of fundamental factors. Then he gets into his outlook for the rest of the year. He has a non-consensus view that we’re in the early days of an earnings recession and expects earnings for the S&P 500 this year to come in around $195 compared to the street average of 210 to 215.
Before we let Mike go, we have him share what he’s positive on in the US. He explains why operational efficiency is the factor he likes most right now and why areas like industrials, financials, commodities, and even some technology names fit that criteria. Now, before we get to the episode, I know all you subscribe to The Idea Farm by now, but did you know The Idea Farm is on Twitter, LinkedIn, and even Instagram and TikTok? Check the links in the show notes to give it a follow on all of our social media channels. Please enjoy this episode with Morgan Stanley’s Mike Wilson. Mike, welcome the show.
Hey, how you doing? Good to see. Meb.
I’m great. Where do we find you today?
I’m in my office in Midtown Manhattan. A nice sunny day here for March and looking forward to spring.
I am too. I haven’t been in New York in many years. It’s on my to-do list for the springtime. Well, there’s a lot going on in markets. It’s been an eventful couple years. I thought we’d start with a quote of yours. If you didn’t say it, you can X it out, but I’m going to attribute it to you, but I liked it so much I thought we’d begin here. It says, “Bear markets are like a hall of mirrors designed to confuse investors and take their money.” What do you mean by that? Can you tell us a little more?
Yeah. I think I’ve been doing this a long time, and so I’ve learned that lesson the hard way. But look, I mean, I think we’re in the situation now. This really refers to the last three or four months where I do believe that a lot of the price action is being determined by non-fundamental factors, the main one being the global liquidity, which has improved significantly since October. The source of those funds has been mostly the Bank of Japan, which is aggressively defending its yield curve control, China’s reopening, which is putting capital back into the system, which is more than offsetting what the Fed is trying to do, which is tightening, as well as the ECB.
That liquidity has created some price action that has been very challenging for fundamental investors. Not just me, but my clients. Our clients here, we talk to them every day. I would say since the beginning of the year, the movement in stocks, particularly for folks who run relative value or long/short books has been challenging because stocks are necessarily moving on what you might think they should be doing. That to me is classic price action that we do see in bear markets. Bear markets tend to have these bear market rallies, for example.
The declines tend to be somewhat vicious and don’t always make sense fundamentally, because in bear markets what happens is you see de-leveraging. You see active managers and passive managers doing things they don’t necessarily want to be doing but have to do. And that creates this what I call hall of mirrors, where you see something and you say, “Oh my goodness, well, that price action looks pretty good,” and the reality is, is that that may be a head fake.
Now, it’s not always the case, but when I wrote the line, I think it really did describe what people were feeling from a client perspective. Quite frankly, I think people somewhat agreed with it. It’s been challenging and it continues to be challenging in that way.
The funny thing, you mentioned Japan, I was just over in Japan, I tried to time it to the yen top at 150, but I was close. But that’s a good example. I feel like so many investors when they look at markets, they have their worldview and they expect it to conform to their worldview in one direction and hopeful that it happens just like a stairstep. But even looking back at Japan for the past 30 years, you have this dominant trend.
In their case, it was for a long period sideways and down, but you would have vicious rallies, these up 50 or up 100% off the lows. The hard anxiety producing part for investors is always, is this that or is it the start of something new? With that in mind, tell us a little bit about what’s your framework for looking at the US markets, what do they look like today, and we’ll use that as a jumping point to get off into everything else.
We do look at a lot of different factors to navigate what we think is going to happen in the equity markets. Let’s say at the fundamental level, that’s really valuation and earnings. When I look at earnings, it’s usually rate of change, rate of change on revisions, rate of change on out year numbers, FY2 if you will, because that has proven to be the most efficacious factor for stocks. If you get that right, you tend to get stocks right, not just at the index level, but at the single stock level. That’s the core of our fundamental view, evaluation and then an earnings analysis, which we can get into more detail on that what we’re seeing currently.
The second thing is we look at sentiment positioning as an important factor. Sentiment is very different than positioning often. Right now, I feel like people generally are fairly neutral to bearish, but their positioning is actually more positive because of the price action. Folks have been forced to add more length perhaps than what they want to because they don’t want to miss out. And that really is an asset manager predicament more than it is an asset owner predicament, although we all know individuals can be greedy and fearful. Also, the third thing is technicals.
We’re not a certified technical analyst, but we spend a ton of time on it, and we look at it for signals from the marketplace also to tell us maybe if our fundamental view is being verified. We use the old Reagan tagline, trust, but verify. We trust our fundamental work, but then we verify it in the marketplace to see if the market is agreeing or disagreeing. It keeps us out of trouble. We tend to be disciplined with stop losses, and we respect the price action in the market. Because as some pretty famous investors have said, and I agree with this, that the best equity strategist in the world is not me.
Unfortunately, it’s the internals of the equity market. They tend to tell you if things are going to be accelerating, decelerating, if there’s trouble, if there’s not trouble. That’s the pyramid. At certain times, we emphasize the fundamentals more so than the technicals because you’re in a trending market and the fundamentals can generally keep you on track. But when you’re at these important turning points, we tend to lean on the second two a little bit more sometimes because the price actions we were talking about earlier can be confusing. We try to marry all three in a way that gives us a higher probability of success.
That’s one of the things I think is thoughtful. You hear different people talk about it. Our buddy John Bollinger calls it rational analysis. You got the pure fundamental camp, pure technical camp. But to ignore both sides I think always makes me feel a little suboptimal. Y’all’s views, I don’t want to preview it, but you can talk about it. I feel like our little non-consensus for the majority of the street right now, is that safe to say on what you expect? I’m speaking mainly to US stocks at this point. That’s usually everyone’s starting point. You want to tell us what you guys are seeing out there currently and thinking about?
This is the other part of the job. I have a privileged seat in many ways because I do get to talk to so many people so I can get real time feedback to, A, what we’re saying, and B, push back on analysis, quite frankly, as to why people disagree or agree with us. We know where we are on the continuum of are we consensus, are we not consensus. For whatever reason, I’m not sure I can explain this, but since I took over this role I guess it was in 2017, and I’ve been doing this for 30 years in some capacity, but this role is very public and it’s very engaging with all walks of clients.
I would say for whatever reason, we’ve ended up being in a non-consensus position more often than I would’ve guessed. That’s both bullish and bearish. That turned out to be right more than not. We’re not always right obviously, but it’s worked. I’m actually most comfortable when we’re very out of consensus and our work is suggesting that something is about to happen that we have high confidence and it’s not price, if you will. I would say currently we’re not extreme at the moment. A lot of people do agree with the view that we’ve had for a while. We’ve been somewhat bearish I would say since the fall of 2021, a little bit early, which we feel is right on time because you want to be a little bit early.
It was based on the two-pronged approach, we call it fire and ice, which is that the Fed was going to have to tighten into this inflationary way that was going beyond what people thought and that would hurt valuations, but then it would also lead to a slowdown. That’s the ice part. I would say we’re into the second part of that now. Now, the Fed’s still hiking. And by the way, we didn’t expect them to be getting more aggressive three months ago, so that’s actually a negative here. But what we’re really out of consensus right now is not on the Fed or on that there’s a slowdown, but on the magnitude of it. Let me give you some numbers.
We believe that this earnings recession that we’re now in, and we called for it a year ago, is early days. I would say the consensus view three months ago was in agreement with us that the earnings were going to be significantly lower than expectations. And now because the economy is holding in better than people thought, all of a sudden people’s view on earnings is not nearly as bearish as we are. Let’s give you some numbers. For the S&P 500, we actually look at forward 12 month earnings, so FY2 if you will, and it peaked at $240 in June of last summer. It’s now down to about $223. That’s the consensus bottoms up rolled up numbers, which is a reflection of company guidance, if you will.
That’s how the markets trade. I would say that the sell side, my peer group strategists, are in the 210 to 215 camp. We’re at 195 on a base case and it could be as low as 180 if we end up having a recession or not, which I still think is a 50/50 coin toss. The buy side is probably closer to my peer group, call it 210, 215. That’s a big enough delta where it’s going to matter. We think that those earnings revisions that have been coming down are going to continue for the next two, three, maybe four quarters and it’s now fully discounted.
I think what the buy side and the investment community is trying to do is say, “Hey, the worst is behind us, looking forward. The revisions aren’t necessarily going to rock it up from here, but they’re not going to get any worse.” I think that’s where we’re different. If we’re right on our forecast on the earnings forecast, even if valuations stay where they are, which are rich, and we’ll get to that in a minute, you’ve got 10 to 15% downside. If the valuations come down also because they’re rich as we think they are, you could have as much as 20 to 25% downside for many stocks and even the major averages.
That’s really the crux of the argument now. I think we’re going to get more data points in the next four to six weeks as we go into the first quarter reporting season. We think our thesis will be proven out further. That’s the pattern we’ve been seeing during this bear market, which is the market trades down in the last calendar month of the quarter in anticipation of those earnings coming down. Then when the earnings actually come down, the market rallies on hope that the worst is behind us. We think this quarter will be no different in that regard.
One of the things you talk about when you talk about equity stocks, you talk about operational efficiency and one of your favorite factors today. Can you talk what does that actually mean to you guys in the context of leverage and why is it your favorite?
Well, it’s our favorite currently because that’s what the market’s paying for. We follow a lot of these. That’s another thing we do is, the fourth leg of the stool for us, is quantitative analysis. People say we’re a quant and not a quant. I mean, if I’m looking at data, that’s quantitative. But this is true hardcore quantitative analysis where we look at factor variables and other things that traditional quants would look at. We look at it because we like to know what the market’s paying for. We can determine certain factors are either positive drivers of stock prices or negative drivers of stock prices.
About a year ago, we came up with this factor because we’ve decided, hey, the market is paying for this thing called operational efficiency. What is that? It means that companies were able to get revenues to the bottom line in a difficult operating environment. Things like inventory to sales growth, you want that lower. CapEx to depreciation, you want that lower. Labor cost as a percentage of cost of goods sold, lower. Those are all good variables right now. That’s what the market’s paying for, and I find it really fascinating. If you listen to some of these big tech companies, they’ve started talking about efficiency.
One in particular, I’m not mentioning names on this call, but one in particular said this is the year of efficiency. Kind of interesting, right? They’ve figured out, hey, that’s what the market wants. That’s what we’re going to give them. That’s been driving stock price performance over the last 12 months. We think it makes sense, because if we’re right about our operating leverage thesis, meaning the pandemic, a lot of companies over earned because revenues came roaring back before cost came in. Now it’s the exact opposite, which is the costs are now exceeding revenue growth because of the timing, the delay in terms of the cost on the balance sheet first, then they roll through the income statement.
This operational efficiency factor will remain, we think, in favor until one of two things happens. Either price comes down far enough where stocks get so cheap that people say, “Well, I’m looking through it now,” or we see the earnings come down in a way because companies have dealt with this enough that they’ve gotten ahead of it. We think they haven’t gotten ahead of it yet. We think there’s going to be more and more cuts on costs, because ultimately, the cost structure are out of whack with the revenue growth.
When you think about factors, it’s always interesting to me, particularly in the media and just the narrative about what is forefront, and that changes by I guess mostly what are people worrying about, but it seems like the big macro one in the past year or two, which is reasonable, has been inflation, which is something for the better part of my career has been a one-way street in the US. Now, of course, abroad it’s a different story, but certainly in the US. That seems to have changed. How are you guys thinking about it? We’re down off the peak, but where do you guys fall and the outlook and impact that that inflation may have?
Inflation, as you know, is something we haven’t really had to deal with for the last 30 years and there’s a lot of variables. I’m not going to go through all of them, but the easy ones are we’ve globalized our workforce. We had fracking and other energy sources that kept energy costs lower, the Fed, because of the financial crisis and everything, the cost of capital is precipitously low, the technology boom, which led to productivity and lower cost structures, et cetera. Sadly, all of those things are now going in the other direction. This exit from secular stagnation or financial repression is not temporary. This is a permanent exit, which by the way is a good outcome once we get through the adjustment period of that.
The way we’ve been thinking about inflation is when we went into the pandemic, we were already writing about this thesis that the next recession was going to likely lead to a fiscal bonanza that would allow us to break out of the secular stag. That’s what we needed, quite frankly, to actually get inflation and get on a different path like in the ’40s and ’50s. In the ’40s and ’50s, it was obviously the World War II that did it. This time it was a global pandemic. You could call it a war, this health crisis. Now, I wasn’t expecting a pandemic obviously when it happened. But when it hit, because we had already been thinking about this, it made it very easy for us to pivot.
We said, “look, this is going to be wildly positive for stocks, because they’re going to do monster fiscal and monetary, we’re going to get inflation.” Inflation, when you’re going from 0% inflation to something higher, it’s really, really good for stacks. It’s really, really bad for bonds, but it’s really, really good for stocks. We caught that whole move in 2021 on the basis of this idea that inflation now is positively correlated to stock prices. Forget all the stuff we learned over the last 30 years where stocks are negatively correlated to the rate of change on inflation. They’re now positively correlated to the rate of change on inflation. Why? Because that determines earnings growth.
We’re now into an era where stock prices are going to be determined by earnings growth more so than financial alchemy or financial repression, whatever you want to call it, lower rates, higher multiples. That era is over. That’s another reason why I think stocks have actually held in better than maybe people thought over the last couple of months is because inflation is starting to tick up again a little bit. We just got that data, and people are like, “Well, that should be really bad for stocks.” But we’re in this little weird period where people are like, “Well, that means maybe we’re not going to have a recession and earnings don’t have to come down.”
The way we think about it really simplistically is that higher inflation increases your operating leverage all else equal. And more importantly, operating leverage can go both ways. In 2020 and ’21, it was positive. Now it’s negative. Eventually we’ll turn positive again, but not this year. It’ll be something next year. We’re into this boom-bust environment that’s driven by higher volatility in all economic burials, but particularly inflation. It’s not the ’70s, it’s the ’40s and ’50s where you get hot inflation and it comes down and you need to learn how to trade that in both bonds and stocks, but particularly for stocks. Hopefully that makes sense.
Yeah. Well, let’s hear it. As we all know, the stock market is just a big amalgamation of different sectors and industries that respond quite a bit differently through the various cycles. As we’re getting near the end of the first quarter of ’23, it’s hard for me to say, are there particular areas that you think in this outlook that look better than others or, said differently, worse than others to avoid too?
Absolutely. Basically it’s things that are geared to this environment where they can benefit from higher prices, number one, but also what we think is going to be real investment as opposed to what I would call financial investment. If you think about the last 30 years where the real cost of capital is below whatever the rate of growth, I mean, it doesn’t make sense to invest capital in risky projects. What you should be doing is borrowing money at negative real rates and buying back your stock. And that’s essentially what the successful stocks did. Not every business is geared to be doing that.
Basically anything that’s long duration that has any growth or both, even better, they can reinvest cheap capital into either M&A or share buybacks or things that are financial engineering, those have been the big winners. But now going forward, you need to think about who’s going to benefit from real capital investments. That would be areas like industrials, financials, some of the commodity complex, clearly materials and energy technology will also be a winner, parts of it, because technology is basically capital investment. One thing I just want to say upfront here, people think about technology, they always say, “Well, technology is like a growth industry.”
Okay, that’s true, but it’s also deeply cyclical. What I really think is going to be the case going forward is it’s going to be a much more democratic stock market. If you think about the last 15 years, it’s been a handful of stocks, literally 10, 20 stocks that have carried the day. And now what we’re going to see is many different types of businesses participate in this environment, and it’s going to be much more idiosyncratic. What I’m saying is instead of saying, “I want to own consumer goods companies. No, I want to own the consumer goods companies that’s a good operator, the one that can actually capture this margin and then not squander it away when you get a headwind.”
And that’s what we’re seeing. Pretty optimistic, quite frankly, over the next three or four years, because this really fits our framework. This is how we invest. We’re cycle analysts. Not to be confused with psychoanalyst, which I might be as well, but cycle analysts. If you understand these cycles, they could be quite profitable, but it’s very, very different than what most investors have experienced the last 10 or 20 years, which is just like you buy the best companies, you hold onto them, and just let it rip. That’s not going to work as well.
Well, speaking of somewhere that hasn’t worked well for a long time is foreign markets. You pull up charts of some country’s stock markets and they haven’t hit new highs in, in some cases, many decades. What’s y’all’s view outside our borders, foreign developed, foreign emerging? Are they interesting? Are they playing along to same similar themes, or is it a totally different story?
No, this is going to be probably one of the biggest shifts of capital we’ve ever seen in history. In the last 10 or 15 years, what’s happened is we’ve seen the greatest concentration of assets in US-based assets or greatest concentration of wealth in US-based assets. Why? Because a dollar’s been strong and the US has the highest quality assets in the world that benefit from a lower interest rate environment and low inflationary environment. They all got bid up. What’s going to happen now is that money needs to be redistributed to other parts of the world that are more geared to the world I just described.
Now, because of the pandemic, we’re not all synchronized right now. We had different stages of recovery, the US being the most robust because we stimulated the most aggressively, but most of the world hasn’t really recovered yet from the pandemic. There’s a lot more pent-up demand in Asia, in particular. That’s the region of the world we think is probably the most attractive right now in terms of stocks, followed probably by parts of Europe and Japan in the developed world. Basically it’s EM, then developed world outside the US, and then the US. Now, the US could become just as attractive if we get a reset on valuation, which is what we’re expecting this year.
The US isn’t going to be left behind. I just think your entry point is much more important. But to answer your question directly, we should see a repatriation or redistribution of money away from US dollar based assets to other assets. And that’s another thing that investors should be considering is currency. There’s going to be probably over the next two, three, four years a pretty weak US dollar market and that means some of your return as US dollar investor is through the currency, whether it be euro, sterling, yen even to some degree, and then, of course, emerging market currencies, which are in a much better shape than they were probably over the last 25 years.
Mike, your views, unfortunately, align too much with the way we think. I’m going to try to be a little more devil’s advocate here. I think a lot of investors, they would go back to both you and I in this discussion and say, “All right, Meb, Mike, I hear what you’re saying, but I feel like I’ve heard that every year for the past five years.” The US has had this amazing run. It looks more expensive. I’m not saying this is your view, but I’m just saying for people who have allocated to foreign, what do you think is going to drive this eventual shift in both sentiment narrative and then eventual relative strength outperformance between the two? It may have already happened, but what do you think?
Well, as you know, anybody who’s done this for more than five minutes, relative strength always drives flows. And by the way though, that relative strength has to be a bit more persistent than four months. Europe has outperformed for four months and people are doing cartwheels. I haven’t heard people this bullish on Europe in quite a while. Now, I’m not that bullish on the European stock market if the US is going to do what I think it’s going to do in the short-term. But over the intermediate term, there should be more money going into those assets because they’re cheaper and they offer more exposure to global growth, which is where the growth engine should be.
The big difference, the big change, I would say, well, first of all, US-based assets just got too expensive. They’re no longer attractive. Secondly, the big winners are being exposed as having been the biggest over earners during COVID. I mean, in October, that was probably the sea change event. In mid-October earnings being reported, the top four or five big tech stocks did not have particularly good quarters. They all sold off by literally 15%, which is a huge number on a quarterly report. There was one that did not, but the majority of them sold off significant, and that money decided to reallocate itself to in the US industrials and financials.
And then it left and went to Europe and it went to Asia, in particular China because of this China reopening. I think that was step one. That was the first real sign that this is not going to be just a temporary shift. And that was also when the dollar topped, by the way. The dollar is down 10% from those highs, which suggested that money was leaving the US. It wasn’t just US investors reallocating, it was actually global investors reallocating. I call that the kickoff move. I think that’s important. And then what’s going to perpetuate it is relative growth and then relative currency strength and I would argue relative behavioral differences.
If you actually looked at the United States’ balance sheet and you looked at their current account deficit, you looked at our balance of payments deficits, you looked at how we run policy, the off balance sheet liabilities that we had, and you would say to yourself, “This almost looks like an emerging market.” You’re like, “These numbers are absurdly bad.” I think the world’s been waiting for that moment where they say, “Well, I got to own dollar based assets because it’s working the relative strength argument. And now once that’s cracked, it will build on itself.”
But I think the other driver that I think most people are figuring out this de-globalization wave, the multipolar world that the US is not this hegemony unipolar leader. And then, of course, the more recent actions on the back of the Ukraine-Russia war where people are trying to de-dollarize. Now, China’s buying oil from Russia in rubles or whatever. Not the dollar, that’s for sure. Same thing for India. We’re seeing China really trying to drive every transaction into yuan. I think there’s this desire by the rest of the world to de-dollarize, because nobody wants to be held basically prisoner by the dollar-based payment system and everything else.
That’s a secular change that has a lot of people around the world, a lot of countries around the world who want that to succeed. Those are powerful drivers that would suggest that this is going to be more persistent.
China probably, to me, nowhere else generates more barbell binary views than almost anything right now I feel like talking to advisors, talking to individuals, talking to institutions, particularly those who went through the experience in Russia and are stuck with their Russian equity investments. And Russia is a lot smaller compared to say China. But how much do you guys talk about, think about what’s the sentiment from the big money on China?
Because presumably equity market looks really cheap, it’s been gone nowhere, slash down. But on the other hand, people worry about a similar playbook with Taiwan, et cetera. How are you guys thinking about it as they get to be a bigger and bigger piece of both the global economy, as well as the global stock market?
I mean, our team in Asia did a really good job of being early on the upgrade going into the reopening trade, if you will, if you want to call it that. I think from a big money investor standpoint, they abandoned China last year, became “uninvestable” because of some of the tensions that were going on, but also this fear about, well, is the money really mine in a rule of law questions, et cetera. That created a very cheap asset with a catalyst, meaning the reopening was a pretty good time to step in there. Like I said, our team, it had nothing to do with me, but our team did a great job getting into that area at the right time.
One of the things we haven’t really hit on yet that much, we’ve covered the stocks part of the world, is real assets and also fixed income. We didn’t dip too much into bonds and how they’re looking if everyone’s starting to salivate again over 5% yield. It’s a weird thing to even say anymore. We didn’t talk too much about commodities and the real estate part of the world. I’m going to let you pick. You can take a left or take a right at the intersection. If you have anything particularly strong viewed on the fixed income or real asset part of the world, let’s hear it.
I’ll try to do both pretty quick. I mean, the fixed income one I think is pretty straightforward, in the sense at least for US dollar based assets. I mean, I’ll tell you this, Meb, I am still somewhat shocked that the Fed was able to get to 5% without causing some cataclysm. Now, if you’re a crypto investor, maybe it was a cataclysm, or if you invested in profitless growth companies, it was pretty nasty. The economy is functioning. Things are slowing for sure, but that’s a win. In other words, we’re out of the financial repression era quickly. What that also does is it creates a safe alternative for investors who don’t really want to go out on the risk curve so far.
Maybe in the last 15 years, you’ve just been financially repressed and taking outrageously high risks because you weren’t getting anything out of your cash. Now, you get 5% plus on cash, so there’s no need to really go out the curve, unless you’re trying to take some recession insurance out. But I’m not so sure that that’s going to really work that well in the near term because the Fed’s not really done with their job. Look, I think we’re very bullish on front end rates just to have your, whatever, safe money is, shorten your duration, be there, take your proceeds in and be patient with then putting that capital to work in the riskier asset parts of the market like stocks, real estate, and real assets.
On the real asset side, look, this stuff is underpriced. If we’re going to do all these wonderful projects everybody’s excited about, like building better infrastructure in the United States, building green energy facilities, completely revamping essentially energy infrastructure around the world, by the way, investing further in traditional fossil fuel infrastructure because we need a bridge, this is massive dollars. I mean, massive amounts of money going into these areas. That will take time. In other words, ultimately, it’ll lead to lower prices for commodities. But in the short-term, I think commodities and things lever to that build out.
You can talk about energy or copper or lithium or these things that you’re going to need for these projects, but then you can also talk about the CapEx that’s going to be required to build this stuff out, the iron ore that’s going to be required to build these facilities, the copper that’s going to be required to do these facilities. That’s a 10-year project or 15 or 20 or 30-year project. I just think we don’t have a lot of these resources. They’ve been underpriced for years. They’re probably into a secular bull market. Commodities are volatile, so you have to understand it’s going to be a bumpy ride, but it should be a bigger part of people’s portfolios for sure in this world.
I was just trying to think if we’ve managed to make it nearly all the way through this podcast without saying the phrase yield curve. You may have said it, I’m not sure. I feel like it’s the only thing I hear all day long on TV anymore is yield curve. As we start to wind down, we can feel free to talk about anything you feel like we’ve missed, but one of the things that I like talking about is there’s a lot of consensus in the world as far as commonly repeated beliefs about investing markets.
This one you may need to take a second to noodle on, but we have a Twitter thread that I repeat mine, but it’s what investment belief do you have that the vast majority of your professional peers, it’s like 75%, most of them believe this thing? It can either be a framework, or it can even be an idea or just a view of the future, whatever it may be. What is something you believe that when you talk to all your CIO buddies, it’s not something that they would agree with you on?
I’m glad you went down this path. This is something I’m really focused on right now and I’ve been focused on for probably 15 years, which is it’s amazing to me how consensus “professional” forecasters have become. There’s a simple reason for that. They’ve all become overly reliant on guidance from a higher power tell them what’s going to happen. In a world where economic variables are quite predictable and suppressed, if you will, and there’s not a lot of variation, that works really well.
There’s two things I would say to really got the ball rolling. First, it was Alan Greenspan for the Fed who started doing the whole forward guidance thing and the whole communication, which is the total opposite of Volcker, obviously. It has just gotten so out of control now, four Fed chairs later, where they literally have to send out a press release to tell us when they’re going to the bathroom.
And then not only that, but they have 15 of these people running around all day contradicting each other, yet the markets continue to hang on their every word, the bond market in particular, such that if they make a move, the bond market prices it immediately, rather than thinking for itself saying, “Hey, these guys are human. We’re in a very volatile period. Why are we holding ourselves so closely aligned with their ‘forecast?'”
What happens is there’s no dispersion in the forecast, which means that when something happens that’s unexpected, the price action is way worse. Now, I think the same thing has happened in stocks, and this really began with Fair Disclosure after the tech bubble blew up. They went to this Fair Disclosure rule where companies had to essentially send out an AKA or whatever, they couldn’t speak to investors individually anymore, which is a good rule, by the way. They had to disseminate information freely and publicly.
The problem with that is, is that then once you start giving people this stuff, then it becomes like an addiction. Now, companies, they spend an inordinate amount of time at conferences, preparing their conference calls every quarter in a way like it’s almost like a Broadway show. I mean, so much attention is being paid on how are we going to guide and lead the witness and the investment so that we can manage earnings, et cetera. What’s happened is the consensus earnings forecast dispersion is non-existent.
It’s basically right on top of whatever the guidance is. This is a long answer to your question, but the punchline is, I don’t listen to this stuff. I mean, not because I’m such a great forecaster, but I know that’s not going to be the answer. I’m not going to make any money if I’m just following whatever the consensus view is. What I look for are situations where I feel like I’m out of… By the way, the consensus is right 80% of the time, so you don’t want to fight it necessarily. But there are times when you’re like, “Holy smokes. I mean, this doesn’t make any sense whatsoever. We got to go the other way.”
I’ll give you two examples. One was December of 2021 when 10-year Treasury yields were trading like, I don’t know, 170 on a 10 year and inflation’s running six, seven, 8%. Jay Powell had already told you after he got renominated that he was going to be tougher. I remember talking to the bond folks going, hey, 10 year 170, that doesn’t seem right. I think we should wildly short this thing. This is going to be a problem for stocks. Well, yeah, but that’s what the Fed’s saying. They’re only going to raise 50 basis points next year.
I’m like, well, that doesn’t sound right. I mean, that’s so out of bounds. Having said that, by the way, I never would’ve thought they’d raise 450 basis points, but I knew it wasn’t going to be 50. That’s not a tough call. I’m just saying. That’s not right. And now, this is why I’m so convicted on our earnings view, where all of our models are saying the earnings are just way too high based on the margin profile, based on this negative operating leverage status that we’ve laid out in detail and our forecasts are so out of bounds with the “consensus,” this is a fat pitch.
That’s where I think a lot of people, they’re don’t not comfortable getting away from these higher powers and what they’re saying. That’s an opportunity, quite frankly.
It means career risk. I mean, I think anytime you move outside of the normal, safe, middle part of the road, it gets really uncomfortable. I mean, my favorite sentiment example, which was always my favorite bubble when I was graduating university, it was late 1999, the AAII Sentiment Survey hit the highest bullish level it’s ever hit. The literal worst time to buy equities in my entire lifetime as far as valuation. I got it to the month, which always makes me smile. Mike, last question while we got you here.
This has been a lot of fun. What’s been your most memorable investment as you look back over your career? It could be good, it could be bad, it could be in between, but just something that’s seared into your brain. Anything come to mind?
I mean, it’s an easy one because it was my first investment. My mom was a financial advisor and she gave us some financial literacy. She said when we were younger, it was like, you should pick a stock that you think might work just based on your experiences. I’m 13 years old in 1980 and I said, “There’s this company called Nike, which makes some really cool running shoes that my buddy, who was a track star, loved.” This was before they did basketball.
I mean, it was early days. I think this is going to be a big winner. Everybody wants his shoes. Whatever, dumb luck. Peter Lynch style investing of just buy you know what and the rest is history. I mean, this thing has still to this day been, not including option trades, but still the biggest investment I’ve ever made in terms of percentage returns and helped me pay for college. I was hooked, of course, after that. That one sticks out to me. It’s an easy one.
By the way, on that one, you learned the most important lesson, which is hard. I mean, I had so many people, the struggle of holding a winner. Being a true trend follower is really hard to do because you see something double, you want to think, oh my God, hey, I’m brilliant. I can do this again to infinity. But B, what am I going to spin this on? Is it going to be college? It would’ve been spring break or a new car or whatever it may be. But every 10 bagger or 50 or 100 bagger was once a two bagger. It’s hard to hold onto those suckers.
I say, unfortunately, I didn’t learn that lesson. I did it in that one. And then, of course, now I never hold on to anything that long. By the way, I gave you a winner. I could give you 100 losers, which I probably learned more from, quite frankly. Look, that’s the game as you know. I mean, you’re going to be wrong a lot, and you just got to understand that’s part of the game.
When you start a brokerage where it’s like the anti-Robinhood, it forces you into holding periods of you designated at the beginning, whatever, one, three, five, 19 years. You’re still allowed to sell it, but it hits you with a fat penalty on the redemption. I think there’s a business model in there somewhere. VCs, hit me up. Mike, this has been a lot of fun. Where do people find you if they want to find your writings? You got a good podcast. I meant to start this. What do you say at the beginning of it? Let’s get it on. No, it’s close to it.
Let’s get after it. That’s called Thoughts on the Market. It’s on Spotify and Apple. It’s available to anybody. You can find us out there. It’s not just me. We have the whole research department does something every week, and they’re three, four minute listens. It’s quite popular. That’s the easiest one. People should probably just pick up.
Awesome. Mike, we’ll have to have you on and check in the future. Thanks so much for joining us today.
Thanks for having me. Great to be with you, Meb.
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