WEBVTT - Embracing 'Maverick Risk' 0:00:13.760 --> 0:00:16.840 Hello, and welcome to What Goes Up, a Bloomberg weekly 0:00:16.880 --> 0:00:20.079 market podcast. I'm Sarah pont Set, a reporter on the 0:00:20.079 --> 0:00:23.279 Cross Asset team. That I'm Mike Reagan, a senior editor 0:00:23.400 --> 0:00:26.200 on the Markets team at Bloomberg. This week on the show, well, 0:00:26.239 --> 0:00:29.240 many investors are shunning emerging market stocks in the wake 0:00:29.280 --> 0:00:32.480 of a trade war. One widely followed investor is making 0:00:32.520 --> 0:00:34.640 a bullish bet. And of course we'll close out the 0:00:34.680 --> 0:00:37.400 episode with our tradition, the craziest thing I saw in 0:00:37.520 --> 0:00:40.040 markets this week, Sara, you better be prepared. Oh I'm 0:00:40.080 --> 0:00:43.080 prepared this week? Are you wait for it now? Sarah? 0:00:43.240 --> 0:00:46.760 You know in our business financial news the words pioneer 0:00:47.080 --> 0:00:50.040 and revolutionary or thrown thrown around a lot. I'm guilty 0:00:50.040 --> 0:00:52.440 of using them a lot, but I can't think of 0:00:52.440 --> 0:00:55.440 a better words for our guests. One of our guests 0:00:55.440 --> 0:00:58.080 here today he did a lot of important work coming 0:00:58.160 --> 0:01:02.040 up with what's known as the I be a fundamental indexing. Basically, 0:01:02.280 --> 0:01:05.440 you can invest in a passive manner at a very 0:01:05.480 --> 0:01:07.880 low cost in an index that gives you a lot 0:01:07.920 --> 0:01:12.480 of diversity. But instead of making market capitalization sort of 0:01:12.480 --> 0:01:15.479 the center of the indexing universe. Uh, you wait your 0:01:15.520 --> 0:01:20.119 stocks based on more fundamental things like revenue, cash flow, 0:01:20.400 --> 0:01:24.600 dividends and buy backs and book value. And this really 0:01:24.680 --> 0:01:29.959 launched a lot of popular investment strategies that have sort 0:01:30.000 --> 0:01:34.280 of taken this and and some more dubious ways to 0:01:34.319 --> 0:01:39.120 do this under the banner of smart beta factoring, investing, 0:01:39.200 --> 0:01:42.160 that sort of thing. But joining us today is Rob Barnett, 0:01:42.160 --> 0:01:44.479 the guy who sort of started it all, the founder 0:01:44.480 --> 0:01:47.960 of Research Affiliates. Rob, can we call you the godfather 0:01:48.040 --> 0:01:50.360 of smart beta? Is that is that appropriate? Lots of 0:01:50.360 --> 0:01:54.440 people have fine with me? That makes it safe? Good good. 0:01:54.600 --> 0:01:56.760 That's that's a it's a nice catchy title. As journalist, 0:01:56.840 --> 0:01:59.800 we need something like that. Also joining us the godfather 0:01:59.880 --> 0:02:06.760 of the newsroom downstairs, Chris. I think that, uh, groundbreaking 0:02:06.760 --> 0:02:12.360 would have been pushing groundbreaking breaking. So and Chris is 0:02:12.600 --> 0:02:17.119 the executive editor here of the markets team at Bloomberg. Um, Rob, 0:02:17.160 --> 0:02:20.799 I think he's read every single one of your research reports, 0:02:20.800 --> 0:02:22.320 so we can quiz him on it if you want it. 0:02:22.360 --> 0:02:28.120 He'd be the only one I sure haven't. But let's 0:02:28.120 --> 0:02:33.799 talk about this notion of what you started calling fundamental investing. Uh, 0:02:34.080 --> 0:02:36.560 and now it's sort of falls under the banner of 0:02:36.639 --> 0:02:39.920 smart data. I get the oppression you don't like exactly 0:02:40.160 --> 0:02:43.720 necessarily everything that's now falling under the umbrella smart data 0:02:43.760 --> 0:02:47.160 is that? Is that fair? That's fair? When UM the 0:02:47.320 --> 0:02:51.079 term smart beta was invented, it was invented by Towers 0:02:51.080 --> 0:02:55.720 Watson out of London, a major institutional consulting firm, and 0:02:56.240 --> 0:02:59.560 they coined the expression actually on the basis of fundamental index. 0:03:00.840 --> 0:03:05.079 They recognize that fundamental index doesn't win because of the fundamentals. 0:03:06.120 --> 0:03:10.400 It wins because you are waiting the portfolio in a 0:03:10.440 --> 0:03:14.079 fashion that's indifferent to price. So as the price goes 0:03:14.160 --> 0:03:16.799 up and down, if it's big swings, you're going to 0:03:16.919 --> 0:03:20.520 contratrate against it. Whatever's sword, you're gonna trim, whatever is tumbled, 0:03:20.520 --> 0:03:24.280 you're gonna buy. And so it profits from the mean reversion, 0:03:24.680 --> 0:03:31.359 as prices tended to mean revert. And so they looked 0:03:31.360 --> 0:03:34.440 around and said, what other strategies do this equal weight 0:03:35.000 --> 0:03:40.840 minimum variance UM ed hex risk efficient strategy toebam's maximum 0:03:40.880 --> 0:03:45.120 diversification strategy and so forth, And so they said, let's 0:03:45.120 --> 0:03:48.119 call it smart beta, and let's encourage all of our 0:03:48.160 --> 0:03:53.520 clients to split their money between bulk beta capuated indexing 0:03:53.960 --> 0:03:57.800 and smart beta mean reversion strategies. Well, the industry loved 0:03:57.800 --> 0:04:00.720 the term smart beta, embraced it, and attached it to 0:04:00.760 --> 0:04:03.440 everything under the sun. So there's a lot of stupid 0:04:03.480 --> 0:04:07.240 beta under the rubric smart beta. And one of the 0:04:07.320 --> 0:04:11.400 quickest to embrace the term was the factor investing crowd 0:04:11.680 --> 0:04:14.360 factor investing starts with cap weight and then puts a 0:04:14.440 --> 0:04:18.680 tilt on. It's not smart beta under the original definition. 0:04:19.000 --> 0:04:21.960 So smart beta now means anything and everything. It also 0:04:22.000 --> 0:04:25.040 means nothing, and that's where we are now. It's it's 0:04:25.040 --> 0:04:28.560 a catchy term for anything goes. Just to clar the 0:04:28.560 --> 0:04:30.839 whole mean reversion theory is this idea that when you 0:04:30.920 --> 0:04:34.400 get a cap weighted index, things get big. They become 0:04:34.720 --> 0:04:38.120 basically enslaved to their wargest components, and that to some 0:04:38.200 --> 0:04:43.479 degree to start the return partly partly, but it's actually 0:04:43.560 --> 0:04:48.680 more fundamental than that. Um If a stock is overvalued, 0:04:49.080 --> 0:04:52.440 by which I mean it's destined to underperform in the 0:04:52.520 --> 0:04:57.680 years ahead, then it has a weight in a cap 0:04:57.680 --> 0:05:02.520 weighted portfolio that's higher than it fair value weight indexers 0:05:02.520 --> 0:05:05.679 will say, yeah, that's a truism, and it's obviously true, 0:05:06.000 --> 0:05:07.880 but so what you don't know what the fair value 0:05:07.880 --> 0:05:13.560 weight is. But if you link to market cap, then 0:05:13.680 --> 0:05:16.800 every single stock that's above its fair value is overweighting 0:05:16.839 --> 0:05:20.919 your portfolio. Every single stock that's below it's fair value 0:05:20.960 --> 0:05:23.280 is underweight. The majority of your money is in over 0:05:23.320 --> 0:05:27.200 priced stocks. By definition, break the link with price, and 0:05:27.279 --> 0:05:30.560 now if it's overpriced, it might be overweight, it might 0:05:30.560 --> 0:05:34.400 be underweight. The airs cancel and the canceling of the error. 0:05:34.400 --> 0:05:36.680 As we did a paperback in two thousand fifteen with 0:05:36.880 --> 0:05:40.600 Harry Markowitz in which we showed that the uh if 0:05:40.640 --> 0:05:45.440 you cancel the errors by breaking the link with price, 0:05:46.040 --> 0:05:50.200 firstly you explain the entire value effect, and secondly, cap 0:05:50.240 --> 0:05:56.080 weighting has about a two perannum reduction in return against 0:05:56.160 --> 0:05:59.279 anything that breaks that link. Along these lines, you guys 0:05:59.279 --> 0:06:01.839 put out a re set research paper as well called 0:06:02.240 --> 0:06:05.560 buy high, Sell Low, which is the opposite of what 0:06:05.680 --> 0:06:07.880 classic investor's thing to do, where you want to buy 0:06:07.920 --> 0:06:11.200 low and sell high. Does it come back to that 0:06:11.240 --> 0:06:14.680 there is a fundamental issue with index funds and what 0:06:14.800 --> 0:06:17.719 actually is this problem? Is it very widespread? How do 0:06:17.760 --> 0:06:20.480 you change this? The notion of buying high and selling 0:06:20.520 --> 0:06:27.560 low is extremely widespread, and it's it's embedded in human nature. 0:06:28.000 --> 0:06:31.400 Whatever has given us great profit and joy, we want 0:06:31.440 --> 0:06:34.039 more of that. Oh, let's buy it, because it's gone 0:06:34.080 --> 0:06:37.920 up and it's made us money. Whatever is inflicted pain 0:06:37.960 --> 0:06:41.400 and losses, we want to get rid of that, and 0:06:41.520 --> 0:06:44.920 so if it's tumbled, get me out of here. It's 0:06:45.480 --> 0:06:50.919 totally human nature, and it's the essential basis for the 0:06:51.000 --> 0:06:55.080 value effect. It's the essential basis for fundamental index alpha, 0:06:55.240 --> 0:06:57.800 or for equal weight alpha, or a whole host of 0:06:57.839 --> 0:07:03.600 these strategies. It happens with regard to stocks. It happens 0:07:03.600 --> 0:07:08.520 with regard to mutual funds and managers. Nothing is better 0:07:08.600 --> 0:07:11.440 for a mutual funds au M than a recent success 0:07:12.280 --> 0:07:16.480 performance may be brilliant, money will pour in. People don't 0:07:16.560 --> 0:07:20.440 ask the question, did this strategy win because it was 0:07:20.480 --> 0:07:24.640 getting more popular and more expensive? And if it wins 0:07:24.680 --> 0:07:27.520 because it's getting more popular and more expensive, it's a 0:07:27.520 --> 0:07:32.480 sell not to buy. So the paper buy high and 0:07:32.560 --> 0:07:36.440 sell low. With index funds focused on how index funds 0:07:36.440 --> 0:07:40.040 do this, it turns out that stocks added to index 0:07:40.120 --> 0:07:43.720 funds UH index funds don't have zero turnover, they just 0:07:43.760 --> 0:07:47.640 have low turnover. But stocks added to index funds on 0:07:47.800 --> 0:07:50.760 average are priced at three to four times the valuation 0:07:50.840 --> 0:07:54.640 multiples of stocks that are dropped. By stocks that are dropped, 0:07:54.640 --> 0:07:58.960 I mean discretionary deletions. If it's UH corporate action, If 0:07:58.960 --> 0:08:02.680 it's a bankruptcy merger, UM, that doesn't count. But if 0:08:02.680 --> 0:08:06.480 it's a discretionary deletion, it's inevitably going to be a 0:08:06.520 --> 0:08:10.160 company that's out of favor, unloved for a long time. 0:08:11.000 --> 0:08:14.040 So that the attitude is, let's get rid of this 0:08:14.120 --> 0:08:20.600 and put put twitter in UM. And so what's added 0:08:21.120 --> 0:08:23.720 is on average three to four times the valuation multiples 0:08:23.760 --> 0:08:26.880 of what's dropped. Now, that's fine if what's added is 0:08:27.480 --> 0:08:31.560 has such such wonderful future growth that it's worth triple, 0:08:32.200 --> 0:08:35.000 but in point of fact, it's not. What we find 0:08:35.080 --> 0:08:38.600 is that the stocks that are added on average underperform 0:08:38.880 --> 0:08:42.600 UH the market by about two In the next year, 0:08:42.960 --> 0:08:47.320 the stocks that are dropped on average outperformed the market 0:08:47.360 --> 0:08:52.000 by about twenty percentage points. Because there's value there, and 0:08:52.040 --> 0:08:56.760 that I imagine, yeah, yeah. And the other thing that's 0:08:56.800 --> 0:09:02.040 interesting is UM starting s and P would pre announce, 0:09:02.600 --> 0:09:06.559 So I got to remember who their clients are. Their 0:09:06.600 --> 0:09:09.640 clients are the index funds. That's who pays the bills. 0:09:10.280 --> 0:09:13.559 And so the index funds were saying, hey, stop blindsiding 0:09:13.640 --> 0:09:17.280 us with these changes in the index, give us some notice, 0:09:17.520 --> 0:09:19.640 tell us when you're going to make the change, and 0:09:19.679 --> 0:09:23.040 tell us what the change will be. And being responsive 0:09:23.080 --> 0:09:27.319 to their clients, they started doing that. UM. It gives 0:09:27.400 --> 0:09:31.440 the index funds and opportunity to put the trade in 0:09:31.559 --> 0:09:36.120 place before the index has changed. Prior to that, they 0:09:36.160 --> 0:09:38.400 they had to play catch up, which meant that they 0:09:38.440 --> 0:09:41.520 were moving the share prices, which meant that they were 0:09:41.640 --> 0:09:45.120 underperforming the index. Now they didn't have to underperform the 0:09:45.160 --> 0:09:48.120 index as long as they got their trades done by 0:09:48.200 --> 0:09:51.480 the time that the stock was being added. And so 0:09:51.559 --> 0:09:55.480 what we found was that between the day before the 0:09:55.520 --> 0:10:01.480 announcement and the day after the change in the index 0:10:01.520 --> 0:10:05.800 took effect, the additions beat the deletions by a thousand 0:10:05.880 --> 0:10:09.320 basis points. That's pretty amazing, Rob. Some of the um 0:10:10.040 --> 0:10:12.720 uh interviews I've I've seen with you recently, you talk 0:10:12.800 --> 0:10:16.679 about putting uh fully half of your own personal assets 0:10:16.720 --> 0:10:20.480 in emerging market value. Um. Now, you're a guy in 0:10:20.520 --> 0:10:24.080 your mid sixties, uh um, picturing sort of the average 0:10:24.240 --> 0:10:26.840 Joe of that age walking into their local you know, 0:10:26.960 --> 0:10:30.079 Raymond James office and say to their advisor, I I 0:10:30.160 --> 0:10:32.440 want to put half my money in the end back 0:10:32.480 --> 0:10:34.960 up the truck, and I feel like their advisor would 0:10:35.000 --> 0:10:37.360 be like, I gotta speak to my manager here. But 0:10:37.720 --> 0:10:41.959 so is that a strategy just for uh someone like you? 0:10:42.040 --> 0:10:44.959 Where would you advise that to a to a normal retiree. 0:10:45.280 --> 0:10:50.200 Most people are sensitive to downside risk and even more 0:10:50.280 --> 0:10:54.000 sensitive to maverick risk. If the markets up and they're 0:10:54.040 --> 0:10:59.440 not they're flat, they feel terrible. If the market's flat 0:10:59.440 --> 0:11:04.200 and they're down, they start to look in the mirror 0:11:04.240 --> 0:11:11.240 and hate themselves. So maverick risk performing differently from how 0:11:11.360 --> 0:11:17.040 you think you ought to perform, UH, is the risk 0:11:17.160 --> 0:11:21.200 that people most want to avoid. Well investing in emerging 0:11:21.240 --> 0:11:24.880 markets value stocks versus investing in the SMP. The tracking 0:11:24.960 --> 0:11:26.800 error between the two is going to be huge. The 0:11:26.880 --> 0:11:29.319 difference in returns between the two is going to be huge. 0:11:30.040 --> 0:11:33.760 So it only makes sense to make a big bet 0:11:33.800 --> 0:11:36.560 like that. If you're somebody who really doesn't care about 0:11:36.640 --> 0:11:40.720 maverick risk, and I don't for myself, for you seem 0:11:40.760 --> 0:11:43.760 to embrace maverick risk to something to some to say 0:11:43.960 --> 0:11:49.319 some extent, yeah, for our clients, UM, I would simply 0:11:49.760 --> 0:11:55.040 advocate UM put nearly as much into emerging markets as 0:11:55.080 --> 0:11:59.000 you would view as your maximum comfortable exposure, and put 0:11:59.040 --> 0:12:03.120 most of that into value, not growth. And that's about 0:12:03.160 --> 0:12:04.880 as far as I push it. For a lot of people. 0:12:04.880 --> 0:12:07.959 That would mean a five or ten percent allocation. That's fine, 0:12:08.120 --> 0:12:10.040 that's enough to move the needle and make a difference 0:12:10.080 --> 0:12:13.400 in your performance. But our expectation is that emerging markets 0:12:13.480 --> 0:12:16.960 value stocks based on our models, should beat the SMP 0:12:17.120 --> 0:12:19.480 by about a thousand basis points per year for the 0:12:19.520 --> 0:12:22.560 next ten years. That adds up big. And I noticed 0:12:22.600 --> 0:12:24.800 on your website you have sort of a calculator that 0:12:24.880 --> 0:12:29.640 tries to predict returns, and the the e M equity 0:12:29.679 --> 0:12:33.640 returns are projected at very high seven percent real versus 0:12:33.760 --> 0:12:36.040 half a percent real for U S stocks, right right. 0:12:36.080 --> 0:12:40.400 But it also uh projects volatility and it looks like uh, 0:12:40.600 --> 0:12:44.880 some some very healthy volatility, healthy volatility so to speak, 0:12:45.000 --> 0:12:47.360 in e M. And it made me look, you know, actually, 0:12:47.360 --> 0:12:50.040 the the SMP is more volatile than the e M 0:12:50.040 --> 0:12:54.240 index right now, So UM, is that just a functional 0:12:54.280 --> 0:12:57.280 mean reversion to for for emerging market stocks. Part of 0:12:57.320 --> 0:12:59.920 that is a matter that emerging markets have been a 0:13:00.040 --> 0:13:03.960 little bit more UM benign of late. In terms of volatility, 0:13:04.760 --> 0:13:08.679 I would expect emerging market stocks to be more volatile 0:13:09.240 --> 0:13:12.920 than the S and P, but again not drastically so. 0:13:13.720 --> 0:13:19.520 And uh so people fear emerging markets because of the unfamiliarity, 0:13:19.640 --> 0:13:25.440 not because they are inherently hugely risky. And certainly when 0:13:25.440 --> 0:13:29.439 the UM, I like to use the Schiller pe ratio, 0:13:29.480 --> 0:13:32.760 which was price relative to ten your smooth earnings US stocks, 0:13:32.800 --> 0:13:36.360 it's north of thirty times emerging market stocks, it's south 0:13:36.400 --> 0:13:39.520 of fifteen times. It's more than half off emerging markets 0:13:39.520 --> 0:13:43.200 deep value it's around eight times. So if you can 0:13:43.240 --> 0:13:46.560 buy half the world's GDP concentrating on the value end 0:13:46.559 --> 0:13:48.440 of the spectrum and pay less than eight times the 0:13:48.640 --> 0:13:53.760 sustainable ten year smooth earnings, that's pretty cool, Chris. I 0:13:53.760 --> 0:13:55.040 want to bring you in here and get the state 0:13:55.080 --> 0:13:58.160 of plan markets because we continue to get more headlines 0:13:58.200 --> 0:14:01.280 on trade, whether it relates to China in Mexico and 0:14:01.320 --> 0:14:04.319 in that arena, the majority of the investors are saying, 0:14:04.760 --> 0:14:07.640 don't go into emerging markets, it's so volatile. Of course, 0:14:07.679 --> 0:14:11.040 they have a shorter term outlook than ten years, But 0:14:11.400 --> 0:14:14.680 over this past week, it seems like markets don't really 0:14:14.720 --> 0:14:18.520 care much, do they? Well, they have stopped being overly 0:14:18.600 --> 0:14:21.800 concerned because somebody rushed to their aid once again, or 0:14:21.840 --> 0:14:24.520 to a degree, I mean, depending someone being oh Jerome 0:14:24.560 --> 0:14:29.000 Pow and if depending on how you slice his his 0:14:29.680 --> 0:14:31.560 did it did look like he was conscious that he 0:14:31.640 --> 0:14:35.400 was being called on to issue some some peaceful commentary 0:14:35.440 --> 0:14:39.040 and they got that. And I don't know, uh, to me, 0:14:39.160 --> 0:14:42.120 not in any way surprising that the SNP of volatility 0:14:42.200 --> 0:14:45.200 is higher than everything right now. It's been a crazy 0:14:45.240 --> 0:14:47.760 market to cover if there's no sign that it's going 0:14:47.800 --> 0:14:50.120 to get any easier. There's lots of economics, I mean, 0:14:50.160 --> 0:14:52.120 I think this is what we're pivoting to. We were 0:14:52.160 --> 0:14:54.920 obsessed with the Fed, we remain obsessed with the trade war. 0:14:55.280 --> 0:14:57.840 But a lot of people are starting to become really 0:14:57.880 --> 0:15:01.720 concerned that there's emerging evidence that the U. S economy 0:15:01.800 --> 0:15:03.440 is not what it what not would it looked like 0:15:03.440 --> 0:15:05.360 a few months ago? And that's probably going to call 0:15:05.400 --> 0:15:07.720 the tune from here. And are the head winds to 0:15:07.720 --> 0:15:11.800 the economy fixable by a few rate cuts? Considering how 0:15:11.800 --> 0:15:13.480 close we all arts is zero? I would just say 0:15:13.480 --> 0:15:15.720 to that the answer, if the economy is in trouble 0:15:15.800 --> 0:15:18.560 has historically been No. I mean, eventually rate cuts will 0:15:18.680 --> 0:15:21.320 will kick in turn things around. But the economy is 0:15:21.480 --> 0:15:24.560 too big of a ship I think really in anything 0:15:24.560 --> 0:15:27.480 but the long term to to to be rescuable by 0:15:27.760 --> 0:15:30.680 you know, FED gestures, particularly now. I mean they don't 0:15:30.680 --> 0:15:48.960 have enormous amounts of bandwidth to deal with it. Rob, 0:15:48.960 --> 0:15:50.760 You were not in your head in agreement there, which 0:15:50.760 --> 0:15:52.640 is rare with NJ. We don't see that, right, we 0:15:52.680 --> 0:15:55.440 don't see that in this office. Uh much? Is is 0:15:55.440 --> 0:15:58.080 this rate cut that everyone's pricing in enough to keep 0:15:58.680 --> 0:16:00.960 the party going? Or is there are too many headlines? 0:16:01.960 --> 0:16:07.840 The short answer is not really. The longer answer is 0:16:08.280 --> 0:16:12.280 um Monetary policy acts with a lag of about eighteen 0:16:12.280 --> 0:16:15.640 to thirty six months, so they should have been doing 0:16:15.680 --> 0:16:21.960 this a year ago. Um. Now, what's interesting is the 0:16:21.960 --> 0:16:25.280 the markets tell the FED whether it's too loose or 0:16:25.320 --> 0:16:28.720 too tight. You have a set rate, the short rate, 0:16:29.240 --> 0:16:33.720 you have a market rate the long rate, and don't 0:16:33.840 --> 0:16:38.160 view an inverted yield curve as a signal that a 0:16:38.240 --> 0:16:41.880 recession may be coming. Few an inverted yield curve as 0:16:42.360 --> 0:16:47.280 something that creates the recession. Thank you. I've always thought that, Yeah, 0:16:48.040 --> 0:16:50.600 is that because of the fear that it creates in 0:16:50.640 --> 0:16:54.920 the investor space, or just because of the actual ways 0:16:55.040 --> 0:16:57.680 that now banks are lending out we're lending rate stand 0:16:58.000 --> 0:17:02.040 more the latter, because when you're dealing with long rates 0:17:02.120 --> 0:17:05.800 at let's say two and a half percent and tenure 0:17:05.840 --> 0:17:11.440 at um Ballpark of two and the T bill yield 0:17:11.520 --> 0:17:17.080 is higher, materially higher. Basically, the long rate is saying, WHOA, 0:17:17.240 --> 0:17:20.199 we're seeing signs of a slowdown. We think two percent 0:17:20.560 --> 0:17:24.480 is about it for the cost of capital in a 0:17:24.560 --> 0:17:28.080 slowing economy, and the FETE is saying, we don't see 0:17:28.119 --> 0:17:30.600 it yet. By the time they see it, it's way 0:17:30.640 --> 0:17:35.160 too late. So Cam Harvey did his nine six um 0:17:35.200 --> 0:17:37.560 PhD dissertation on this very topic. He was the one 0:17:37.600 --> 0:17:41.760 who originally found the yield curve and versions had a 0:17:42.200 --> 0:17:46.840 then perfect track record. To gauge the track record of 0:17:46.880 --> 0:17:50.160 any indicator, you're looking for false positives and false negatives. 0:17:50.480 --> 0:17:54.000 False positives would be signal that there's a recession coming 0:17:54.200 --> 0:17:57.080 and it doesn't happen. False negatives would be no signal 0:17:57.119 --> 0:18:00.160 and it does happen. There were no false positive those 0:18:00.280 --> 0:18:04.359 or false negatives from nine well, there's been no false 0:18:04.400 --> 0:18:09.680 positives or negatives since then, that's pretty unusual. So when 0:18:09.680 --> 0:18:13.760 you see an inversion, it doesn't guarantee the recessions coming, 0:18:13.880 --> 0:18:17.320 but sit up and pay attention, because basically the market 0:18:17.359 --> 0:18:24.080 is saying this FED is too tight, it's stifling UH investment, 0:18:24.880 --> 0:18:30.320 and historically it's a perfect indicator. It's never failed. You know, 0:18:30.359 --> 0:18:32.520 I can't resist the chance to get a little plug 0:18:32.560 --> 0:18:34.639 in here if you want to hear more about Cam Harvey. 0:18:35.160 --> 0:18:37.879 A few episodes ago our four Horsemen of the Apocalypse, 0:18:37.880 --> 0:18:41.040 we we interviewed Cam Harvey, Rob's colleague at at Research 0:18:41.359 --> 0:18:45.480 Affiliates UM Rob. We also heard from Mario Draggy this week, 0:18:46.000 --> 0:18:48.960 and the market didn't react very well to him. I 0:18:48.960 --> 0:18:52.119 mean they the ECB obviously has less sort of biggle 0:18:52.240 --> 0:18:56.080 room to stimulate UH still at zero percent interest rates. 0:18:56.560 --> 0:18:59.320 I mean he's developed Europe a lost cause in the 0:18:59.359 --> 0:19:04.479 stock market, uh for the over I mean you have 0:19:04.520 --> 0:19:08.040 European banks index trading at basically the level of traded 0:19:08.080 --> 0:19:10.800 at in the in the nineteen eighties. You know, when 0:19:10.840 --> 0:19:16.240 when Chris was well, you've got you've got to recognize 0:19:16.240 --> 0:19:19.240 the downside risk is constrained. I mean Deutsche Bank that 0:19:19.800 --> 0:19:21.560 I can't lose more than two bucks to share because 0:19:21.600 --> 0:19:25.600 it's a two bucks share um, so you have a 0:19:25.640 --> 0:19:29.199 firm zero lower bound is firm when it comes to 0:19:29.240 --> 0:19:34.840 share crisis, I would argue, and central bankers just don't 0:19:34.920 --> 0:19:38.800 see this that if you reduce rates from six percent 0:19:38.920 --> 0:19:42.679 to four percent, you're stimulating. If you reduce rates from 0:19:42.720 --> 0:19:47.560 two percent to zero percent, probably not. If you're reduced 0:19:47.560 --> 0:19:50.520 from zero to minus one, you're not stimulating. Your singing 0:19:50.600 --> 0:19:55.960 signaling panic, and people instead of going out and spending 0:19:56.600 --> 0:20:02.000 are going to hoard. They're going to um set money 0:20:02.040 --> 0:20:05.359 aside for a rainy day because the central bank is 0:20:05.400 --> 0:20:08.919 signaling watch out, big rainy days are coming. So no, 0:20:09.080 --> 0:20:13.359 I don't think it signals that the opportunity in European 0:20:13.480 --> 0:20:19.919 equities are for clothes for the foreseeable future. The market 0:20:20.000 --> 0:20:22.600 knows about the impact of negative rates even as central 0:20:22.600 --> 0:20:28.360 bankers don't, and it's already priced it in European stocks. Uh. 0:20:28.480 --> 0:20:33.159 The European stock index is priced at half the Schiller 0:20:33.200 --> 0:20:36.600 pe ratio of the US emerging markets. A little cheaper 0:20:36.640 --> 0:20:42.000 than that, but half off already says we don't like 0:20:42.119 --> 0:20:44.320 the way things are going here, and we're pricing that in. 0:20:45.160 --> 0:20:48.159 So I would much rather invest in Europe than in 0:20:48.160 --> 0:20:50.280 the US. That's saying a lot. You don't hear that 0:20:50.320 --> 0:20:52.639 many times, especially when short Europe is still one of 0:20:52.640 --> 0:20:55.960 the most crowded trades out there, supposedly according to some 0:20:55.960 --> 0:21:00.480 Bank of America dat Maverick. Maverick, Chris, I don't like crowded. Now, 0:21:00.760 --> 0:21:02.679 we know that, we know that. I do want to 0:21:02.720 --> 0:21:05.040 bring it back to Jerome Powell for a second, because 0:21:05.040 --> 0:21:06.520 he said at the beginning of the week that he 0:21:06.560 --> 0:21:10.160 would do whatever is appropriate to sustain the expansion, which 0:21:10.240 --> 0:21:13.879 is nice and ambiguous. Right what is what it is appropriate? 0:21:13.920 --> 0:21:17.040 We don't know. But you've said on Bloomberg Television before 0:21:17.480 --> 0:21:21.160 that this can potentially cause an issue because it encourages 0:21:21.200 --> 0:21:23.480 investors to buy on the dip, and we did not 0:21:23.520 --> 0:21:25.520 gloss over the fact that ten minutes ago you just 0:21:25.600 --> 0:21:28.040 said that over the next ten years, US stocks will 0:21:28.080 --> 0:21:31.960 probably return half a percentage point above inflation. Are these 0:21:32.000 --> 0:21:35.480 two at odds or is it the possibility that investors 0:21:35.520 --> 0:21:38.080 are buying on dips and continuing to drive the market 0:21:38.160 --> 0:21:40.879 higher that could potentially make the fall out even worse. 0:21:41.160 --> 0:21:43.760 I think they've been buying on dips for a long time, 0:21:43.800 --> 0:21:46.920 and that has a lot to do with evaluation multiples 0:21:46.920 --> 0:21:50.440 we see here in the US. My concern about US 0:21:50.520 --> 0:21:54.040 stocks is all valuation related, it's not growth related. I 0:21:54.040 --> 0:21:57.640 think US is better positioned for economic growth in Europe 0:21:57.960 --> 0:22:00.520 or Japan, and I think demograph fix are a big 0:22:00.560 --> 0:22:03.159 part of that. We still have a rising population and 0:22:03.240 --> 0:22:08.199 a rising population working age population, um Japan has a 0:22:08.200 --> 0:22:11.960 shrinking population, in Europe has a shrinking working age population, 0:22:12.480 --> 0:22:17.000 so they have demographic headwinds that are much more serious 0:22:17.080 --> 0:22:20.440 than the ones that we face. But even our demographics, 0:22:20.800 --> 0:22:25.320 the baby boomer population is huge, and roll the clock 0:22:25.359 --> 0:22:28.000 forward ten years and the vast majority of boomers will 0:22:28.040 --> 0:22:33.520 be retired. When the vast majority is retired, they will 0:22:33.600 --> 0:22:37.240 be having to sell assets in order to buy goods 0:22:37.240 --> 0:22:42.280 and services in retirement, whether it's through a direct sales 0:22:42.440 --> 0:22:45.719 or indirect through a pension paying out to them. In 0:22:45.760 --> 0:22:51.000 either case, those are valuation in different sales. You're selling 0:22:51.040 --> 0:22:55.000 because you need to regardless of the price. So baby 0:22:55.000 --> 0:22:58.320 boomers switch from ten years ago being valuation in different 0:22:58.480 --> 0:23:04.240 buyers to valuation in different sellers. That's a big switch, 0:23:04.520 --> 0:23:09.000 and that could easily lead to valuation multiples being rather 0:23:09.119 --> 0:23:13.040 drastically lower ten years from now, Rob, one quick thing 0:23:13.080 --> 0:23:15.400 before we get to the craziest thing in markets this week. 0:23:15.440 --> 0:23:17.479 I think everyone's favorite part of the podcast, and at 0:23:17.520 --> 0:23:20.600 least mine two and fifteen I actually interviewed it you. 0:23:20.640 --> 0:23:22.240 I don't even know if you remember. I'm a very 0:23:22.280 --> 0:23:27.240 forgettable guy, but one quote really, uh stuck with me, 0:23:27.280 --> 0:23:29.000 and I just want to read it back to you. Uh. 0:23:29.160 --> 0:23:31.240 You said, right now, we have earnings coming off of 0:23:31.240 --> 0:23:34.440 a record high as a percentage of GDP, and yet 0:23:34.480 --> 0:23:36.680 you have Wall Street saying, don't worry, it's going to 0:23:36.760 --> 0:23:40.159 sort of new hides. Pardon me, but when when do 0:23:40.240 --> 0:23:43.680 the peasants with pitchworks come out and start rioting? Society 0:23:43.800 --> 0:23:46.119 at large has to enjoy some of the large guests, 0:23:46.480 --> 0:23:49.520 or else the pitchforks come out, you know. And that's 0:23:49.520 --> 0:23:51.720 really stuck with me because you look at some of 0:23:51.760 --> 0:23:57.240 the political developments that populism have since then. The populism, um, 0:23:57.280 --> 0:24:01.000 you know, the blue collar support for President Trump on 0:24:01.000 --> 0:24:05.080 one hand, that on the left you have a very 0:24:05.080 --> 0:24:10.399 big lurch to the left into downright socialism. Um, is 0:24:10.400 --> 0:24:13.040 that a sign of the pitchforks? And and ultimately, what 0:24:13.240 --> 0:24:15.720 is the target of pitchforks? I wonder if one of 0:24:15.720 --> 0:24:18.199 them might be buy backs, which is an element of 0:24:18.240 --> 0:24:21.760 the fundamental index um. Where do you see who's going 0:24:21.840 --> 0:24:24.320 to get punctured by it by a pitchworks? Buy Backs 0:24:24.359 --> 0:24:28.080 I don't think are a big deal. It reflects companies 0:24:29.080 --> 0:24:32.960 concerns that they don't have new initiatives that are worth 0:24:33.000 --> 0:24:35.439 investing in, and therefore the best thing they can do 0:24:35.480 --> 0:24:38.959 for their share prices to buy back stock. That's a 0:24:39.040 --> 0:24:43.960 lot healthier than secondary equity offerings, which dilute the shareholder, 0:24:44.600 --> 0:24:49.080 and through most of market history, secondary equity offerings have 0:24:49.200 --> 0:24:52.520 been much bigger than buy backs. But back to the 0:24:52.520 --> 0:24:56.879 basic question. Populism is a manifestation of the pitchforks. The 0:24:56.920 --> 0:25:00.280 pitchforks come out with people being angry and not knowing 0:25:00.600 --> 0:25:05.600 who to be angry at. So the Brexit tears are 0:25:05.680 --> 0:25:11.159 angry at Brussels, and they're angry at the mainstream politicians 0:25:11.200 --> 0:25:17.000 that got them married to Brussels. The Trumpians are angry 0:25:17.000 --> 0:25:21.119