The Meb Faber Show - Better Investing

In Episode 60, we welcome the great William (Bill) Bernstein.

Bill starts by giving us some background on how he evolved from medicine to finance. In short, faced with his own retirement, he knew he had to learn to invest. So he studied, which shaped own thoughts on the matter, which led to him writing investing books, which resulted in interest from the press and retail investors, which steered him into money management.

After this background info, Meb jumps in, using one of Bill's books "If You Can" as a framework. Meb chose this as it starts with a quote Meb loves: "Would you believe me if I told you that there's an investment strategy that a seven-year-old could understand, will take you fifteen minutes of work per year, outperform 90 percent of financial professionals in the long run, and make you a millionaire over time?"

The challenge is the "If" in the title. Of course, there are several hurdles to "if" which Meb uses as the backbone of the interview.

Hurdle 1: "People spend too much money." Bill gives us his thoughts on how it's very hard for a large portion of the population to save. We live in a consumerist, debt-ridden culture that makes savings challenging. Meb and Bill discuss debt, the "latte theory," and the stat about how roughly half of the population couldn't get their hands on $500 for an emergency.

Hurdle 2: "You need an adequate understanding of what finance is all about." Bill talks about the Gordon Equation, and how investors need an understanding of what they can realistically expect from stocks and bonds - in essence, you really need to understand the risks.

Hurdle 3: "Learning the basics of financial and market history." Meb asks which market our current one resembles most from the past. Bill tells us it's a bit of a blend of two periods. This leads to a good discussion on how higher returns are more likely to be coming from emerging markets than the U.S.

Hurdle 4: "Overcoming your biggest enemy - the face in the mirror." It's pretty common knowledge we're not wired to be good investors. So Meb asks the simple question why? And are there any hacks for overcoming it? Or must we all learn the hard way?

Hurdle 5: "Recognize the monsters that populate the financial industry." Basically, watch out for all the financial leeches who exist to separate you from your money. Bill tells us a great story about being on hold with a big brokerage, and the "financial porn" to which he was subjected as he waited.

There's way more in this episode: Bill's thoughts on robos... What Bill thinks about any strategy that moves away from market cap weighting (Bill thinks "smart beta" is basically "smart marketing")... How buying a home really may not be a great investment after all... Cryptocurrencies... and even Meb's "secret weapon" of investing.

All this and more in Episode 60.

Episode 59 is a radio show format. This week we're diving into some of the recent market stories which Meb has found most interesting. We also bring back some listener Q&A.

We start with a Tweet from Cliff Asness, in which he rebuffs a Bloomberg article titled, "The Death of Value Investing." The article states that value isn't working. Sticking to that approach has resulted in a cumulative loss of 15 percent over the past decade, according to a Goldman Sachs Group Inc. report. During roughly the same period, the S&P 500 Index has almost doubled."

So is value investing dead? Meb gives us his thoughts. We discuss its underperformance, mean reversion, and factor-crowding.

Next up is a New York Times article referencing a recent stance-reversal from Burt Malkiel, a passive investing legend. He's now saying he recognizes where active investing can exploit certain market inefficiencies. The same article has some great quotes from Rob Arnott on the topic of factor investing, and the danger in tons of quants all looking at the same data and trading on it. Meb gives us his thoughts on factor timing and rotation, using trend with factors, and the behavioral challenges involved in both.

Another Arnott quote steers the conversation toward backtesting - the pitfalls to avoid when backtesting, so you don't create a strategy that looks brilliant in hindsight, but is hideous going forward.

Next up are some listener questions:

There's plenty more - including our new partnership with Riskalyze, which enables advisors to allocate client assets into Trinity portfolios. But the more interesting story is how Meb gave his wife food-poisoning the other night. How'd he do it?

Find out in Episode 59.

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In Episode 58, we welcome Axel Merk from Merk Investments. After a bit on Axel's background, the guys jump in, discussing the Fed's decision to raise interest rates today (recorded on Wed 6/14/17).

Axel discusses how the Fed has announced the normalization of its balance sheet and the pace at which it would like to do so - but they've left out lots of details. He likens it to driving into a tunnel with no lights on. In essence, the Fed doesn't know where it wants to go.

Axel's response touches upon our current low volatility. Meb hones in on this, asking if the low volatility is in part due to actions from the Fed.

Axel believes this to be the case (central banks in general, not just the Fed). Yet there's plenty more, involving how central bank activity has fueled this up, up, up market, with investors piling into risk assets. But Axel thinks asset prices are likely to come down from here. He says "A lot of that (rising asset prices) has been induced by central banks. The unwinding of that is going to be, at the very least, let's put it in quotes "'interesting.'"

Meb then focuses the conversation on equities. He says how here in the U.S. they're expensive. So what does Axel see as the opportunity set in equities around the globe?

You'll need to listen for the details, but Axel likes a pairs trade, going long France and short the S&P. Of course, he is quick to say he could be wrong on both legs.

Meb segues to China, as Axel had mentioned it earlier. If you're a regular Meb Faber Show listener who heard Steve Sjuggerud and Jason Hsu's thoughts on China, you'll want to hear Axel's thoughts for a different take. He's not nearly as bullish. He concludes by saying "I happen to think that if you want to be looking at the one risk event that's out there, that's going to get people's attention, China is certainly at the very top of the list."

Since Axel is a currency guy, Meb then brings currencies into the conversation, asking how investors might think about them in a broader portfolio context.

Axel gives us a great overview of different currency markets, with additional detail on the Dollar vs Euro. Overall, he sees the Dollar toward the top of its cycle, and the Euro toward its bottom. He concludes by predicting that the Euro will be substantially stronger a year from now.

There's a great deal more in this episode: whether retail investors should be following an endowment allocation... how holding cash is not necessarily a bad investment choice... a great discussion on gold, and how it fits into a portfolio... even Axel's thoughts on cryptocurrencies and Bitcoin.

And of course, we get Axel's one piece of investment advice for listeners, as well as his most memorable trade (Hint - he bought Apple early).

Find out all the details in Episode 58.

Episode 57 is another "radio show" format, yet this one is different than our others.

In this episode, Meb discusses his 17 different "million-dollar" fintech ideas. In essence, Meb has had various business ideas over the years which he's wanted to pursue, but hasn't had the time. Some he's tweeted about, some he's blogged about, others he's kept to himself. But in Episode 57, he'll run through all 17, diving into more detail.

Can a listener take one and run with it? Sure. Let us know how it works out! Or work on it with us. We're open to ideas.

Either way, here are the 17 concepts:

Are all of these ideas good? (We have our doubts...)

But find out for yourself in Episode 57.

In Episode 56, we welcome Meb's good friend, and CEO of ETF.com, Dave Nadig. Per usual, we start with some background information. Dave tells us about his early days in the investment industry, starting a consulting firm that was working on a then-new idea: fee-only financial advising. His first client was a little shop that went on to become none other than BlackRock. After some professional twists and turns, including running money for a while, Dave ended up at ETF.com.

Meb then dives in by referencing an article Dave wrote toward the end of last year, called "Outlook for ETFs in 2017." There were several key points in the article which Meb thinks can help provide a general, 30-thousand-foot overview of the ETF space. The first point - ETF flows.

Dave tells us "this is a big year for ETFs." He then takes us through a quick recap of the evolution of ETFs, going from a purely institutional product back in its early days, to something embraced by investment advisors, to an investment vehicle for retail investors. And here we are now, somewhat full circle, with ETFs even more embraced by institutions (think endowments), only now, they're no longer held as fringe investments, but as core holdings. 

Meb asks at what point ETF assets will surpass mutual fund assets. Meb had predicted within about 10 years back in 2013. Dave tells us there will always be a demand for mutual funds - that said, he believes the cross will happen around 2025, with asset levels around $14 trillion. 

Meb asks if the evolution in the ETF space today is primarily a movement from higher fee to lower fee. David believes this is the case. Most of the new flows are going toward low-cost vanilla products. Dave thinks the whole active/passive debate misses the point - it's really about cost. This dovetails into another business/investment idea Meb has that he's offering to any listener willing to pursue it.

Next, Meb brings us back to Dave's 2017 Outlook piece, this time bringing up "ESG."(This stands for "environmental, social and governance" for anyone unaware.). Dave believes that we're near/in the greatest intergenerational wealth transfer in history. And the 40-year-olds that are inheriting, say, a $5M portfolio from their 70-80-year-old parents have different desires about what to do with that money. Dave tells us that this younger generation wants their money to do something - and this usually gets labeled ESG. So Dave believes we'll see more funds targeting this wealth transfer. 

As usual, there's plenty more in the episode: exchange traded notes... the regulatory change Dave would like to see... buying ETFs at NAV... Dave's one piece of advice offered to help listeners the most... and Dave's answer to a new question: since Dave is a big "game" lover, Meb asks which three games are his top 3 of all time.

What are they? Find out in Episode 56.

In Episode 55, we welcome Ed Easterling. Meb starts by referencing a survey he just conducted, asking readers’ opinions as to the single best investing book out there. It turns out that Ed’s book, Unexpected Returns, made the top 50 list, so Meb offers Ed a kudos.

But the guys hop into market discussions quickly. Ed tells us that the stock market is not driven by randomness. It’s predictable in the long run, driven by three components: 1) earnings growth, 2) dividend yield, and 3) the change in valuation level. Stock market returns over the short-term are unpredictable, but over the longer-term they’re highly predictable. And the key driver is the starting level valuation.

Meb brings up how numerous investors are currently expecting 10% returns (based on long-term averages). He asks Ed if that’s warranted.

It turns out, we need to distinguish between long-term returns (say, 100 years) and a return-period that’s more relevant to the average investor (say, 10 or 20 years). This is because changes in PE levels are much more significant for returns over 10-20 year periods for individual investors, more so than over 100 years.

Meb asks if Ed has a favorite PE ratio. Ed likes Shiller’s CAPE and the Crestmont PE – which is driven by GDP and EPS. Ed finds value in comparing the two. They have similar results yet have different approaches.

All the talk of valuation leads the guys into a discussion of secular versus cyclical markets. Ed offers some general context for secular versus cyclical, then says we’re definitely in a secular bear market. He offers up some great details here, factoring in valuations and the inflation rate.

Meb asks what will make the cyclical bear end? Ed says the PE has to get low enough where it can double or triple. So, starting out in the high 20s right now, the PE would need to get down to at least the mid-teens, if not the low-teens.

Soon, the conversation gravitates toward “volatility gremlins,” with Meb asking Ed to define the term and explain.

There are two volatility gremlins that compromise the compounded returns investors receive: 1) the effect of losses – Ed gives us example of the math behind wins and losses; 2) the dispersion of returns – steady returns yield the best compounding, but when returns are more dispersed, it adversely affects the compounding. Meb asks, “what then?” How does one build a portfolio knowing this? Ed answers by giving us a great analogy involving rowing and sailing.

Next, the guys touch on volatility and what will be the trigger that moves us from this mellow inflation environment. Ed says that volatility is a reflection of the movement of the markets, which also reflects investor sentiment and complacency. By one of the measures of volatility that Ed tracks, he says we’re well-into the lowest 3% or 4% of all periods since 1950. The other volatility measure is the VIX, which is settling again, back around 10. Do you know how many days since 1990 the VIX has dipped below 10? Ed tells us, and yes, we’re flirting with a sub-10 level right now.

There’s far much more in this episode: Where Ed would point a new investor starting in this environment… The biggest investing misconception Ed sees from his students… Ed’s favorite investing styles/strategies within the hedge fund space… And advice for retirees and/or income investors.

What is it? Find out in Episode 55.

In Episode 54, we welcome Elizabeth “Liz” Dunn, author of the book, “Happy Money: The Science of Happier Spending”.

Meb suggests they walk through the book using its five broad takeaways as their outline. But before they dive in, he asks Liz about her inspiration for writing the book.

Liz tells us that when she began making a “real, grown up” salary, she wasn’t entirely certain what to do with it. She was curious how to use it most effectively to promote her own happiness. Interestingly enough, there wasn’t a great deal of research on the topic.

Next, Meb asks Liz to discuss her first main finding (and likely the best-known finding) – our happiness tends to increase when we spend money on experiences rather than things. Liz gives us the key takeaways, after which Meb asks why buying experiences over things is hard for us, when we know that’s what we should do.

Meb and Liz soon move on to the second takeaway from the book: “make it a treat.” One of the greatest misunderstandings of happiness is the idea that if something makes us happy, then more of it should make us even happier. Apparently, that’s not the case. Whether we’re talking someone’s salary or a little luxury like “avocado toast” (Meb and Liz are both big fans), when we have more of it, this can erode our capacity to appreciate it.

This dovetails into the discussion of the salary “line in the sand” above which added dollars has diminishing impact on real happiness. Liz tells us that in the U.S., this figure is about $75K. But she mentions it with an interesting context…

There are two “flavors” to happiness: 1) the kind that comes when you evaluate a question like “am I living the kind of life I want to live?” and 2) the kind that comes when you ask “did I laugh or smile yesterday?”

If you’re making more money – well beyond $75K, you’re more likely to answer #1 in an affirmative way. Sure, as you jet off to Bora Bora and evaluate your life, you’re likely to feel good about having the wealth to enable such a trip. However, it turns out this added wealth has very little effect on the second type of happiness – day-to-day happiness.

The third takeaway is “buying time.” What are we actually doing with the minutes of our lives? Is there a way to trade our money for more time? Liz and Meb discuss spending an hour commuting to work every day, and how miserable that makes people. Wherever appropriate, it makes sense to spend money on things/services/people that can give us back our time, which we can then spend with loved ones or volunteering, etc.

The fourth takeaway is “pay now, consume later.” This is hardly the way our culture does things, with its credit card mentality. Unfortunately, consuming first and paying later is exactly the wrong thing for happiness. Liz and Meb discuss this in detail, dovetailing into the toxic effects of debt.

The final takeaway is “invest in other people.” Liz has found that we tend to be happier when we spend our money on other people, more so than ourselves. In supporting this takeaway, she tells us of her study in which she gave people either a $5 or $20 bill, and asked them to spend it by the end of the day – the caveat was that some people were asked to spend it on themselves, while others were asked to spend it on other people. Liz’s team followed up at the end of the day, calling the participants, and found that those who spent the money on others reported feeling happier than the people who’d spent it on themselves.   

There’s plenty more in this episode, including Liz’s next research project, discussion of Syrian refugees, what prompted a classic Meb-meltdown as a child, and finally, Meb’s pointed question to Liz: If I put you on the spot and asked you to give us one single piece of advice for achieving more happiness, what would it be?

What’s Liz’s answer? Find out in Episode 54.

Episode 53 is another “radio show” format. This means we tackle a handful of topics from Meb’s blog and tweets.

TOPIC 1 – VALUATIONS

3 DIFFERENT TAKES ON CURRENT VALUE PICTURE:

Meb’s recent blog post “A Bar Too High” indicated that for stocks to meet expectations over next 10 years, valuations must rise to highest they’ve ever been in history. With a current CAPE ratio of 29, that means the stock market multiple needs to INCREASE to all-time 1999 bubble highs to meet investor expectations. He thinks tepid growth is more realistic.

On the other hand, James Montier, member of the asset allocation team at the Boston-based asset manager GMO, is convinced that the US stock market is in bubble territory. However, European equities aren’t particularly cheap, either. Only emerging markets value-stocks appear vaguely attractive to him. Investors should be patient and hold a lot of cash in their portfolios in order to be able to buy when markets are correcting.

What would make the US equity market attractive again – how much would it have to correct? To get back to our sense of fair value tomorrow, it would have to fall by more than 50%. Then we would be on average valuation, which again we estimate based on profitability going back to normal.

A third option from a reader question: “Lately there seems to be a lot of talk about CAPE measure not being as meaningful as many seem to think that it is because the very low yields on bonds and full pricing of bonds are basically changing the overall risk adjusted returns landscape. I think the point people are making is that stocks are fairly priced for current overall market conditions, despite many indicators which suggest that prices are historically high.”

Three viewpoints – how does Meb see them all? You’ll hear his take.

TOPIC 2 – INVEST IN SINGLE STOCKS AT YOUR PERIL

A new study by finance professor Hendrik Bessembinder, called “Do Stocks Outperform Treasury Bills?” found that while investing in the overall stock market makes sense, individual stocks resemble lottery tickets: A very small percentage of winning stocks have done splendidly, but when gains and losses are tallied up over their lifetimes, most stocks haven’t earned any money at all. What’s more, 58 percent of individual stocks since 1926 have failed to outperform one-month Treasury bills over their lifetimes.

Professor Bessembinder found that a mere 4 percent of the stocks in the entire market — headed by Exxon Mobil and followed by Apple, General Electric, Microsoft and IBM — accounted for all of the net market returns from 1926 through 2015. By contrast, the most common single result for an individual stock over that period was a return of nearly negative 100 percent — almost a total loss.

Given all this, what reason is there for the average retail investor to be in specific equities instead of broader sector and index ETFs?

TOPIC 3 – VOLATILITY

We'll post a chart about our current low volatility – actual U.S. stock market volatility going to back 1928 has only been lower about 3% of trading days.

How does Meb interpret this – do these low readings mean a reversion is likely? Or is it the opposite – more of a trend approach where objects in motion tend to stay in motion?

Also, how would an investor act upon this using a tail-risk hedging strategy involving puts?

There’s plenty more and a handful of rabbit holes in this radio show episode, including investor sentiment, the name of Meb’s new child, how to avoid value traps, and yes, as the title suggests, the cheapest countries in the market today.

What are they? Find out in Episode 53.

Episode 53 is another “radio show” format. This means we tackle a handful of topics from Meb’s blog and tweets.

TOPIC 1 – VALUATIONS

3 DIFFERENT TAKES ON CURRENT VALUE PICTURE:

Meb’s recent blog post “A Bar Too High” indicated that for stocks to meet expectations over next 10 years, valuations must rise to highest they’ve ever been in history. With a current CAPE ratio of 29, that means the stock market multiple needs to INCREASE to all-time 1999 bubble highs to meet investor expectations. He thinks tepid growth is more realistic.

On the other hand, James Montier, member of the asset allocation team at the Boston-based asset manager GMO, is convinced that the US stock market is in bubble territory. However, European equities aren’t particularly cheap, either. Only emerging markets value-stocks appear vaguely attractive to him. Investors should be patient and hold a lot of cash in their portfolios in order to be able to buy when markets are correcting.

What would make the US equity market attractive again – how much would it have to correct? To get back to our sense of fair value tomorrow, it would have to fall by more than 50%. Then we would be on average valuation, which again we estimate based on profitability going back to normal.

A third option from a reader question: “Lately there seems to be a lot of talk about CAPE measure not being as meaningful as many seem to think that it is because the very low yields on bonds and full pricing of bonds are basically changing the overall risk adjusted returns landscape. I think the point people are making is that stocks are fairly priced for current overall market conditions, despite many indicators which suggest that prices are historically high.”

Three viewpoints – how does Meb see them all? You’ll hear his take.

TOPIC 2 – INVEST IN SINGLE STOCKS AT YOUR PERIL

A new study by finance professor Hendrik Bessembinder, called “Do Stocks Outperform Treasury Bills?” found that while investing in the overall stock market makes sense, individual stocks resemble lottery tickets: A very small percentage of winning stocks have done splendidly, but when gains and losses are tallied up over their lifetimes, most stocks haven’t earned any money at all. What’s more, 58 percent of individual stocks since 1926 have failed to outperform one-month Treasury bills over their lifetimes.

Professor Bessembinder found that a mere 4 percent of the stocks in the entire market — headed by Exxon Mobil and followed by Apple, General Electric, Microsoft and IBM — accounted for all of the net market returns from 1926 through 2015. By contrast, the most common single result for an individual stock over that period was a return of nearly negative 100 percent — almost a total loss.

Given all this, what reason is there for the average retail investor to be in specific equities instead of broader sector and index ETFs?

TOPIC 3 – VOLATILITY

We'll post a chart about our current low volatility – actual U.S. stock market volatility going to back 1928 has only been lower about 3% of trading days.

How does Meb interpret this – do these low readings mean a reversion is likely? Or is it the opposite – more of a trend approach where objects in motion tend to stay in motion?

Also, how would an investor act upon this using a tail-risk hedging strategy involving puts?

There’s plenty more and a handful of rabbit holes in this radio show episode, including investor sentiment, the name of Meb’s new child, how to avoid value traps, and yes, as the title suggests, the cheapest countries in the market today.

What are they? Find out in Episode 53.

In Episode 52, we welcome Jason Hsu, joining us all the way from Taipei. We start with a bit of background on Jason and his company, Rayliant, which is a spinoff off Research Affiliates. Listeners might recognize the name Research Affiliates, as it was co-founded with another Meb Faber Show guest, Rob Arnott. Rob and Jason decided to spin off Rayliant to enable Jason to focus on his investing passion, China.

As the conversation naturally led to China, Meb decides to run with it. He brings up how a prior Meb Faber Show guest (Steve Sjuggerud) is incredibly bullish on China. Meb asks Jason for a “boots on the ground” perspective. Does Jason agree with Steve’s bullishness?

In short, absolutely. Jason has two hypotheses as he evaluates China: One, as China continues moving toward, and eventually becomes, the world’s largest economy, investors will realize they’re underexposed to this market. Given this, there will be major rebalancing into Chinese equities; Two, Jason tells us that approximately 80-90% of Chinese daily trade flow comes from retail investors (here in the U.S. this percentage is significantly lower). This means more market inefficiencies, so the probability for “alpha” for managers is greater. Both these factors make China a market that should be on investors’ radars.

The China discussion dovetails into investor sentiment on China, and how emotionally-driven we are, which typically ends in underperformance. This leads Meb to ask pointedly, why are people so bad at investing?

Jason gives us his thoughts, which tend to reduce to “flow chases short-term performance.” He goes on to say how oftentimes, investors get crushed as they buy in at the peak of a style or asset class cycle.

Meb asks how investors should combat this. Jason has a classic response: “Whatever you think is a good idea… do the opposite and you’re going to be more successful.” The reason this tends to work is because “This is a market where the average human tendencies are precisely the wrong thing to do.”

This prompts Meb to bring up a study idea he wants a listener to undertake for him regarding historical news headlines and investor sentiment. Listen for the details. Anyone up for the project?

The guys stay on the topic of behavioral challenges, with Meb pointing toward one of Jason’s papers about how investors prefer complexity to simplicity. It’s a fascinating look into our wiring as humans and why investing is such a challenge for us.

Next, the guys move on to smart beta and factor investing. Meb asks Jason to provide an overview, and any main takeaways for investors implementing smart beta strategies.

Jason gives us his thoughts, including revealing his personal favorite factor: value. This leads the guys into a discussion of Warren Buffett and his true alpha being his ability to stick to his style and not abandon it at precisely the wrong time, as most of us do. The guys then discuss manager performance and underperformance, and the tendency to always be chasing.

There’s far more in this episode: Meb’s “forever fund” idea (which most people he’s discussed it with actually hate)… Why hedge fund lockups and opaqueness can actually be a good thing… The unique “values” which Jason created for Rayliant, and how they’re so different than those of most other money managers… Jason’s most memorable trade… And lastly, his final takeaway for listeners looking for better market performance.

What is it? Find out in Episode 52.