Episode #36: “Listener Q&A”
Guest: Episode #36 has no guest, but is co-hosted by Meb’s co-worker, Jeff Remsburg.
Date Recorded: 1/10/16
Topics: We’re back with the first Q&A episode of 2017.
We start by discussing the “Zero Budget Portfolio,” about which Meb wrote a recent blog post. The quick idea is that when considering your portfolio, you should start from scratch, or “zero.” Imagine your perfect portfolio – which markets you’d like to own, which assets, tilts, etc.
Now compare that perfect, hypothetical portfolio to your actual portfolio. To the extent that your real, owned assets have a place in your perfect portfolio, you’ll continue owning them. Any assets that don’t fit, you sell immediately.
But it’s not long before we dive into listener questions. A few you’ll hear tackled are:
- How do I decide whether I should use a robo-service or manage my portfolio myself? How likely am I to underperform a robo?
- We know that value can lag market returns, but should lead over time. What is the time horizon by which you determine whether a strategy like value is successful?
- Are there are country ETFs that you would not trade in a global, low-CAPE portfolio because of country risk?
- How has your timing model performed since you introduced it a decade ago?
- Will you discuss momentum investing versus chasing performance? It seems that a long-only momentum portfolio basically chases what has already gone up.
- Given real world tax issues, is active investing still a better strategy than buy-and-hold?
- Given that 44% of the S&P 500 revenue and profit comes from overseas, is there really a home country bias if you are invested in the S&P? And with this in mind, what is the right allocation to Emerging Markets?
As usual, there are plenty of additional rabbit holes, including options, currencies, and even the Baltic Dry Index. What’s Meb’s take on it? Find out in Episode 36.
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Transcript of Episode 36:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing, and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions, and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Sponsor: Today’s podcast is sponsored by Global Financial Data. We’ve been using data series from GFD for almost 10 years, ever since I wrote my first white paper. The data’s been vital in our research in areas such as CAPE ratio calculations and historical simulations. For almost 20 years now, Global Financial Data has been aggregating and transcribing data from original sources, with many sources no other data provider has published before. Please have a look at their website at globalfinancialdata.com for more info and to set up a trial account. If you mention that I sent you, they’re offering a 20% discount on all new business subscriptions. Again, that’s globalfinancialdata.com.
Hello, listeners! Happy New Year. We have a radio in-between-isode [SP] with Jeff Remsburg. Jeff, Happy New Year.
Jeff: Happy New Year. What’s happening?
Meb: Oh, man. It’s rain in L.A., which means it’s snowing somewhere, which is exciting for a big skier like me. Although, I haven’t put on skis yet this year. Have you been out?
Jeff: No, but Mammoth is getting dumped on, and I want to get up there. It’s supposed to have something like 20 feet in the last 10 days.
Meb: Yeah. I’m feeling a little antsy, a little itchy. How’s the new year treating you so far?
Jeff: Fair. I’m been in a pattern of getting sick, and I just have come out of a sickness. So, I’m good.
Meb: Listeners, Jeff is currently drinking some sort of paste that one of our co-workers brought in.
Jeff: It’s this sort of, honey, lemon…
Jeff: …jasmine type thing. I don’t know.
Meb: Paste, is what it looks like. You were a paste-eater as a child, weren’t you? Paste and hot water. Apparently, that makes you feel better. Anyway, good holidays?
Jeff: Yep. [inaudible 00:02:29]…
Meb: Any resolutions? So, wait [inaudible 00:02:30] say you’re back east?
Jeff: Back east with the folks.
Meb: Oh, cool.
Jeff: Yep. They’re doing well.
Meb: I was in Colorado as well, and still no skiing. Seven nieces and nephews kind of makes it…gets filled up with a lot of stuff other than free time.
Jeff: I can imagine.
Meb: But I did go to a 9 AM screening of Rogue One. Have you ever been to a movie theater, 9 in the morning?
Jeff: I have not.
Meb: It’s filled with children. But the good news is that they brought donuts. So, pre-movie, I had a Fruity Pebbles donut, which was incredible, by the way. But I can’t watch a movie in the theater without popcorn, so I ate a huge tub of popcorn. So I came out of the movie at like 10 or 11 AM feeling the worst I’ve felt in 10 years. And then, we proceeded to go to a hamburger place for lunch for the birthday party afterwards, and have hamburgers, fries, and cake. So…
Jeff: Healthy resolutions are out the window, huh?
Meb: I have been nauseous just thinking about that. Yeah, you get…do you got a resolution? What’s…
Jeff: No, I’ve never…
Meb: I’m big on resolutions.
Jeff: I’ve never been a resolution guy. Basically, it’s because my life is already just fantastic.
Meb: I don’t really have a good one this year. I was thinking right before I came in here, I said…you know, we listened to last week’s podcast, which was Jerry Parker, who… It’s such an awesome story. I mean, a lot of young people don’t know the Turtle story. And, we got a lot of responses to that one. And, for those who may want some more reading, Covel’s two trend volume [SP] books are a great place, by the way. But, I think my resolution after listening to that is every once in a while, I’ll go off the reservation. And in that episode, I talked so much, and I’m so embarrassed about it. Jerry, if you’re listening, I apologize.
So in general, my reservation…my resolution is to stop talking so much with guests and let them talk. So, I need some sort of sign, reminder, in the booth. But we did write a little bit about New Year’s resolutions recently, in one of our most unpopular – I shouldn’t say “unpopular” – least read posts. You know, it’s always funny. I’ll put something on Twitter or write a post where I think it’s incredibly profound, it’ll just be crickets. And then we’ll write some stupid Tweet or photo, and it’ll be something that everyone responds to.
So anyway, you know, end of the year, good time to reflect. You know, I was just printing out returns for various markets in 2016. I thought I’d read it for listeners, just as a little, take a step back.
You know, U.S. markets did about 12. So, great year. You know, a lot of people don’t know, but these sort of normal returns in that 0 to 10, or 0 to 15% range, which people think most returns happen, is actual a rarity. So last year is actually a rarity. It’s something like 75% of all years are either above 15% or negative. So these kind of normal, what you’d think would be the normal years, we say normal stock market returns are extreme. So last year was kind of a rarity. Small caps did even better, about 18%.
Foreign, in general, foreign development is around 5, foreign emerging around 12. A CAPE approach…so a value approach crushed it last year, almost 20%. I think it was up around 17. Bonds did nothing. You basically got your yield. [inaudible 00:05:28] in the U.S. did about a percent. Foreign bonds, depending if you hedged or not, had a pretty good year. Emerging market bonds or a value approach to bonds had a great year, up almost 10%.
Jeff: Did anything get crushed?
Meb: Yes. So there’s a couple asset classes that had a big, kind of, up and down. You know, real estate started out the year with great relative strength. Finished up, but not a lot. Commodities was kind of the big variability. So you had agriculture [inaudible 00:05:57] a negative year. But base metals had a good year. And then precious metals, same sort of thing, had a good year, and then gave a lot of it back, but still up on the year. So for almost any asset allocation should have had a good year in 2016.
You know, some of the trend following strategies depended on what they do. You know, a lot of our trend following strategies had a great year. But a lot of them managed future style, had a tougher year. But there’s a huge disparity. So if you look at the managed futures funds, you know, I would say the center is somewhere around zero. But there’s funds that printed minus 15, and there’s some that did plus 15. So depending on the style of the system, markets traded, you know, pretty wide variability in the returns.
But in general, 2016 was a great year for a lot of markets.
Jeff: Kind of curious. You mentioned real estate. The de facto definition of that, is that residential? I wonder, because I used to do some commercial development stuff. And, you know, they’re different markets. So what are people referring to?
Meb: I should be more clear. I meant REITS, publicly tradable REITs…
Jeff: REITs, okay.
Meb: …in the U.S. and in foreign, and foreign didn’t have as good a performance. Housing, you know, is something we don’t talk about as much, because it’s not that tradable. But the Shiller indexes certainly follow housing, and housing has had a great rebound since the crisis. And I don’t know what the Shiller numbers did last year, but if L.A. is any indication, they probably had just a great year.
Jeff: Think the guys at PeerStreet would take offense to you saying it’s not very tradable.
Meb: Yeah. Right. Well, it’s not…theirs isn’t that tradable. It’s investable, but not tradable. But, so we wrote a piece that, I think is really useful for investors, particularly this time of year, called “The Zero Budget Portfolio,” and it started from the standpoint of, you know the 3G guys down in Brazil, right?
Meb: You know who they are? They were the guys that partnered with Buffet on a lot of leverage buyouts, essentially. Who’d they do? They did Heinz…
Jeff: Yep. Heinz, and then…
Meb: Couple others.
Jeff: …did InBev.
Meb: Yep, that was a big one. But so these guys have something called “zero budgeting review,” or something? What’s it called? Something “zero budget…”
Jeff: Zero-based budgeting.
Meb: Okay. And then the concept there is that, when they take over a company, or look to improve the operations, a lot of people say, “Look…” You know, they’ll look at your business, and here’s a way to think about it, as personal finances. So think about your own personal finances. You know, a lot of people will look at their credit card statement, or look at their own personal finances, and be like, “All right, what can I cut out?” Or you’ll go in your closet, “What can I get rid of?” And that’s a totally different mindset than if you’re starting from zero.
If you went into your closet that was empty, you would say, “Okay, what would I add?” Or same thing. if you’re starting a personal finance, you say, “All right, I’m cleaning out all these recurring expenses, I’m getting rid of everything. What would I start with? Would I sign up for DIRECTV today for $3,000 a year? Would I add Netflix?” Whatever they may be.
And so we wrote this article. We said, “All right, two applications. One is personal finance…” And so, I actually do this. And so I often will cancel some of my credit cards at year end, and…because a lot of them have accrued a lot of these reoccurring charges that I forget about or don’t use. And it’s a good way of kind of resetting. And you can kind of start over. The problem with that, that I just went through, is I was out of town, and I cancelled one of my credit cards, and came home to my internet service not working. And my wife had been emailing me and texting me, saying, “Meb, I can’t get the internet service to work.” And we have a love/hate relationship with technology, her, in particular, and I said, “You know, Jackie, just unplug and replug.” Like, don’t…stop bothering me about this right now. And I get home to like nine letters from Frontier being like, you know, “You’re not paying your bills. We’re cutting off your service.”
Jeff: “We’re shutting you down.”
Meb: Because I switched cards. So there’s a little downside. You have to pay attention to the ones you care about. And they’re like, “Oh, no, we have send someone out, and it’s going to take two weeks.” I said, “How can you not just flip it back on in this day and age?” They’re like, “No, someone has to come to your house.” Anyway.
But I think it’s a really useful exercise for both personal finance, but I think it’s also a really useful exercise for your portfolio. And this is what we talked about in the paper, and we said, “All right…” And listeners, you should do this, this should be your New Year’s resolution. You should go home. If you already are home, take out a white piece of paper, and say, “What is my ideal portfolio?” And write it down. If I had to start today, if someone sold all my investments December 31st, and I had to start today, what would my ideal portfolio be? You can call it your Policy Portfolio, which is what endowments and institutions call their strategy, and then how would I update it?
And so, something for me, for example, is, you know, I use a Trinity Portfolio. I’m around to number three and a half, four. It’s automated. Everything kind of whirs in the background. And then, for a smaller portion of my portfolio, very small, I play around with some private investments. And the vast majority of my net worth is determined by the companies I’m invested in. That’s very simple to write down.
But a lot of people…and I can’t tell you how many investors come into the office – and you’ve seen this – will…they’ll say, “Hey, Meb. Let’s talk about your services.” Or “Here’s my current portfolio,” or they’ll email it to me. And it is the biggest mess.
We had one come in. He emailed me. He must have had 2 or 300 positions. And, you know, it was with one of the big investment management shops, where it was all these different mutual funds, and then different bonds, and individual stocks, and I’m like, “I don’t even know what you own. Do you?” And he’s like, “Well, not…” He’s like, “Well [inaudible 00:11:23].” And then I’m like, “But percentages, like what’s [inaudible 00:11:24].” It’s just a total mess.
And often, this is what our buddy Josh Brown calls “mutual fund salad,” you’ll get like 20 mutual funds. And they’re expensive. And so there’ll be like a percent a half across all these terrible mutual funds, because something’s…that somebody bought, forgot about, left in the portfolio.
But it’s so weird to see the psychology of people, because they’ve grown attached…not attached, but they have this kind of baggage. And so instead of just selling everything and starting new, they think, “Well, maybe I’ll trim this weird mid-cap fund. And maybe I’ll do this and that.” And my comment to most of these people is, mentally and psychologically, you’d be better off just cleaning house.
Meb: And starting over.
Jeff: And I was thinking about it, we didn’t really mention this as much in the paper, but a point I thought about afterward is when doing that, it has this inadvertent requirement that you reconsider your goal. Because you can’t really determine if an investment is worth buying right now if you don’t think about where you want to go. So a lot of people potentially have something from two or three years ago, which might have made sense back then, but your net worth has changed, or maybe you don’t need as much cash flow now, and so it would have made sense back then, and you just sort of don’t think about it and leave it in. But if you’re starting from scratch right now, your goal might be different, or you might be closer to your goal and not need it anymore.
Meb: Yeah. And, you know, a lot of people listen to this and be like, “That’s a great idea,” and they’ll go home and never do it. But I think actually going through the exercise, it’s kind of like going through a weight-loss program. Like, writing it down…and I think it’s actually important to share it with someone. Say, your wife, your son, your neighbor, someone else. Because it makes you a little more accountable.
Meb: And say, “Look, this is my plan.” Or with your adviser. Whatever it may be, share it with someone, and say, “Look, this is what I’m going to do.” Otherwise, the way most people kind of build portfolios is just…it’s like a shoot-from-the-hip, whenever it comes up, it comes up. And then don’t do anything until some sort of crisis occurs.
Meb: But New Year’s is a particularly good time to clean house. You know, be able to reflect as well.
Jeff: I like it. I thought it was a good piece.
Meb: Anyway. We got some Q and A’s.
Meb: Readers, by the way, keep sending in some feedback in the mebfabershow.com. We’ve had some great reviews. We actually read them, so we really appreciate your iTunes reviews. I saw the most recent one someone left. Said, “Meb” – paraphrase – but, “Meb, been loving the podcast. Randomly started on Episode XYZ, and it was where you talked about the unclaimed property website, and I found $456.” So, congratulations. Send us a bottle of tequila. Jeff will happily share it with me.
So readers, if you remember that, we used to talk about unclaimed.org as a way to see if you have unclaimed property with any of the states across the country. So if you find any big amounts, send us an email. Also, send us some questions. We love to read them. So fire away.
Jeff: Yep. We got some great ones this week. Let’s just dive in. So number one. “I am trying to figure out how does one decide whether his or her retirement accounts should be managed by him or her, or instead outsourced to a robo-advisory. And if one decides that a robo-adviser is the right answer, how does one determine which one is most appropriate? I mean, we are all different. Some are very wealthy and young, others have little savings and are getting ready to retire. What I struggle with, as a retail investor, is to answer a seemingly basic question. Does a robo-adviser justify its fee in today’s market, as well as a long-term strategy? Or perhaps, the question really is a reverse thereof, how likely am I to consistently underperform a robo-adviser by at least the fee that the service charges?”
Meb: My lord, that was a…
Jeff: It’s a lot.
Meb: …question essay. You know, there’s a lot in there. But first, it’s…your investing style should be what you’re comfortable with. For the people who are looking for a robo-adviser, or any investing service, a great idea is just to try it out. You know, let’s say you got a million-dollar portfolio. Say, open an account for 50 grand, or whatever, and see what it feels like.
Now, I’ve gone through this with my own money, and we’ve talked about this before, is that, I can’t fathom why anyone would every go back. You know, and I tend to be on the younger generation, used to technology, but the ability for something to be low cost, automated, in the background so you don’t have to worry about it, it’s this kind of enlightening freedom moment, where you’re like, “I don’t have to worry about my portfolio. It’s just going to whir in the background.”
So, for me, it’s been a wonderful…you know, and we have our service, the Cambria Digital Advisor. It’s been opening up about 50 accounts per month. You know, and a lot of people seem to love it.
Now, so there’s a big landscape, of course, when you say robo-adviser. So first, almost all of them are, let’s call it, 30 basis points and less. So Vanguard’s the biggest. It charges you about 30 basis points, put you in Vanguard’s funds. Schwab is second biggest, and now Schwab actually has two, kind of, offerings. One is, it’s technically quote-free. Well, it’s not really free. And then, they now are saying, “Hey, Vanguard was really successful. Let’s also offer a adviser.” So now they’re offering an adviser version for about 28 basis points. So they came in two basis points, of course, below Vanguard, and put you in a bunch of Schwab funds. Both those are perfectly fine. And then, of course, Wealthfront, Betterment, any of these others that do the buy and hold. Like, that’s a perfectly fine allocation. It’s low cost, most of them don’t charge you any commissions.
And by the way, listeners…I keep wanting to say “readers,” because I’ve been saying that for 10 years on the blog: readers. Listeners, commissions…everyone focuses on management fees, but there’s other embedded costs. Commissions, if you go look at traditional brokerages, many of those still charge 10, 20, $50 a trade. And most people just don’t look at that. But those trades, if you have, say, a $500,000 portfolio or less, actually are more important than the management fee, or they can be. If you have a portfolio of 10 ETFs and you re-balance once a year, $100,000 account, even at 10 bucks is like 20 to 50 [inaudible 00:17:14]. So, a lot of people don’t know that, because they look at a trade, they’re like, “Oh, $8. Cost of a coffee. Whatever.”
Jeff: Yeah, I was shocked when I first heard that, because I’m so used to like a Scottrade trade being $7.95, or something like that.
Meb: Yeah. And a lot of them charge even more. Aand there’s free services like Robinhood. But the whole key is, is it something you’re comfortable with? You like it? And is it going to prevent you from doing dumb stuff when it hits the fan? You know, like, a lot of these robo-advisers, they’re all buy and hold, and that’s fine. You know, we do it totally different with trend following, but the biggest risk with the buy and hold portfolios’ drawdowns – and, you know, 2008, many of those had 50% drawdowns – if you don’t have the adviser in between, I think it will be problematic at some point. I think it would be hard for people.
Jeff: Got to have your finger on the nuke button, in a sense, you know?
Meb: Well, so look back. Look back a year ago, we wrote an article called, “C’mon Bounce,” and it looked at the Sentiment. And Sentiment, when it gets to extremes, is always like, the best contrary indicator. And the stock market had the worst start at the beginning of the year ever, in January and February last year. It just puked, right? And so, at the end of January, we wrote this article, where the Bear Sentiment on AAII – which goes back to 1980s – was one of the 10 worst readings ever. Or it might have been [inaudible 00:18:23], but whatever. One of the lowest readings ever.
And we ran a study and said, “Okay, when we look at those, what does future 10, 12-month returns look like?” And they were something like 14%. Which, by the way, [inaudible 00:18:34]…
Jeff: [inaudible 00:18:34].
Meb: …have in stocks. We had…so, we actually said, “Hey, it’s probably a great time to buy.”
Meb: No one wanted to buy in January, of course. And then, it’s also the flip side, where…so, right now – and we’ll update it in a week or two, when we hit the one year anniversary – the Bullish side is ticking up. In general, when in you’re in the kind of, middle zone, it doesn’t really matter. But when you do get to extremes, it can be a useful indicator.
But it coincides with a lot of other stuff, such as – and we’re getting off the rails a little bit – but, you know, we talked two years ago about coal, down five years in a row. And it printed I think at, a straight up double last year, up 100%. And then, at the end of December, we did a kind of fun follow-up. We said, all right, we’d talk about coal. This year, there’s another one called…uranium was down six years in a row. It’s already up 20% this year.
Meb: Yeah. Someone Tweeted it this morning. And I said, “My god, I wasn’t even paying any attention.” So anyway, but…
Jeff: What ETF are you tracking on that?
Meb: I think it’s a Global X one. URA.
Meb: Anyway. But it’s meant to be a fun idea, not 100% of your portfolio in uranium stocks.
Jeff: I’m already all in. Sorry.
Meb: Yeah. Well, what you need…knowing you, you need options on the uranium ETF.
Meb: Yeah, but look, I mean, the automated solution, I think, is a wonderful offering. Almost every custodian is going to have versions of it in the coming months and years. So it’s really about finding one that you’re comfortable with. And if you’re comfortable with an adviser, great.! That’s totally fine. And, in a lot of, you know, the really high net worth people – 5, 10 plus million – you know, a lot of those will implemented the automated solution within the more holistic adviser relationship, because they need a lot more hand holding on the wealth management side. But I don’t see a whole lot of people going back to sort of the subjective, you know, sort of asset management. I don’t know why you would.
So my advice is to try it out. See if you like it. And I think most people would find that it’s going to be a one-way street. I don’t think they would ever go back to the hassle. Except for the doctors and engineers listening, and I can say this because I’m an engineer, but you guys are almost always the worst investors we ever meet, because you’re incredibly smart, and you love to tinker. And almost every doctor and engineer we have is like the worst investor. Because, you know, they try to extrapolate onto a different field and say, you know, “Of course, I’m a brilliant surgeon. Therefore, I should be able to dominate the investing space.” And usually, the hubris just destroys them. But it’s probably a particularly great thing for that profession.
Jeff: All right. Moving on. “In a future Listener Q and A, would you please tackle the topic of momentum investing versus chasing performance, which many investment researchers state is a loser’s game? The academic momentum thesis bought top performing assets and sold short poor performing. It just seems that a long, only momentum portfolio is akin to simply chasing what has already gone up. Your thoughts and insights would be appreciated.”
Meb: So, momentum just means following what’s going up, getting out of what’s going down on relative basis. But the beauty of a momentum is that it has objective rules. So, whether it’s each month, each quarter, you’re buying and selling, and there’s an exit. The problem with most people, with performance chasing, is they’ll look at something after it’s had a great run, invest, and then their exit is when it does really poorly. So they’ll wait for…chase something, and you can look at dollar versus time-weighted returns. You can look at a lot of the hot fund managers and subsequent returns and look at the flows, and it almost always correlates very highly. Same thing with asset classes, industry, strategies, everything.
The momentum is you have a buy and sell, rules-based system, or trend following. Same sort of…they’re cousins. Whereas, the performance chasing, most people don’t. They’ll buy it after a great run, and then they don’t know when they’re going to sell. And so usually, the only time they sell is when it pukes, and it goes through a period of underperformance, and then they say, “Oh, that was stupid. Why would I…?” You know? So like, commodities over the last year, for some commodities markets people…the whole thing to me is not momentum versus performance chasing. It’s do you have a rules-based system? Otherwise, you’re going back to this, just emotional investing, which is really the problem.
Jeff: Yeah. I mean, it seems performance chasing is largely just reactionary, whereas if you’re using your system, that’s a proactive, implementable sort of strategic plan that you have decided to act on ahead of time, in a sense.
Meb: Yeah. I mean, again, it’s just…it’s rules based. So, you’re getting the…you’re taking the emotions out of it.
Jeff: Next question. “We know that a value can sometimes lag market returns, but should lead over time. My question is what is the time horizon by which you will determine whether a particular strategy, i.e., the Trinity portfolio, is successful? Said differently, with all the tilts and filters, at what time horizon do you expect to see, say, 2% outperformance that model suggests you can obtain?”
Meb: So, there’s a lot in that question. So, here’s an example. So, we’ve talked a lot about the Buffett example, where we said Buffett’s stock picks have underperformed 8 of the last 10 years, despite outperforming by 5 percentage points over the last 16. You know, that’s an example of a strategy, or an active manager, or a tilt, that, you know, goes through very long time horizons.
So if you believe in an asset class, or a strategy, etc., then you know, a decade, easily, is the time required to understand what’s going on. And, of course, there’s additional circumstances. So if you have an asset class, you say, “Look, I believe in U.S. stocks.” Totally reasonable. Expect them to return 5% real plus inflation, so high single digits historically. But there’s times like the late ’90s, where because of valuation, that strategy is going to underperform going forward, for the next decade.
There’s also structural considerations, such as, we were listening to a great podcast with Wes Gray and Michael Covel…I highly recommend it. Y’all check it out. It just came out recently, where Wes humorously talked about laying down, pooping his pants, and sucking his thumb, kind of in the same sort of category. But…
Jeff: What, as a value investor?
Meb: Yeah. But so he talked about value pain train, but there’s also structural changes. So he said DFA – Dimensional Fund Advisors – was an early adopter of value investing, and they have a great track record. But they used to always focus on price to book. And then, they’ve raised hundreds of billions of dollars putting into price to book, and it’s destroyed price to book as a value indicator. So that price to book has had horrible returns over the past couple decades. But that’s an example.
So, I mean, in general, we talk a lot about flows changing factors, and we can talk about dividends in a minute, because we did a recent article called “Dividends are the Worst,” but…so, any strategy, you have to take a step back and say, you know, “What are the reasons I believe in this asset class or a strategy?” You know, “What are the conditions that might underperform? Is this reasonable?”
So we did another article called “U-S-A” recently where we said, “Look, U.S. stocks versus foreign stocks is a coin flip historically. U.S. stocks outperform foreign stocks 50/50 in any given year. However, they can go many years in a row one way or the other. And particularly, if valuations come into play, and they get stretched, you know, the opposite can happen.” And then we said, “All right, well, let’s look at a global CAPE ratio approach,” or value approach. That only beats investing in U.S. stocks 60% of the time. You know, and most people are looking for 90, right? They want any strategy to outperform any given year.
The probably number one mistake I hear people…people will email me, call me, and they’ll be, “Hey, Meb. I’m looking up one of your funds that just launched, and it’s underperforming for three months. Why would I invest in this fund?” Or a year, or whatever the…and I’ll often say, “You know, would you rather it have outperformed a lot over the last three years?” Because, chances are, it’s going to do the opposite and mean revert at some point. You know, not every strat… So even a great value strategy only outperforms in 60% of all years.
I was actually making the argument that value foreign investing, it’s a great time for it, because it’s done so poorly versus the U.S. stock market since 2009. U.S. stock market, number one performing stock market in the world since 2009, which is astonishing. Because it’s never been, I think, the number one performing stock market on an annual basis in any given year, at least I remember back to the ’80s.
Anyway, you know, you have to take a step back and use some common sense, and then say, “Has anything changed?” Or “Is there any extenuating circumstances?” So extenuating circumstances would be something like U.S. stocks in the late ’90s, China and India in the mid-2000s, Japan in the ’80s. So you could say, “Look, I believe in these asset classes, but maybe not so much going forward right now.”
Jeff: And you’re again, referencing the valuation as that…
Meb: For stocks.
Jeff: …criteria. Yeah.
Meb: And then, second would be, is there a structural change that has changed this? Or is there a reason that this might underperform or outperform?
Jeff: What’s an example?
Meb: Dividends…you know, flows into dividend stocks, farmland over the past 15 years. You know, dividend stocks right now, if you type in any dividend ETF into Morningstar’s holdings report, they’re all more expensive than the broad market. You know, so you have to use a value approach. And, whether that’s, you know, shareholder yield with value, whether it’s something else, but incorporating a value filter, because this zero-interest rate environment, where there’s been this search for yield has transformed dividend stocks into being very expensive.
But so, though, the question also touches on something like a strategy. And so let’s call it managed futures, as [inaudible 00:28:00] trend following is one that we often talk about. You know, managed futures can also go years of underperformance, crushed in ’08. Almost any managed futures fund was up probably 10 to 50% in ’08. But since ’09 has had a somewhat of a mixed track record. Didn’t have a particularly good year last year.
But, you say, “What has changed? What is different? Have the markets fundamentally changed, that this strategy wouldn’t work?” And that applies to anything: convertible arbitrage, long/short equity, whatever. It’s a little more complicated and nuanced, I think. And if you’re a super long term investor, it doesn’t really matter. Because you say, “Look, I’m going to allocate to these four asset classes that historically have had risk premium [SP], and valuations won’t matter over the next hundred years, but they’ll matter certainly over the next 5 or 10.”
Jeff: Gotcha. Okay. All right. “Are there any country ETFs that you would not trade in a global locate [SP] portfolio because of the country risk?”
Meb: Well, it’s always funny when people talk about country risk, because for almost every example of what that country is going through, you could say the U.S. has done that at some point. Or the U.S. has had that same risk, whatever it may be. With the exception being, I would say that the smaller countries are essentially not very liquid. So if you start talking about the frontier markets, so not really foreign developed and emerging. I think foreign developed and emerging is a reasonable universe for most individuals, 45 countries.
Once you get into the frontier markets, you know, it’s just stuff that’s…there might be five stocks in the index, and they’re dominated by one stock that’s 30% of the index. So it starts to get into this really, kind of extreme, really small companies that would be pretty…I think pretty tough to allocate to or trade for a lot of liquidity reasons. But not because of risks.
Jeff: Do you ever get freaked out by a risk? I mean, for instance, it was a couple years ago – and I think I bought Russia – and I was talking with my uncle about it, who’s an investor as well, and his take was probably very similar to a lot of listeners, in that, “Well, it’s just way to sketchy over there right now. They’re bombing. They’re, you know, trying to re-annex certain territories. It’s just way too sketchy. I’m not getting in.”
Meb: Yeah. I mean, again, you could make all the same arguments that the U.S. has done at some point. Not maybe to the extent that Russia has, but, you know, U.S. has shot down commercial planes, U.S. has started wars, U.S. gets involved in geo-politics, like, all of these same things, you know. But it’s funny, Russia’s a great example, because you heard all these things a couple years ago, and Russia got to a CAPE ratio of 5.
Meb: And had a monster year last year. Great year. But it’s funny how much the tone has changed. I mean, look. I mean, you now have a very pro-Russian president coming in. It’s still really cheap. Russia could easily double or triple from here, I think. You know, or would you say, is there any “geo-political risk” that would cause me not to invest in a country? Perhaps. I don’t know what it’d be.
Jeff: I mean, in essence, the question is, “Can you ever say, ‘No, this time it’s different,’ and mean it?”
Meb: You probably could. I would have to think about it. I don’t know what the reasoning would be, but…
Jeff: Would you have gotten scared out of Greece a few years ago?
Meb: No. I mean, we…our global value fund, probably to its detriment, still owns it. But Greece…by the way, Greece…so, here’s a good…interesting comment. Because, a lot of countries since 2009…not just countries, asset classes…my favorite investing setup is when value and momentum and trend intersect. And that has not been the case since 2009. The U.S. has been outperforming everything. U.S. is probably the second or third most expensive equity market in the world. It’s not terrible, but everything else is much cheaper. But most of the foreign markets haven’t been outperforming. They haven’t had the momentum and trend.
That changed last year. So now, Brazil, Russia, a lot of these countries have been entering uptrends, and I think that’s where you get the most explosive returns. And so, Greece recently entered an uptrend. A lot of these European…Europe has really been the basket case, and Eastern Europe is even cheaper, and a lot of the PIGS – Portugal, Italy, Spain, Greece – have lagged, but they’re all entering uptrends, and that’s when you can have a lot of these explosive returns.
It was something…I forget…I Tweeted out a whole CAPE ratio Tweet storm, where I did about 12 Tweets, and we’ll add it to the show notes. But one of them was something like – and I’m going to get this probably wrong – but like half the countries in the world are still in bear markets, meaning down 20% or more. And the U.S. is at all-time highs. And so a lot of the countries in the world have that mean reversion potential. And some of them are down. There’s probably a dozen that are down 50% or more, and there’s a handful that are, you know, really…I mean, Egypt, Greece, a couple that are down even more than that.
So, there’s potential. So, for the first time in a long time, the cheap stuff is going up, which is really, I think, when you can have the really, just monster outperformance.
Jeff: As soon as we end this podcast, I’m buying Egypt and uranium.
Meb: Yeah, good. Should have bought it last month.
Jeff: How about this one? [inaudible 00:33:07]. “Do you have any data regarding just how the timing model you follow on your site has done over the past 1, 3, 5, 10 years, along with max drawdown, Sharpe, etc.? But mostly, how much has it gained or lost investors based upon whatever year period you follow?”
Meb: Man, the old timing model. You know, it’s getting ready to be 10-year anniversary of that, I think, in February or March.
Meb: We published this in the “Journal of Wealth Management.” We’ve told the story before. But when it first came out, it was Melanie Faber, a long lost relative, apparently. But, you know, we’re definitely going to do an update to the paper, for the anniversary. I imagine it’ll come out free on the SSRN. But maybe we’ll do it as a book, or something else, and expand it, and just kind of say, “Hey, what would…how did this work since publication? What would we do differently? What are our thoughts on it?”
And, we kind of, published it with three…in general, there was the base case model, which we call moderate, which was nothing more than five asset classes, 20% each – U.S. stocks, foreign stocks, bonds, REITs, commodities – and then a 10-month moving average on top of it. Super simple.
And granted, we published it kind of right before the perfect storm happened, which was 2008. And so we published it, I think, in ’07. You know, the goal of that strategy and what a lot of people kind of came to understand about trend following on a binary basis on asset classes is that it is a volatility and drawdown reducing strategy, not particularly return enhancing. A lot of people were looking for the Holy Grail, market timing indicator, but in general, what it’s meant to do is give you buy and hold-like returns – or at least, we called it equity-like returns – with bond-like volatility and drawdown.
So if you look over the last 10 years, it’s done exactly that. It’s had very similar returns as buy and hold, and with something…I think, it’s like, half the volatility in this case, which I don’t expect really, historically, or in the future, to be that low, and something like, one quarter of the drawdown. So it was roughly flat in ’08, when the market was down…when that buy and hold allocation was down 30%. But it’s only outperformed, like, 3 or 4 of the 10 years.
And so, had you started in ’06, ’07, yeah, you would…and, buying…the irony is, buy and hold hasn’t had that great a return since then. It’s like maybe 3% a year, because of that enormous crater in 2008.
Meb: Now, stocks have done better. But historically, it’s kind of a wash.
And then, we added on a lot of things. We said, “Look, here’s a lot of tweaks and tilts you can do within that model. You can do an aggressive version that combines momentum and trend, kind of what Antonacci talk about with his “Dual Momentum.” So you pick only the top third, say, of assets in the model. And we expanded to 13 asset classes. You said we could also add cash and bonds. There’s all these things you can do to tweak it to your kind of interests. But it’s done exactly what it’s supposed to do.
But the challenge that we mentioned earlier, we said, “Look, the challenge with buy and hold is the big drawdowns. The challenge with trend following is looking different.” And so years where you underperform, and the market does great, it’s really hard for a lot of people to continue that system, because they say, “Oh, man. I underperformed this year, I underperform next year. These whipsaws and foreign stocks.” Or “Man, I don’t want to get into commodities now.” And so, the behavioral aspect, the same problems buy and hold has, trend following has, but it’s just different reasons.
And so, usually by the time they throw up their hands and give up is usually about when the next big one coming is. So it’s done exactly what it’s supposed to do. And, you know, pretty basic, and nothing earth shattering, but has done a good job.
You know, a lot of the – Vanguard talks a lot about this – but a lot of the data mining publications, people will publish and everything just falls apart. Because it’s kind of a data mining idea. But this…the trend following is an idea that’s been around 120 years, easily, you know, since the time of Charles Dow. So I think it’s something that, you know, certainly, I love. I talk about trend following more than anything else on this podcast. But I think it’s a viable strategy going forward.
Jeff: But theoretically, then, if I was completely in control of my investing emotions, and did not get shaken out in a huge drawdown, does that mean there would no real value to me of picking trend following over buy and hold?
Meb: All the listeners know you, Jeff, and know that that is implausible of a hypothetical situation. You know, look, if you have the ability to blind yourself, put your investments in a lockbox, and not care about drawdowns ever, then the basic, kind of, simple trend following on that portfolio, I don’t think it’s going to matter much.
Meb: Now, you could do the aggressive version, which, I think for similar volatility and still lower drawdowns, will outperform by 2 to 4 percentage points over time, I think?
Jeff: Okay, [inaudible 00:37:57].
Meb: So you could do something that’s more aggressive, and again, put it in a lockbox, have the rules set, so it works. And that strategy actually had a pretty good year last year. It wasn’t as good as buy and hold. Buy and hold probably did, on the global market portfolio, high single digits, and this was probably mid, but good for a trend following strategy, largely because of equities. But yes, on the basic binary, but I don’t know anyone that can handle a 50% loss, and just whistle along. Maybe they can.
Jeff: A lot of the systems, just in general, you know, seem to be far more defensive in nature and their orientation. Is there any sort of overlay that you’ve studied that’s purely offensive? A way to try to, you know, catch all the huge, sort of, upward volatility sometimes?
Meb: Yeah, sure. There’s lots. I mean, again, going back to the one we just talked about, the aggressive portfolio, where you’re concentrating on the top momentum names, if and only if they’re above their trend. So that’s one. Historically, momentum and that style is an outperformance strategy.
And this is actually a good – we’re probably getting too long on the tooth here today to really get into this – but I think a good topic, and it’d be fun to coral some friends and ask them this questions is, if you were looking for big returns. So you’re not looking for diversification, sleep at night, volatility reduction, low drawdown. If you wanted the big returns, how would you go about it? And I have some thoughts on this. We don’t need to go down that rabbit hole now.
But like, you could leverage up, like, managed futures, trend following, like Bill Dunn. You know, he’s this…a trend follower that’s been around for forever, and Jerry Parker talked about it last week, where a trend following strategy and a futures, kind of, concept, you can target whatever level of volatility and return you want. You want to dial that sucker up to where it’s going to target 20% plus returns? You can do that.
Meb: But you’re going to be sitting through some monster drawdowns at some point, 50%. I mean, Dunn has these, like, 50% drawdowns, like, he probably just calls it Tuesday. You know? And he has no sweat. But, you know, you could dial that down all the way to say, “Look, I’m going to target a 5% return.”
Jeff: Well, I mean, it was Jerry, I guess, who said he was down, what, 63% in one day?
Meb: Yeah. And again, that was extreme leverage and extreme positioning. Still finished up over 100% in the year.
Jeff: [inaudible 00:40:07].
Meb: But that’s the same thing. There’s a lot interesting concepts. If you said, “Look, I’m going to go for as big a returns as possible,” I mean, one idea is option writing, you know?
Meb: All these funds have these Sharpe ratios of 2, and eventually, they’re going to blow up. And that’s kind of a fun game theory, that – there’s a couple of odd guests that I’d like to have on and talk about that – per se, at what percent return would you have to accept for a strategy that was going to go to zero every five years? And you can’t predict when…it’s random in those five years.
Meb: Or 10 years. Whatever you want to…and that’s option writing. And we used to write about it a ton on the blog, because I said, “These things are a disaster waiting to happen.” And then they all blow up and disappear. And then, some new ones start, and they all write options and make a percent every month, or whatever it may be, and then they all blow up and lose a bunch of money.
You know, there’s actually a way you could do it where you bias the option writing away from the trend. So, you’re…[inaudible 00:41:04] it’s a up market, and you’re selling two puts versus one call. We actually used to do a bunch of research, and that’s a very viable strategy. And, I don’t know if anyone’s doing that. A few years ago we looked up…there’s a couple of these managed futures databases, and there was a few funds doing it. IASG is one of these managed futures databases. And it seems like a reasonable approach. But I don’t know.
Jeff: Sounds expensive.
Meb: What do you mean? Like, the fees? Or just what?
Jeff: Well, as you say, you’re selling premium? Or how…what’s the actual strategy exactly?
Jeff: You’re selling…okay.
Meb: Yeah. So, but anyway, it’s a…and you’re selling straddles, or strangles. But the way to do it, in my mind, was you would do it across 10 or 20 markets. So you get this…it’s basically the same thing as…well, I mean, technically, it’s a short volatility. But if you bias in the direction of the trend, you’re getting this long vol tilt. Anyway, I don’t even know why we’re talking about it. There’s no one…
Jeff: Rabbit hole. All right, all right.
Meb: …on the…everyone has fallen asleep and is…
Jeff: All right, moving on. Let’s get back to something legit here. All right. “Given real world tax issues, is active investing, e.g. via trend following, still a better strategy? Or is it better just to buy the S&P index and hold it forever?”
Meb: You can’t say stuff like “e.g.” because doesn’t that mean “environmental and governance?” Yeah, it’s ESG, social and governance. You lost me on the question. What was it? Something versus the S&P?
Jeff: When you factor in tax, is active investing still worth it, or should you just go buy and hold?
Meb: Well, as you know with ETFs, it doesn’t matter if you’re active or passive. Most ETFs can kind of, avoid passing on capital gains. So it doesn’t matter if you have capital gains until you sell the position. So, a lot of these active strategies, you can wrap in an ETF wrapper, and kind of defer the capital gain, so it’s a much more tax efficient wrapper.
Jeff: Yeah. I would assume they’re probably thinking about if they’re going to try to implement the handful of positions themselves.
Meb: Yeah. I mean, doing it on your own’s a headache anyway. Like, again, I don’t know why you’d want to do it on your own. But, you know, thinking about taxes is hugely important. You know, so we actually did this recent post called “Dividend Stocks are the Worst” that…you know, I know all the listeners love dividend stocks. And, dividend stocks have outperformed, and we had our buddies Wes and Jack over at Alpha Architects run this study.
We said, “In 1974…” And we had Ned Davis run it originally, and then Wes and Jack take it back to the ’70s. And said, “All right, compare a portfolio of the top 2,000 stocks, market cap weighted, to top 2,000 stocks, equal weighted, and then, a dividend index, etc., etc.” And so dividends outperform by about a percent a year over the equal weight, and then about…I mean, 3% over the market cap weight. So, right? Ra, ra, dividend stocks win. Everyone loves them.
But on an after-tax basis, and this is either at the low historical tax rate or at a high historical dividend tax rate – we modeled both – dividend stocks underperformed the markets. So, if you’re a dividend investor, you should only invest in high dividend stocks in a tax exempt account. Otherwise, you’re better off in the S&P.
However, you know, and we wrote about this a couple times in the past year, we said, “Dividend stocks are actually just a poor representation of value.” They give you kind of a value tilt, but not a very good one. They give you junky companies, etc., etc. So we said, “Well, what if you just did a value index, and then a value composite?” So I used five traditional value metrics, very famous ones – price earnings, price sales, yada yada – and then, you excluded, say, the top quarter or a third of high dividend yielders. Well, it turns out, that…
Jeff: Oh, the assumption is because that means they’re just crappy companies?
Meb: No, it means because they’re really tax efficient. Because if you’re paying taxes on dividends every quarter, you’re paying them now. So, theoretically, if you had a fund that has a 5% dividend yield, you’re paying dividend taxes on those taxes each quarter when dividends are distributed. If you have the exact same fund, and it has the exact same performance, but isn’t distributing any dividend yield, theoretically, you have a huge advantage to that fund.
So our whole thesis was, “Can we replicate the outperformance of dividend stocks, so that 1% to 3% per year, by using a value strategy that avoids dividend stocks, or at least the really high yielders. Because remember, dividend stocks don’t outperform after tax. And it turns out you can.
And so if you eliminate, say, the top third of dividend yielders, use a value strategy, you not only keep even pre-tax, in a tax-exempt account, you actually outperform. But even if you just kept up…let’s say you just kept up by eliminating a lot of the dividend distributions, you save anywhere – and this depends on the historical numbers on tax – it’s, like, 50 to 400 basis points per year. So for an investor, that 0.5% to 4 percentage points per year outperformance. And in some…that high range, of course, is…with a lot of dividends, you see a tax way higher.
But if you set it today’s rates, I mean, it’s something like, 50 to maybe 200 basis points is a reasonable estimate, that is an enormous amount. So almost everyone should prefer a fund or a strategy that invests with a tilt towards value that avoids high yielders.
Jeff: What are your thoughts on, you know, the strategy some people suggest, where…one pushback would say, “Well, you know, I want cash flow.” And so, the strategy is, well, create your own dividend, in a sense. You know, have the investment, get the capital gains, and then sell off a very small portion of the actual underlying. Then, in a sense, create your own dividend, and have a better tax treatment…
Meb: Yeah. Or just invest 95%, and…or 90%, first couple years, you can just peel it off. I mean…
Meb: But people have gravitated towards this concept of, they think they’re getting checks in the mail, as if like, they’re working at a job, or something. And once they realize that, in reality, that’s a really…I mean, look, Berkshire doesn’t pay out dividends, and Buffett’s the smartest investor on the planet. I think he once famously said…they paid a dividend, and it was like, very early days, he’s like, “I must have been in the bathroom when they decided to pay the dividend.” Because he knows that it’s a very…
Jeff: It’s inefficient.
Meb: …inefficient way to distribute cash. And so some companies do buybacks, of course. But, I mean…so we’ve written about this. I can’t find much in the academic literature that talks about this. So, investors, by the way, if you’ve read anything, any white papers, any research on this, please send it over and we’ll talk about it and incorporate it.
But I think it’s a fascinating area, to where you say, “Huh. Okay. Well, actually, we don’t want high dividend yielders, particularly now, because they’re so expensive.” So it’s a particularly terrible time to be investing in these companies. But we’re going to…you know, “Huh. We’re going to have a value approach. We’re going to avoid the high yielders. And as long as we even keep up, outperformance is gravy. As long as we keep up with the S&P or the dividend index, we’re going to outperform those by probably a percent or two per year, because we’re not paying the taxes on dividends as they come.”
Jeff: It’s just so against people’s orientation, though. To be able to hold that check in your hand, or see it deposited in your brokerage account, I mean, that’s such a, sort of, you know, stimulation in a sense. It’s hard to sort of let go of that.
Meb: Well, it’s the same thing with buybacks. You can talk to people…so, obviously, we love a shareholder yield approach as well, which correlates very highly with free cash flow, which has been one of the best value metrics there is. And it’s also had a great run for the past, you know, number of years, after we published our book, as well.
But people said…they have the same dissonance when they’re talking about buybacks. You know, buybacks is the exact same thing as a dividend, if the company’s trading intrinsic value and ignoring taxes. So it’s even more efficient, but people, for whatever reason, don’t like buybacks nearly as much as they like dividends. Whatever reason.
Jeff: Well, the reason is because the return is camouflaged. You don’t see it as easily. You know?
Meb: Right. Because they get a check in the mail.
Jeff: Yeah. I mean, that’s it.
Meb: So one of our good friends, who we’ll name “nameless,” said, “Meb, why don’t you just launch a fund, and call it the 5% fund, and just distribute 5% yield, or essentially, just sell off part of the portfolio every quarter so that this fund has an exact 5% yield every year?” He’s like, “People would love that. You have a guaranteed yield.” And I said, “That’s so stupid.” And he said, “However, that would probably raise $10 billion.” We could do a 10% fund, too. WisdomTree, iShares, if you’re listening and you steal this, you owe me a dividend check for the idea.
Jeff: All right. “Given that 44% of the S&P 500 revenue and profit comes from overseas, is there really a home country bias if you are invested in the S&P 500? In fact, taking this into account, what is the right allocation to emerging markets and international developed markets? It seems like it could be easy to over allocate to foreign businesses if you don’t take into account that U.S. companies have a significant amount of their business overseas?”
Meb: We get this question a lot, and the simple answer is, “Don’t you think foreign companies have exposure to the U.S.?” So, they don’t publish the numbers, but the largest economy in the world, I would guess they probably have well over half of their sales to the U.S. So in a world of Koh Ming Ling [SP] and globalization…in this world of globalization, it’s even more of an argument if everything’s correlated and cross pollinated to find the companies and stocks that are cheapest. So now, why not have a “just go anywhere” method, instead of focusing just on any particular country?
You know, there’s also an…so, obviously, we like the global value approach with CAPE, right? So, that’s…one solution to that is forget the global market portfolio, where the U.S. is now over half. It’s almost 54, 55% of the world, because it’s been going up. And if you look at the bucket…so, last year, CAPE for example had an awesome year. The cheapest countries, high teens. Expensive countries, I think were low single digits, if not negative. So 7 of the 10 countries in the cheap bucket had positive returns. Seven of the 10 countries in the expensive bucket had negative returns. The outlier on the expensive bucket, obviously the U.S., U.S. had a good year, 12% last year. At some point, that’ll change. Anyway, so that’s one argument.
As an interesting aside, there’s a lot of fun companies and indexers that’ll do indices now where it’s…location is kind of meaningless, other than currencies. But like, let’s say you had a Canadian company that actually did 100% of their revenues in Mexico, for whatever reason. Is that a Canadian company? Is that a Mexican-exposed company? You know, it’s more of a philosophical question. And once you do diversification, it doesn’t matter, of course. But, if you were looking for, say, pure exposure to Mexico, or to Spain, you know, the domicile is less relevant. But again, in a global world, why not just look for the cheapest?
Jeff: Well, then there’s also the currency issue to factor.
Meb: Yep. Yep. What do you think about us writing that currency book? Should we do it? I mean, it’s…
Meb: You may not be much help. Do you have a decent currency understanding?
Jeff: I can get by.
Meb: Most people….my favorite quote is, “Currencies aren’t difficult. They’re just confusing.” But we get so many questions on currencies that I think it would be useful, but I don’t…I don’t know what people…like I say, it’s not going to impact people’s portfolios and what they do.
Jeff: I remember writing…
Meb: Other than their travel, maybe.
Jeff: Back in my former life, writing an article about, basically, the strong dollar and its impact on, basically, trade with…or companies that have a lot of commercial products, your Targets of the world, your Walmarts, and, you know, if they’re doing a lot of business with, say, China, what’s the implication of the…
Meb: China. I love listening to Trump say “China.”
Jeff: You know, what are the implications of the strong dollar? And people had a hard time wrapping their mind around how those changes and rates really affect [inaudible 00:52:56]…
Meb: It is confusing, and it’s hard. It’s probably the most mind numbing area of finance. “Triumph of the Optimists” has a great intro on currencies that most people probably need to read three or four times. But if you want a good currency primer, that’s one. We got a couple other books on my shelf that are good currency books. We’ll add to the show notes, because I can’t remember what they are offhand.
But, you know, the best way to think about currencies is where are you going to go ski this year, if you’re a U.S. investor? Because U.S. dollar is making some great bargains. Powder Highway, that’s my choice. It’s that Revelstoke, Kicking Horse, sort of eastern British Columbia.
Jeff: Sounds good.
Jeff: All right. Last one here. The question itself is about the Baltic Dry Index, but I’m going to expand it a little bit. So the question as written is, “Do you use Baltic Dry Index during investment allocation?”
Jeff: “Or do you use the index to understand current or future economic data?”
Jeff: So the broader question really is, do you use any sort of indicators in making your decisions, or are you more just a value guy, [inaudible 00:53:54] with CAPE?
Meb: We used to look at a lot of the…if listeners are familiar with Nelson Freeburg, you know, there’s a lot of these kind of, econometric concepts, where you can use a lot of these indicators. Bridgewater does a lot of it. You’d find some old Bridgewater presentations before. We used to post them on the blog before they asked us to take them down, and then also asked us to re-upload them. So, there’s been some funny articles about Dalio and…in the journal recently. It’s an interesting place.
Anyway, so there’s a lot of these indicators that are valid and useful, and we used to actually run, when I first came to Cambria, some econometric ideas. And so Nelson Freeburg, who sadly passed away a year or two ago, used to write one of my favorite newsletters called “Formula Research.” And wrote it for probably a couple decades. And I told him this, so I don’t feel so bad about it anymore, but when I was a young quant, cash-strapped, you know, he would sell the old newsletters online for, like, $50 an issue or something. And a subscription was maybe $200, $300, $400. I don’t know.
But I found some guy in Germany, who had a binder, who…he just, I guess, photocopied all of them, that said he would send them on some message board to me. So I got a huge binder of “Formula Research.” And we actually got featured in “Formula Research” later, and I told Nelson that, and he kind of chuckled a little bit.
But I actually…I had to reach out to his family. I said, “Man, you guys, it would be really a shame to lose all of the incredible research that was in a lot of these publications, because he also built Excel models for them. And a lot of them were simple, based on Marty Zweig, based on a lot of famous researchers that he then implemented and actually had great outperformance post-publication.
Jeff: Any in particular you can point toward for the listeners?
Meb: Man, there’s a lot. You know, and a lot of them had trend following inputs. A lot of them had interest rate inputs. And, you know, a lot of the signals would be, such as, “Hey, we’re going to invest in the stock market when…you know, it’s above its long term moving average and interest rates are going down.” Commercial paper. Something like that. And the results are, you know, great.
And so it inspired a lot of our original research and ideas. But there’s a lot of the other indicators. So Baltic Dry reminded me of, like, a lot of the ideas and concepts that he would use in a lot of these systems. And often…I mean, I still have a folder of a lot of these models that we recreated, and I think there’s a lot of validity. And you could build, I think, a long short econometric index based on a lot of these ideas. But, it’ll take some digging. I’ll look into that. It’s a good reminder.
Jeff: Sounds like a new ETF for us.
Meb: Good blog post. Yeah, good book. But, you know, and he based…and a lot of the original guys, you know, the Ned Davises of the world…a lot of the researchers based on kind of the first generation. So the Marty Zweig…what is the name? “Stock Market Logic” by Fosback. A lot of these old school publications will ask…we got some really fun guests coming up, we’ll ask…that are the kind of, market historians, we’ll ask them some of the ideas when they come on. But there’s a lot of these ideas that I think are totally valid that would be used.
And Ned Davis does a lot of these econometric models now. They have the Fab Five, you know, and some of these where they incorporate, like, not just five indicators, but like, 50. So it’ll be trend, monetary, sentiment, something else, valuation. And so they’ll incorporate signals from each, and when the composite says positive, you’ll invest. When it doesn’t, it’s negative, and [inaudible 00:57:22]…
Jeff: Bit curious. At what point adding on more sentiment, or more indicators, would actually be detrimental?
Meb: [inaudible 00:57:28]…you run the risk of curve fitting and data mining. Right.
Jeff: Well, sort of like, shuffling cards. Don’t they say that if you shuffle more than X many times, you’re actually reorganizing the cards?
Meb: [inaudible 00:57:37].
Jeff: And, in a sense here, it’s almost like, if you add on X many indicators, you’re deluding your potential return somehow.
Meb: By the way, listeners, hopefully some of you followed our old NFL consensus sports betting system. It had a monster year. Our office pool, which has about 20 people in it…and I wrote about this three or four years ago. I said, “Here’s the easy way to win your office pool on NFL Pick’Em, or College Pick’Em. As usual, Meb won this year, despite the fact that I tell everyone exactly what I’m doing, which is fading the consensus, which historically, by the way, listeners, against the line, wins about 55% of the time. Jeff, who came in last this year? Oh, it was you.
Jeff: Well, who beat you in the last game of the season this year? That was me!
Meb: That was meaningless. That’s meaningless. So, anyway, listeners, if you use that system, again, send us a bottle of tequila. We should have entered the Hilton SuperContest. I think it would have won this year. Anyway.
Jeff: [inaudible 00:58:32]. Next year?
Meb: But, that’s actually a consensus input. There’s actually a betting…and I used to spend some time with sports betting, building models. Because there’s some very simple models you can build that have an advantage in sports betting. The problem is that – and eventually I said, “What am I doing? These financial markets are a hundred times bigger” – a lot of these sports betting, you can come up with the edges, but again, you can’t really…you have to either live in Vegas, or you have a limited sort of fund you could have. Maybe 10 million?
Jeff: No, [inaudible 00:59:05]…let’s not go down the Rain Man rabbit hole today.
Meb: What is the name…there’s some sports betting software, let’s you back test a lot of these things. Like, if a team flew from…had a Sunday game, and they have to fly Thursday, and it’s on the West Coast, and like, the circadian rhythms, like, if they’re an East coast team, they should be in bed, and it’s a night game. Like, they lose some huge percentage of time.
Jeff: What happened to those gaming websites?
Meb: But you can go and access that. Huh?
Jeff: What happened to those gaming websites that were getting in trouble for insiders?
Meb: Well, the biggest problem…oh, DraftKings and FanDuel? I think they merged.
Meb: But, yeah. I mean, so that’s an example of not a insider trading. It’s an example of a rigged game. Meaning where someone has information that they’re applying to something else, and that it’s not a fair game. But the problem with sports betting is it’s not scalable. You get to about a $10 million fund, that’s it.
Jeff: All right. Well…
Meb: Which isn’t bad.
Jeff: Not bad. All right.
Meb: Is that it?
Jeff: That’s it for today. Take us out.
Meb: Readers, send us some new Q and A. Jeff is running low on his Q and A mailbag. So send some in. Again, leave us some reviews. If you found more than $450 on unclaimed.org, let us hear it. Thanks for taking the time to listen. We always welcome feedback, firstname.lastname@example.org. You can always find the show notes and other episodes at mebfaber.com/podcast. You can subscribe to the show on iTunes, Stitcher, Overcast, all those other apps. Castro is my new favorite, by the way. And if you’re enjoying the podcast, please leave a review. Thanks for listening, friends. And good investing.
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