WEBVTT - Rob Arnott on Bubbles 0:00:00.440 --> 0:00:03.840 Strap on your parachute. Is time for What Goes Up 0:00:04.120 --> 0:00:14.200 with Sarah Ponzick and Mike Reagan. Hello and welcome to 0:00:14.280 --> 0:00:18.280 What goes Up, a Bloomberg Weekly Markets podcast. I'm Sarah Ponzek, 0:00:18.400 --> 0:00:21.560 a reporter on the Cross Asset team, and I'm Mike Reagan, 0:00:21.720 --> 0:00:24.520 a senior editor at Bloomberg. And you can think of 0:00:24.560 --> 0:00:28.480 me as the Polly Walnuts to Sarah's Tony Soprano. Let's 0:00:28.560 --> 0:00:30.760 keep it going, Mike, keep it going. You like you 0:00:30.800 --> 0:00:32.879 like that one that makes you the boss? You know 0:00:32.880 --> 0:00:34.760 I am the boss here. You know that that's a 0:00:34.800 --> 0:00:37.760 big compliment in Jersey here, so I hope you like 0:00:37.840 --> 0:00:39.760 that one down in North Carolina. I don't know if 0:00:39.760 --> 0:00:42.040 they take Tony Soprano as as big as a compliment 0:00:42.240 --> 0:00:45.360 as with you in Jersey, but I'm gonna take it 0:00:45.479 --> 0:00:48.440 and run with it. Alright. Good a big week on 0:00:48.479 --> 0:00:51.159 the show. So the breakneck rally in the stock market, 0:00:51.200 --> 0:00:55.240 even amid the economic uncertainty surrounding the coronavirus, has many 0:00:55.360 --> 0:00:59.440 market observers wondering if a bubble is forming. Our guest 0:00:59.560 --> 0:01:02.800 is the absolute perfect person to discuss this, and for 0:01:02.960 --> 0:01:06.840 years has analyzed the nature of bubbles across financial markets, 0:01:07.319 --> 0:01:09.759 and as always, will close out the episode with our 0:01:09.800 --> 0:01:13.199 tradition the craziest thing I saw in markets this week, 0:01:13.640 --> 0:01:16.000 And remember, if you saw anything crazy, give us a 0:01:16.040 --> 0:01:19.440 call on the Bloomberg Podcast hotline at six four six 0:01:19.959 --> 0:01:23.960 three to four three four nine zero, or tweet to 0:01:24.080 --> 0:01:27.679 us at Podcasts and maybe we'll read your tweet or 0:01:27.760 --> 0:01:31.080 play your voicemail on the show. And Sarah, as you said, 0:01:31.240 --> 0:01:33.840 very very excited to welcome back this week's guest. But 0:01:33.920 --> 0:01:36.080 before I introduce him, I do want to point out 0:01:36.160 --> 0:01:40.119 one thing to listeners. You know how the big thing 0:01:40.200 --> 0:01:43.120 on Wall Street now, the big trend is to look 0:01:43.160 --> 0:01:47.360 at all the alternative data, the Apple Maps mobility data 0:01:47.480 --> 0:01:50.200 open table, that sort of thing. I want to warn people. 0:01:50.240 --> 0:01:52.640 I think there's a problem with the Apple mobility data 0:01:52.680 --> 0:01:54.520 and sorry, you know what that is. I'm waiting for 0:01:54.520 --> 0:01:56.840 this explanation. Let's hear it. The upticking that data is 0:01:56.840 --> 0:02:00.160 all because of Sarah. I think, truly I did. I'd 0:02:00.240 --> 0:02:03.480 use Apple Maps a very fair amount over the past 0:02:03.520 --> 0:02:05.920 week or so planning out how I was going to 0:02:05.960 --> 0:02:09.080 get up here. Um I will say, though, service is 0:02:09.280 --> 0:02:13.840 very rocky, so the Apple Mobility data probably hasn't been 0:02:13.840 --> 0:02:16.880 able to send through a decent amounts of time. I'm 0:02:16.960 --> 0:02:19.960 hiding out. It's pretty cool hiding out Florida. Now I'm 0:02:20.000 --> 0:02:23.760 hiding out in the woods. You look like you're in 0:02:23.760 --> 0:02:26.280 a giant sauna right now. We're we're you can't see 0:02:26.320 --> 0:02:28.160 this at home, but we're all on a zoom calls. 0:02:28.160 --> 0:02:31.480 How we do our podcasts in the age of COVID 0:02:31.520 --> 0:02:34.560 and Sarah. Sarah fled New York because the virus got 0:02:34.600 --> 0:02:38.919 really bad to her family home in Florida. It got 0:02:38.919 --> 0:02:41.400 bad in Florida. Now she's fled to North Carolina. So 0:02:41.520 --> 0:02:44.239 if you're listening from North Carolina, I mean, I'm no doctor, 0:02:44.440 --> 0:02:48.120 but I'm gonna say, maybe shelter in place because this 0:02:48.200 --> 0:02:52.240 virus is following side. I've really timed COVID nineteen very 0:02:52.240 --> 0:02:54.600 well with my travels across the country, and I have 0:02:54.680 --> 0:02:58.120 been driving everywhere too and keeping to myself. Um, but yes, 0:02:58.200 --> 0:03:01.400 fingers crossed, that doesn't happen obviously, I would hate for 0:03:01.440 --> 0:03:04.720 that to happen in North Carolina. There's an alternative explanation. 0:03:04.800 --> 0:03:07.360 Maybe she's bringing it wherever she had never had it. 0:03:07.400 --> 0:03:12.079 I promise I've been tested nothing this this is one 0:03:12.080 --> 0:03:14.680 more reason why I'm glad we're doing this, uh these 0:03:14.720 --> 0:03:18.280 podcasts remotely these days. But that other voice you here, 0:03:18.320 --> 0:03:20.520 that's our guest this week. Very very excited to have 0:03:20.600 --> 0:03:23.760 him back on the show. His name is Rob or Not. 0:03:24.000 --> 0:03:27.640 He's the co founder of Research Affiliates. Rob, welcome back 0:03:27.680 --> 0:03:30.120 to the show. Thank you so much. It's a pleasure. 0:03:30.680 --> 0:03:33.080 And Rob, where are you? You're in California? I presume right. 0:03:33.480 --> 0:03:37.120 I live mostly in Miami Beach, but I flee Miami 0:03:37.160 --> 0:03:40.600 Beach during the summer months and returned to Newport Beach, 0:03:40.600 --> 0:03:44.520 where I used to live. So I'm I'm hunkered down 0:03:44.600 --> 0:03:49.840 here at home until end of September, roughly Florida, California. 0:03:49.920 --> 0:03:54.520 Rob can't escape it either. Yeah, well, Rob, as Sarah 0:03:54.520 --> 0:03:56.560 pointed out in the in the introduction, You've thought a 0:03:56.600 --> 0:04:00.360 lot of really fascinating research over the years on bubbles, 0:04:00.560 --> 0:04:04.040 and boy, I think that one of the craziest things 0:04:04.080 --> 0:04:07.280 I've seen this year is this notion of the valuation 0:04:07.320 --> 0:04:11.440 expansion that we've seen in a market that already seemed 0:04:11.840 --> 0:04:14.440 very frothy before the recession hit. You know, of course, 0:04:14.480 --> 0:04:17.040 we had the the big correction, the bear market that 0:04:17.120 --> 0:04:22.000 was very quickly almost completely reversed. How shocking is it 0:04:22.040 --> 0:04:25.200 to you to see this valuation expansion we're seeing right now, 0:04:25.360 --> 0:04:28.839 and you know, based on on your studies of past bubbles, 0:04:29.520 --> 0:04:31.400 is there any way to sort of expect how far 0:04:31.440 --> 0:04:34.320 it goes or or when the sort of the music 0:04:34.360 --> 0:04:36.919 stops playing and we all have to come back to 0:04:36.960 --> 0:04:40.880 earth sort of mean reverting valuations, if ever, I'll take 0:04:40.920 --> 0:04:43.680 the last part of your question. First. Short answer is no, 0:04:43.800 --> 0:04:45.760 there's no way of knowing when it's when the bubbles 0:04:45.800 --> 0:04:49.000 going to peter her out. We just know that it will. Um. 0:04:49.120 --> 0:04:54.360 We also know that people buying bubble assets will make 0:04:54.400 --> 0:04:57.600 money until they don't. And if they're buying on the 0:04:57.600 --> 0:05:00.920 presumption that hey, it's soaring, I want to get on 0:05:00.960 --> 0:05:05.240 this and uh right at the next leg up. Um, 0:05:05.279 --> 0:05:08.760 if they don't have a cell discipline, if they don't 0:05:08.839 --> 0:05:13.039 have a view of what will it take for me 0:05:13.200 --> 0:05:17.760 to say, okay, enough already, I'm going to get out, Um, 0:05:17.920 --> 0:05:21.200 then they are doomed to ride the roller coaster over 0:05:21.240 --> 0:05:26.680 the top and down. And uh so, without a cell discipline, 0:05:26.680 --> 0:05:35.599 buying bubble assets is insanely stupid. Bubbles. Jeremy Grantham went 0:05:35.640 --> 0:05:38.400 on record saying this is the third bubble of his lifetime. 0:05:39.000 --> 0:05:45.880 I view bubbles on a more uh scaled approach. There's 0:05:45.920 --> 0:05:48.599 always bubbles. There's a little micro bubbles at work in 0:05:48.600 --> 0:05:52.640 the market all the time, bits of irrationality all the time. 0:05:53.200 --> 0:05:56.000 What we think of as a bubble is really when 0:05:56.480 --> 0:06:00.520 a market as a whole goes to irrational levels, or 0:06:00.560 --> 0:06:02.479 when a segment of the market as a whole goes 0:06:02.520 --> 0:06:06.440 to irrational levels. One of the things that I've done 0:06:06.520 --> 0:06:10.120 that I think is relatively important is to come up 0:06:10.160 --> 0:06:13.599 with a workable definition of the term bubble. People bandy 0:06:13.600 --> 0:06:17.520 around the term, and all it means is, well, it's frothy. Okay, 0:06:17.600 --> 0:06:20.560 froth is a characteristic of bubbles and vice versa. But 0:06:21.360 --> 0:06:23.320 that doesn't define it in a way you can use 0:06:23.360 --> 0:06:27.000 it in real time. Uh. My definition that you can 0:06:27.160 --> 0:06:30.200 use in real time is if you wanted to value 0:06:30.279 --> 0:06:35.240 an asset using discounted cash flow or some other accepted 0:06:35.320 --> 0:06:40.080 valuation method, you would have to use implausible assumptions to 0:06:40.240 --> 0:06:44.720 justify the current multiple second part of the definition, and 0:06:44.839 --> 0:06:49.520 no less important. The marginal buyer, the person who's buying 0:06:49.520 --> 0:06:55.560 it today's prices, doesn't care about valuation models. At all. 0:06:56.440 --> 0:06:59.520 If those two definitions are in place, you've got a 0:06:59.600 --> 0:07:02.400 bubble and you can identify it when it's happening. Now, 0:07:02.400 --> 0:07:05.159 the right answer is not to short short all of 0:07:05.160 --> 0:07:08.839 the bubble assets, because bubbles can continue farther than you 0:07:08.839 --> 0:07:11.600 can imagine. The The old adage the market can be 0:07:11.640 --> 0:07:16.160 irrational longer than you can remain solvent is absolutely true, 0:07:16.200 --> 0:07:33.360 and there's there's myriad examples of that. I love the 0:07:33.400 --> 0:07:36.280 title of one of the papers that Research Affiliates put 0:07:36.320 --> 0:07:39.760 out back in April, and it's yes, it's a bubble, 0:07:40.200 --> 0:07:42.920 so what And you mentioned micro bubbles and at the time, 0:07:43.360 --> 0:07:46.440 one of those micro bubbles that you mentioned was Tesla, 0:07:46.520 --> 0:07:49.520 And of course look at where we are now with Tesla. 0:07:49.600 --> 0:07:53.920 But we hear the word bubble being thrown out almost 0:07:54.000 --> 0:07:57.160 constantly these days, whether or not it relates to tech 0:07:57.360 --> 0:08:00.280 or the fame names or Tesla for example. Well, we 0:08:00.320 --> 0:08:02.440 had a recent guest on the podcast we talked about 0:08:02.440 --> 0:08:04.960 the concept of a melt up and said that hold 0:08:05.000 --> 0:08:08.240 on a second. Sure, it's scary because eventually will end 0:08:08.240 --> 0:08:11.200 and roll over, but you can enjoy it while it's 0:08:11.280 --> 0:08:14.160 happening well from your perspective, because it's so difficult to 0:08:14.200 --> 0:08:19.000 time these things. What advice can you give on how 0:08:19.040 --> 0:08:24.040 to possibly approach what maybe a bubble? Well, you can 0:08:24.160 --> 0:08:27.360 enjoy it as long as it keeps going, for sure. 0:08:28.480 --> 0:08:31.080 The question is do you have a cell discipline? So 0:08:31.160 --> 0:08:34.840 whoever said enjoy it while it's running, the question to 0:08:34.960 --> 0:08:37.320 them would be a very simple one. Okay, So what 0:08:37.400 --> 0:08:41.400 will it take for you to sell? Tesla is currently 0:08:41.520 --> 0:08:45.960 valued larger than the entire US auto industry x Tesla. 0:08:46.720 --> 0:08:49.840 It's valued at more than twice the value of Toyota, 0:08:50.080 --> 0:08:54.760 which has remained profitable through the COVID crisis, remained profitable 0:08:54.800 --> 0:08:58.360 through the global financial crisis, and produces thirty times as 0:08:58.400 --> 0:09:01.120 many cars as Tesla. Now, Tesla is not just an 0:09:01.120 --> 0:09:04.600 auto company. It's also a technology company and a patents company, 0:09:04.600 --> 0:09:07.280 and an energy company and so forth. But what they 0:09:07.320 --> 0:09:10.360 purport to make money on at the moment is cars, 0:09:11.000 --> 0:09:14.600 and what they hope aspirationally to make money on is 0:09:14.880 --> 0:09:18.280 some of these other things too. The bottom line is 0:09:18.840 --> 0:09:25.000 to justify a valuation larger than Test than Toyota plus 0:09:25.120 --> 0:09:29.280 the entire US auto industry the combination of all of that, 0:09:29.800 --> 0:09:34.400 you'd have to paint a scenario in which Tesla's revenues 0:09:34.640 --> 0:09:41.080 are comparable to all of those companies combined in let's 0:09:41.120 --> 0:09:47.120 say ten years. Is that possible. Yes, That's why I 0:09:47.200 --> 0:09:52.760 use the word plausible. Is it plausible? No? It would 0:09:52.760 --> 0:09:56.400 have to see thirty or forty growth per annum for 0:09:56.440 --> 0:10:00.560 the next ten years in order to have that uh 0:10:00.800 --> 0:10:05.040 thirty full fortyfold fiftyfold growth in business in just ten years. 0:10:05.160 --> 0:10:09.520 In fact, in its last ten years, it hasn't grown fiftyfold. Sir, 0:10:09.640 --> 0:10:12.480 I think Ellen needs to restock those short shorts he 0:10:12.559 --> 0:10:16.320 was selling to justify this valuation. Summer is not gonna 0:10:16.400 --> 0:10:21.480 last forever. I would note that I have never shortened Tesla. 0:10:21.840 --> 0:10:24.319 I've thought it was overpriced since it was a lot 0:10:24.400 --> 0:10:27.520 cheaper than than current levels. At level, I was thinking 0:10:27.559 --> 0:10:31.480 it's a short, but I've never shorted it for the 0:10:31.679 --> 0:10:34.480 very simple reason that bubbles can continue longer than you 0:10:34.520 --> 0:10:37.120 can possibly imagine, and can go further than you can 0:10:37.160 --> 0:10:41.120 possibly imagine. They don't last forever. When I use the 0:10:41.160 --> 0:10:46.679 word plausible, it's important because you do have bubble stocks 0:10:47.000 --> 0:10:51.679 that that simple definition would identify as a bubble, and 0:10:51.840 --> 0:10:57.080 correctly identify as a bubble that subsequently proved to have 0:10:57.840 --> 0:11:03.200 results that that exceed plausible and that actually justify those prices. 0:11:03.600 --> 0:11:07.000 The vivid example that comes to mind from the earlier 0:11:07.080 --> 0:11:10.720 tech bubble of two thousand is Amazon. Amazon and ninety 0:11:10.800 --> 0:11:14.240 nine was priced at levels that it would have had 0:11:14.240 --> 0:11:18.839 to achieve implausible growth to justify the prices at that time. 0:11:19.240 --> 0:11:22.240 Well over the next ten years, it underperformed the market 0:11:22.559 --> 0:11:25.840 in a big way over the next ten years. It's 0:11:25.880 --> 0:11:29.920 in that second decade that they finally hit their stride 0:11:30.000 --> 0:11:32.800 and achieved the kind of growth that would have justified 0:11:33.280 --> 0:11:37.760 the price. That's a long time to wait, so bubbles 0:11:38.480 --> 0:11:44.200 usually burst. There's just enough exceptions to the rule that 0:11:44.320 --> 0:11:49.640 do achieve implausible growth, and then some that it draws 0:11:50.000 --> 0:11:53.360 suckers in to say, Okay, this time is different. I 0:11:53.400 --> 0:11:56.320 wonder if there is an element of people trying to 0:11:56.360 --> 0:11:59.320 put a book value on on Elon Musk's brain, you know, 0:11:59.400 --> 0:12:02.360 and look looking, and it's the Amazon example is a 0:12:02.400 --> 0:12:06.840 great example. You know that valuation for an online bookseller 0:12:07.440 --> 0:12:09.640 was one thing, but of course we saw, you know, 0:12:09.760 --> 0:12:12.360 Amazon turn into something much more than that. I wonder 0:12:12.360 --> 0:12:15.000 if people are thinking, Nielon will will turn this into 0:12:15.040 --> 0:12:17.200 something bigger than just a car company, you know, a 0:12:17.280 --> 0:12:20.760 battery company that you know whatever. I don't know, but 0:12:21.120 --> 0:12:23.000 it's hard to get into the brains of people that 0:12:23.040 --> 0:12:26.720 are buying uh Tesla at ten thousand times trailing earnings 0:12:28.640 --> 0:12:32.720 or or twelve times annual run rate revenues to make 0:12:32.760 --> 0:12:36.640 money at ten times revenues, if you assume maybe the 0:12:36.679 --> 0:12:39.520 company will have a twenty or thirty percent profit margin 0:12:39.600 --> 0:12:42.679 down the road, how how big would those revenues have 0:12:42.800 --> 0:12:46.360 to grow to justify ten times revenues. Well, you'd have 0:12:46.440 --> 0:12:49.280 to have the revenues grow to thirty to fifty times 0:12:49.360 --> 0:12:55.000 current levels to justify ten times revenues today, and thirty 0:12:55.000 --> 0:13:02.160 to fifty times growth, My goodness, that is an extravagant expectation. 0:13:03.280 --> 0:13:05.719 I would also say that Amazon has entered what I 0:13:05.720 --> 0:13:09.520 would call bubble territory um. When it announced its first 0:13:09.600 --> 0:13:14.679 quarter earnings at the end of April, it was priced 0:13:14.679 --> 0:13:16.319 at the end of that day at a hundred eleven 0:13:16.360 --> 0:13:19.760 times trailing. When you're earnings now, I use trailing earnings, 0:13:19.760 --> 0:13:22.600 not expected earnings, because expected earnings haven't happened yet and 0:13:22.640 --> 0:13:26.199 they often don't. But in any event, they were selling 0:13:26.200 --> 0:13:30.040 at a hundred eleven times the trailing earnings. My chief 0:13:30.080 --> 0:13:33.840 investment officer Chris Brightman did a very simple analysis. He said, 0:13:34.120 --> 0:13:37.000 what if Amazon grows tenfold in the next ten years, 0:13:37.480 --> 0:13:42.600 grows tenfold and at that stage is bigger than the 0:13:42.840 --> 0:13:47.200 entire US retailing community in terms of its sales, bigger 0:13:47.240 --> 0:13:50.600 than all of US retailing in the space of ten years, 0:13:50.640 --> 0:13:52.920 what would it be worth And he came up with 0:13:52.960 --> 0:13:55.400 an answer of seventy times earnings. It would be worth 0:13:55.440 --> 0:13:58.199 a massive premium to the market. Seventy times earnings is 0:13:58.240 --> 0:14:00.719 a big premium. It's not a hundred times, and it's 0:14:00.760 --> 0:14:04.000 not today's hundred sixty times. Right. It's a good point 0:14:04.000 --> 0:14:07.160 about trailing earnings, especially in this environment when boy, who's 0:14:07.200 --> 0:14:10.040 even given a forecast anymore, it's it's almost impossible to know. 0:14:10.679 --> 0:14:13.440 But rap I think what a lot of from the map, 0:14:13.480 --> 0:14:16.640 from sort of the macro angle, um, I think what 0:14:16.760 --> 0:14:19.080 a lot of people are struggling with when they try 0:14:19.120 --> 0:14:23.880 to do valuation models is the notion that real yields 0:14:23.880 --> 0:14:26.440 are negative right now. In other words, you know, treasury yields, 0:14:26.480 --> 0:14:30.600 the safest assets are paying a yield uh that's less 0:14:30.600 --> 0:14:33.280 than the inflation rate. Even out I think all the 0:14:33.280 --> 0:14:35.080 way to thirty years, I'd have to double check that. 0:14:35.120 --> 0:14:38.680 But the whole curve pretty much is negative on a 0:14:38.720 --> 0:14:42.560 real basis. How much does that gum up your attempt 0:14:42.600 --> 0:14:47.000 to to find a fair valuation. You know, our colleague 0:14:47.000 --> 0:14:49.600 of mine who writes a colum at Bloomberg, Cameron Christ, 0:14:50.040 --> 0:14:53.520 keeps joking that, you know, people think this justifies sort 0:14:53.520 --> 0:14:57.040 of an infinity valuation on tech stocks. But there is 0:14:57.080 --> 0:14:59.600 some truth to the fact that when the you know, 0:14:59.640 --> 0:15:02.560 when the ascount rate is solo, when real yields are negative, 0:15:02.960 --> 0:15:07.720 we should be able to sort of expect some valuation expansion. 0:15:07.800 --> 0:15:10.920 But how do you wrap your head around an equity 0:15:11.000 --> 0:15:14.960 valuation from a macro level when when real yields are negative. Well, firstly, 0:15:15.400 --> 0:15:20.600 low real yields do justify higher evaluation, So let's stipulate 0:15:20.680 --> 0:15:23.160 that and move that out of the way. The question 0:15:23.240 --> 0:15:27.760 is how much higher? Now one of the nuances, there's 0:15:27.800 --> 0:15:32.440 a Gordon equation, which is uh dividends over a discount 0:15:32.520 --> 0:15:37.640 rate being a valuation metric for companies, which means that 0:15:37.680 --> 0:15:40.440 if the if the discount rate is zero, that the 0:15:40.440 --> 0:15:45.640 evaluation is infinity. Okay, Well, that is tacitly the argument 0:15:45.680 --> 0:15:50.640 that negative rates justify any evaluation. You choose. My pushback 0:15:50.720 --> 0:15:54.640 on that is, we had negligible real rates in the 0:15:54.680 --> 0:15:59.240 mid fifties and stocks were trading at ten twelve times earnings, 0:15:59.400 --> 0:16:02.800 so it didn't work. Then we have negative rate real 0:16:02.880 --> 0:16:07.400 rates in Japan and Europe. They're trading at half to 0:16:07.480 --> 0:16:11.720 two thirds are multiples, so it's not working there. So 0:16:12.000 --> 0:16:16.120 if it doesn't work in other locations or at other times, 0:16:16.760 --> 0:16:21.360 then why not? And I think the reason is very 0:16:21.440 --> 0:16:26.280 very simple. Your your growth rate is also linked to 0:16:26.440 --> 0:16:29.680 real interest rates. Real interest rates being low can mean 0:16:29.760 --> 0:16:33.800 money is cheap and the discount rate is way down. Uh, 0:16:33.840 --> 0:16:37.800 And it can mean that growth expectations are anemic, and 0:16:37.960 --> 0:16:40.640 you have to take that into account. If growth expectations 0:16:40.680 --> 0:16:43.560 dropped just as much as the interest rates, they cancel 0:16:44.120 --> 0:16:46.360 and the low rates don't help your valuations at all. 0:16:46.920 --> 0:16:49.040 So what does research affiliates do in that environment? I 0:16:49.040 --> 0:16:51.120 spoke with Chris Brightman back in April, so just a 0:16:51.160 --> 0:16:53.320 couple of months ago, early on in a month, and 0:16:53.360 --> 0:16:55.120 he explained to me how you are moving from a 0:16:55.160 --> 0:17:00.000 more defensive posture to more so riskon moving into small 0:17:00.080 --> 0:17:05.240 tap us stocks, moving further more so into value. Obviously 0:17:05.640 --> 0:17:08.320 that's worked out well as that was early April, but 0:17:08.440 --> 0:17:11.760 it does feel like a good amount has changed since 0:17:11.800 --> 0:17:14.680 that point in time. Is that still where you stand. 0:17:15.160 --> 0:17:20.399 We've been moving back towards a defensive posture recently, and um, 0:17:20.920 --> 0:17:24.840 we're reluctant to go fully to a defensive posture until 0:17:24.920 --> 0:17:29.879 this next stimulus bill gets negotiated and passed and starts 0:17:29.880 --> 0:17:32.520 to work its way into the economy. In the last 0:17:32.560 --> 0:17:35.680 two weeks, the rumored size of the stimulus has risen 0:17:35.680 --> 0:17:39.760 from one trillion to two trillion. Uh. That's a big delta. 0:17:40.000 --> 0:17:44.160 And we know, we know from the past that stimulus 0:17:44.440 --> 0:17:48.840 doesn't just drop into consumer pockets and drop into their 0:17:48.880 --> 0:17:52.320 spending and stimulate the economy. What it does is stimulate 0:17:52.400 --> 0:17:57.040 asset bubbles, and so to the extent that it drops 0:17:57.080 --> 0:18:00.600 into people's pockets and people aren't working, so there's less 0:18:00.640 --> 0:18:05.040 goods and services to buy, then you're either going to 0:18:05.160 --> 0:18:10.080 get asset inflation or consumer price inflation, or a bit 0:18:10.080 --> 0:18:13.639 of both. We didn't get the consumer price inflation after 0:18:13.680 --> 0:18:16.639 the global financial crisis because the money may remainstalled on 0:18:16.680 --> 0:18:20.760 the Fed's balance sheet and in rebuilding the balance sheets 0:18:20.800 --> 0:18:23.640 of banks, and didn't get out into the macro economy. 0:18:23.680 --> 0:18:27.399 To be spent to create the demand. Now, if it 0:18:27.440 --> 0:18:29.399 gets out in the economy to create the demand and 0:18:29.440 --> 0:18:32.880 there's no supply, there's elements of truth in both Keynesianism 0:18:32.960 --> 0:18:36.479 and supply side economics. If there's no supply, you're going 0:18:36.520 --> 0:18:40.240 to create inflation, and so there in lies the challenge. 0:18:41.040 --> 0:18:43.160 Do I think some of the stimulus will make its 0:18:43.200 --> 0:18:48.000 way into the capital markets? Of course yes, And so 0:18:48.200 --> 0:18:53.560 does that push the market higher very possibly yes, um, 0:18:53.680 --> 0:18:57.280 or at least it props it up at levels that 0:18:57.640 --> 0:19:03.400 don't make economic sense. Um. I never thought after the 0:19:03.520 --> 0:19:07.119 tech bubble that I would ever see dispersion and valuation 0:19:07.240 --> 0:19:10.800 between growth and value stocks as wide as we saw then. 0:19:11.040 --> 0:19:17.240 It was insane, and we're there again. The spread between 0:19:17.280 --> 0:19:20.680 growth and value stocks using price to book value, which 0:19:20.680 --> 0:19:25.800 is a very flawed measure, reached a point of nine 0:19:25.840 --> 0:19:29.679 to one ratio, growth being nine times as expensive as 0:19:29.720 --> 0:19:33.239 value during the tech bubble. That's an astonishing ratio. Well, 0:19:33.280 --> 0:19:38.000 it's now eleven to one, eleven to one. Using price 0:19:38.080 --> 0:19:41.480 to sales, it reached a point of sixteen or seventeen 0:19:41.520 --> 0:19:45.919 to one. It's now nineteen to one between growth and value. 0:19:46.720 --> 0:19:52.160 Some valuation metrics you mentioned Elon Musk and the negligible 0:19:52.200 --> 0:19:56.840 book value of Tesla. Some valuation metrics like price to 0:19:56.920 --> 0:20:00.520 book are actually pretty deeply flawed. We have a paper 0:20:00.600 --> 0:20:05.840 coming out shortly the demonstrates that intangibles are a huge 0:20:05.880 --> 0:20:10.400 missing component of book value and that if you incorporate 0:20:10.440 --> 0:20:14.840 intangible as you get a better valuation metric. And that 0:20:14.960 --> 0:20:18.119 I think is exciting work because it actually makes the 0:20:18.280 --> 0:20:24.400 FAMA French price to book based value factor about thirty 0:20:24.800 --> 0:20:31.200 more powerful. That's cool, That's that's pretty interesting, you know. Rob. 0:20:31.240 --> 0:20:34.520 That brings us to another really interesting report that you 0:20:34.520 --> 0:20:37.240 guys have out recently about the sort of the notion 0:20:37.280 --> 0:20:41.240 of when that turn to value uh might happen? Uh. 0:20:41.280 --> 0:20:44.520 And you point out that value tends to underperform in 0:20:44.560 --> 0:20:46.679 a in a downturn in a market like like we 0:20:46.720 --> 0:20:50.679 saw this year, and then outperformed during the recovery. The 0:20:50.800 --> 0:20:53.720 question I always have with this is, you know, when 0:20:53.720 --> 0:20:55.920 you look at sort of what the cohort of value 0:20:55.920 --> 0:20:59.200 stocks is right now, Um, you know a lot of banks, 0:20:59.240 --> 0:21:03.400 a lot of energy companies, um, that would clearly benefit 0:21:03.440 --> 0:21:07.120 from higher interest rates, higher energy prices, that sort of thing. 0:21:08.040 --> 0:21:12.320 So how much of of the phenomenon is actually the factor, 0:21:12.359 --> 0:21:15.000 and how much does it depend on sort of what 0:21:15.119 --> 0:21:18.600 sectors are in that factor at any given time, or 0:21:18.640 --> 0:21:22.400 does it just so happen that cyclical stocks like that 0:21:22.440 --> 0:21:27.000 tend to be in the value factor a lot more often, 0:21:27.119 --> 0:21:30.080 especially at these sort of inflection points in the economy 0:21:30.160 --> 0:21:33.920 like this. That's a lot of questions rolled into one. Firstly, 0:21:34.760 --> 0:21:40.399 the notion that value loses during bearer markets. Actually, what 0:21:40.480 --> 0:21:44.440 our research showed is that it's a coin toss um. 0:21:44.680 --> 0:21:48.959 People buy value thinking it's going to help cushion the downside. Uh, 0:21:49.080 --> 0:21:51.920 it sometimes does, and it sometimes doesn't. If you buy 0:21:52.000 --> 0:21:56.680 furcate bear markets into those that are driven by the 0:21:56.760 --> 0:22:03.520 bursting of a bubble, value when is big big the 0:22:03.960 --> 0:22:09.800 end of the tech bubble, value stocks actually were up 0:22:10.000 --> 0:22:13.879 about thirty percent in the first two years of that 0:22:13.920 --> 0:22:20.480 bear market up, all right, that's interesting. When the nifty 0:22:20.520 --> 0:22:24.200 fifty burst in seventy three and four, value outperformed handily. 0:22:24.920 --> 0:22:30.400 When you have a macroeconomic shock where the economy itself 0:22:30.480 --> 0:22:34.960 is getting hit hard, value tends to perform as badly 0:22:35.000 --> 0:22:39.560 as the market or worse. Global financial crisis, it performed worse, 0:22:39.680 --> 0:22:43.040 not drastically worse, but worse enough. To get people's attention 0:22:43.080 --> 0:22:44.600 because they thought it was going to protect them on 0:22:44.600 --> 0:22:49.040 the downside, which it doesn't. Where value really shines is 0:22:49.080 --> 0:22:51.680 in the first two years after a bear market peters out, 0:22:51.720 --> 0:22:54.320 and it makes very little difference whether the bear market 0:22:54.480 --> 0:23:00.840 was fundamentals related or bubble related. The recovery um of 0:23:01.000 --> 0:23:05.800 value tends to beat the market as a whole by 0:23:05.920 --> 0:23:10.200 ten to twenty percentage points over the next two years, 0:23:11.400 --> 0:23:15.720 and taken together, the bear market and the recovery value 0:23:15.720 --> 0:23:20.119 on average winds by about ten percent in cases where 0:23:20.840 --> 0:23:25.960 it's it's economic dislocation and uh forty or fifty percent 0:23:26.080 --> 0:23:28.080 in times when it's bursting in bubble. What do we 0:23:28.119 --> 0:23:31.080 have now? We have kind of both, right, yeah, kind 0:23:31.080 --> 0:23:33.920 of economic driven bearer market, and the bubble has not 0:23:34.000 --> 0:23:37.800 yet burst. So if we have a second leg to 0:23:37.800 --> 0:23:39.960 the bearer market, my prediction would be that it will 0:23:40.000 --> 0:23:43.679 be a bubble bursting portion of the bearer market. I 0:23:43.800 --> 0:23:47.480 have no idea when is the right time to pivot 0:23:47.600 --> 0:23:52.160 into value. I have a very strong view that value 0:23:52.200 --> 0:23:55.680 over the next five years will beat growth handily by 0:23:55.680 --> 0:23:58.520 a wide margin. But if you want to pick the 0:23:58.600 --> 0:24:01.320 entry point, I have no clue. I would say average 0:24:01.320 --> 0:24:02.920 in over the course of the next year or two. 0:24:03.800 --> 0:24:08.000 Do not do not cut your value exposure just because 0:24:08.040 --> 0:24:10.560 it's hurt. You have laid now. The other part of 0:24:10.600 --> 0:24:14.720 your question is what about those sectors that comprise value, 0:24:15.200 --> 0:24:20.160 aren't they Let me rephrase your question and put words 0:24:20.200 --> 0:24:24.040 in your mouth. This time is different, People say this 0:24:24.119 --> 0:24:30.240 time is different lots of times and usually always things 0:24:30.280 --> 0:24:33.400 are different. Things are always a little different. Rarely are 0:24:33.400 --> 0:24:39.160 they different enough to matter this particular economic meltdown. Things 0:24:39.160 --> 0:24:42.719 are different enough that they do matter. And the question 0:24:42.880 --> 0:24:45.040 is by how much there are going to be a 0:24:45.080 --> 0:24:49.760 ton of bankruptcies. Those bankruptcies will be overwhelmingly on the 0:24:49.840 --> 0:24:53.199 value side of the spectrum. So to the extent you 0:24:53.240 --> 0:24:57.080 can invest in value and avoid value traps that are 0:24:57.080 --> 0:25:02.160 headed to zero, that is wonderful. It's a tough thing 0:25:02.200 --> 0:25:06.920 to do, but that is a wonderful aspirational goal. Then 0:25:06.960 --> 0:25:10.040 the question is how much of the value segment would 0:25:10.080 --> 0:25:13.520 have to go bust to justify that current eleven to 0:25:13.600 --> 0:25:19.000 one spread. That spread is absolutely enormous. Growth stocks eleven 0:25:19.080 --> 0:25:22.399 times as expensive as value using price to book and 0:25:22.640 --> 0:25:27.920 different ratios using earnings or sales eleven to one spread. 0:25:28.400 --> 0:25:32.199 What's the normal spread, it's about five to one. So 0:25:32.280 --> 0:25:34.200 what would it take for the eleven to one spread 0:25:34.240 --> 0:25:37.000