Episode #493: Michael Batnick & Ben Carlson – What’s Your Favorite Diversifier? PLUS: Future Proof!
Guests: Michael Batnick, CFA. Michael Batnick is the Director of Research at Ritholtz Wealth Management. Ben Carlson is the Director of Institutional Asset Management at Ritholtz Wealth Management.
Date Recorded: 8/2/2023 | Run-Time: 48:44
Summary: In today’s episode, Michael & Ben give us a preview of the Future Proof Festival in September, which I was at last year and will be going once again. Then we talk about a bunch of topics, including asset allocation given the world today, the behavioral aspect of investing, the best diversifier to the average portfolio, and more.
Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
1:10 – Welcome back to our guests, Michael Batnick & Ben Carlson; Episode #435: Radio Show with Michael Batnick & Ben Carlson
4:25 – Future Proof 2023
7:36 – Expected returns
9:49 – Higher bond yields ease stock market expectations for a healthy 60/40 portfolio return; Jim O’Shaughnessy Post
13:09 – Twitter Chart: what would you use to diversify your portfolio
19:11 – Products aim for advisor fit, not investor fit
28:34 – Patience and dedication are key for optimizing portfolios with trend-following
35:55 – Trend-following benefits from diverse markets and human emotions
43:01 – Dividends alone are a poor strategy, need to incorporate buybacks and valuation
Learn more about Michael and Ben: Animal Spirits Podcast; Future Proof
Transcript:
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.
Meb:
Welcome, welcome everybody. We got a fun episode today. Our returning guests are Michael Batnick and Ben Carlson of Ritholtz Wealth Management and host of the awesome Animal Spirits podcast. Today’s episode, Michael and Ben give us a preview of the Future-Proof Festival in September, which our team was at last year and we’ll be attending once again. Then we talk about a bunch of investing topics including what is the single best diversifier to the average portfolio today. Please enjoy this episode with Michael Batnick and Ben Carlson. Ben and maybe Batnick welcome back to the show.
Ben:
Glad to be here.
Michael:
What’s up, Meb?
Meb:
I had the pleasure of getting to hang out with Batnick recently in Manhattan Beach. Batnick, what was your review? What’d you think of our little beach town?
Michael:
I saw the Cambria headquarters on the way out. I said, “Oh, shit.”
Meb:
Thanks for stopping in. So you’re too busy having beers on the beach, taking naps while we’re there.
Michael:
It’s miraculous. It’s almost like too spectacular. I don’t know how you live there. I don’t even know what I’m saying. It’s magnificent. What I was saying is, I don’t know how you live there. Does that wear off or do you wake up every day and you’re like, “Holy shit, I’m in paradise.” That’s got to wear off, right, a little bit?
Meb:
I like being at the beach. It hasn’t yet, 15 years in. But you guys are coming back. We’re excited to see everybody coming up here in September at Future Proof. I’m a little surprised, to be honest, I got invited back given some of my antics last year with the airplane. But give us an update. What’s going on?
Michael:
Are you doing a B42 this year or did we say no more airplanes?
Meb:
I’ll tell you what I actually tried to do. So listeners, it turns out those spring break airplanes, where you see the giant Bud Light signs in Panama City or something, are not that expensive to rent. And so if you didn’t attend Future-Proof last year, that would be great-
Ben:
How long did you pay? For an hourly thing or what?
Meb:
We had a couple hours, but we did a couple things. First of all, we had a Monday night football to watch the Broncos get pummeled and then we did a surf lesson for… It was like 50 financial advisors showed up and I had quite a bit of regret as soon as I watched them all just run into the ocean. We had a couple young hot surf instructors, guys and girls, that were like 20 teaching everyone how to surf. And all these financial advisors from the Midwest that are middle age that have never surfed and it was a pretty decent sized day at Huntington Beach. And I was the photographer for the first round. And I’m like, “Oh man, nobody signed a waiver. I’m just going to assume the waiver was with the instructions at this point.” And then there was a current, and you just see everyone just get swept down the beach. But it ended up great. Everyone had a lot of fun.
But the plane, we hired a plane to fly by and it said, Cambria shareholder yield or something. No, it was tail risk. Excuse me, it was tail risk. However, we were getting out of the water and we see the plane go by and I said, “The plane is supposed to be at lunch and I get out of the water, I shower, I get dressed. And I have all these texts from Josh and Barry that are basically like, “Meb, your plane is so loud we can’t hear the speakers talk because it’s outdoors.” And I said, “Well the plane was supposed to be at lunch and over the ocean.” And I’m like, “I can’t call the plane like he’s flying around.” And he was supposed to fly the next day. And I said, “If it had been any other conference…” If this was Schwab, TD, I would’ve said, “You know what? You just circle above head for like five hours now. Don’t even…” But this one I said, “You know what? Fine, I’m not going to fly it.”
Ben:
People did get pretty creative. I think there’d be more creativity. There was surfboards were handing out and skateboards at some of the different booths. I think people get even more… One of the places had a bar at it.
Michael:
So one of the companies that is coming asked if anybody has claimed the Miami Vice thing, which is the official drink of Animal Spirits. So I guess it’s unofficial. It’s semi-official. And I-
Meb:
Which is what?
Michael:
… don’t know if that’s best muster. Miami Vice…. Ben, why don’t you say because you put me onto it.
Ben:
I started getting this when I would go on Caribbean vacations. It’s half pina colada, half strawberry daiquiri.
Meb:
It’s also called the Lava Flow.
Ben:
It’s perfect diversification for a poolside drink.
Michael:
That is the 60/40 of Caribbean drinks. Wait Ben, I’m interested to hear you say you mix it together because it’s layered. It’s usually one on the bottom, one on the top. I don’t mix, but I was thinking are you supposed to mix? You mix?
Ben:
No, I don’t stir. They put it together but yeah… Wait, someone is picking up the Miami Vice tab for us?
Michael:
No, somebody might have a machine serving Miami Vice. I believe it’s the plural. So yeah, we’re excited about that. Virgil Wealth is coming out with an In-N-Out Burger truck, a food truck burger. Super excited about that. And this is going to be coming out in the August single digit dates. I don’t know if it’s the sixth or the eighth, whenever it’s coming out. From there, you only have until August 15th to secure tickets. And if you’re on the fence, let me entice you with a carrot so to speak.
Advisor Circle is putting on this thing called Breakthru. Which gives you an opportunity to have 15 minute one-on-one sessions with either a platform company or an asset manager or another RA that you’re thinking about talking to. There’s no obligation to attend all eight meetings. You have to sign up for eight or at least… See the fine print. I might be talking out of turn, but see the fine print.
But if you do sign up for Breakthru, what you’ll get is a $750 travel voucher in real money, no tokens, real actual fiat dollars. And which by the way… But dollars look good today and you’ll also receive a free ticket. So if that sounds interesting to you and I don’t know why it wouldn’t sound interesting. You could see Red Man and Method Man. Hang out with your favorite Podcasters Meb’s going to be there. We’d love to see you. Great time. That’s my commercial.
Meb:
Yeah, listeners, there’ll be a link in the show notes. Futureproof.advisorcircle.com.
Ben:
Meb, back to your California thing. Being a Midwest guy, I always think like, “God, the cost of living in California is so nuts.” And then you go out there for a few days like Huntington Beach last year and I’m like, “Oh, okay, I get it. I see it.”
Meb:
Yeah. It’s not so bad. So what we were going to do this year, which your producers are not too enthused about was we were going to try to do a drone show. And drone show is sort of the opposite of the plane. The plane is cheap. It’s like Vanguard Beta. Drone show is not. Drone show is like a hundred bucks per drone. You need a couple hundred drones and it’s only lasts for eight minutes.
Ben:
That’s like one of those light shows?
Meb:
Have you ever seen a drone show? Google on YouTube drone show and particularly in China. You don’t have to do it right now, but you can do it later. But it’s pretty spectacular. But they only last like eight minutes. But if you’ve never seen one, they’re super cool. And half the people probably think it’s like aliens or something. But anyway, if I surprise them, we still do it. You got a sneak peek. Listeners, I think they’re putting the kibosh on it.
Anyway. All right, so you got met man, it’s going to be fun. Listeners will be there. Come say hi, it’s a great time, good people, no ties allowed. What do you guys want to talk about today and what should we get into?
Ben:
I got the first topic. I just was looking at this. I don’t know what caused me to do this. Someone sent me something like… Remember the Bill Gross El-Erian thing from PIMCO about the new normal? They put it out in 2009 and I think they kind of nailed the lower rates, lower economic growth because that’s what we had in 2010s. But it was also bond yields are low, prepare for really low returns across all financial markets. And I looked… By decade, I have a spreadsheet I updated once in a while, decade returns. And I think any financial blogger in the early to mid 2010s was saying, “Listen, valuations are really high, you should probably expect lower returns going forward.”
Michael:
Hand up. Guilty.
Ben:
I’m sure all three of us wrote that piece. And internationally you could say that was right. But in the US, the US stock market returned almost 14% per year in the 2010s. And I just updated through the 2020s, through all the crazy ups and downs we’ve had. It’s almost 12% per year. So that sounded like such a smart argument to make and if you were a reasonable investor looking at historical averages in terms of valuations. Or pretty much any metric you wanted, you would’ve said, “Yeah, you should definitely expect lower returns coming out of the GFC because of what’s happening. What the Fed’s doing and all this stuff.” And it doesn’t make any sense. And look what happened. We ended up having above average returns over the next two decades, decade and a half.
Michael:
Macros impossible. Micros, not much easier, but macros impossible, nobody knows. And what you couldn’t have figured out with the macro, and I think the calls were reasonable at the time. The valuation calls were reasonable, but what they were saying was reasonable. A lot of the economic side would not to be true. What you couldn’t have predicted was what Apple, Microsoft, Google and Amazon were going to do to carry the weight of the S&P 500.
And the fact that we had those returns, not just because of multiple expansion, which I’m sure was a piece of… I don’t know the numbers off the top of my head but I think… Again I’m making this up. 85% of the returns came from fundamentals actually delivering. I don’t know what earnings per share growth was over the decade, but it was not bullshit multiple expansion the whole time. It was real.
Meb:
Couple comments. One is, I love linking to Ben’s pieces on the decade long stuff because there’s times when if I tweet about a couple topics, buybacks, CAPE ratio, people will lose their mind. And I like to often link to Ben’s and say, “Hey, it’s not my data. Go get mad at Ben. I’m just interpreting it.”
But a couple things. One is, if you look at the bottom in 2009, you guys know I love CAPE Ratio. US was screaming cheap. I think it got as low as intro month like 12 and 13 at the end of the month, even at the end of the decade. So 2010, it was reasonable like sub 20. If you look at long-term CAPE, it’s usually around 17, 18. Low inflation rate times, it’s like 20 to 22. So totally reasonable. And we actually did an old post based on I think Ben’s data where we said, “If you look at decades and sorted them, whether CAPE ratio below 20, above 20. And the argument I was making was actually in how the returns were and below 20 they were much higher, above 20 they were much lower.
But then you take it further out above 30, above 40 the course of the decade. And then take it globally above 40, you basically have never had a scenario where stock market returns were even average. They were always below average for global markets, which is about 5% real. But what’s interesting was that for a long time people took sort of the inverse of that argument and said, “Stocks are allowed to be expensive because bonds yields are low.” Which is a version of the Fed model. And that’s actually never been true.
And I actually updated this yesterday on Twitter where I did the top quartile, maybe even decile. I can’t remember. Top tractile we’ll call it, of stock market returns in history and this is probably using Ben’s data. And then the worst stock market returns in history and what were the characteristics? And you have all the economic characteristics, but usually it’s the least technical way to say it is, “Good times follow the bad, and bad times fall the good.” It’s not that complicated.
Ben:
Yeah. That was like the easiest tell is that we had a lost decade in the first decade. Because to your point, if you go from that, I think the worst entry point ever for stocks even worse than 29 was end of ’99, early 2000. And if you look at the end of… If you invested at the start of 2000 in the S&P, it is below average. It’s like 6.8% annual returns even with the great 2000s decades and early part of this decade. So mashing those two together from that high CAPE of all time in ’99, 2000, you still get below average returns from that even though they’ve been above average since the great financial crisis.
Meb:
I was hoping we were going to hit… I mean hoping is the wrong word. I thought we might hit all-time highs on the CAPE ratio in this last little meme stock we got to about 40. But what’s interesting is Jim O’Shaughnessy had posted during the bottom of the GFC, this sort of… I can’t remember if it was a 10-year rolling compound of returns or 20 on the S&P. Producers can dig it up, we’ll put it in the show notes. But he gave it as a reason to buy and Q1 2009. But the funny thing is if you look at that chart and we posted it to Twitter. We’ll put it in the show notes and there’s two variants.
One is, we did a 10-year rolling compound and returns, which as you mentioned is dealt well into the double digits. But then also the sharp ratio meaning risk adjusted returns, which is essentially net of the risk-free rate. And essentially there’s four peaks in history. There’s the roaring twenties, the nifty fifties, the internet bubble and then the COVID meme stock, whatever we want to call it. All four of those, it looks like four little mountaintops. And in so far as three of the cases, the returns on the other side were pretty subpar. So we’ll see this new environment, 5%, 6% bond yields. I don’t know. That looks attractive to a lot of people except for Batnick who apparently is shorting bonds.
Michael:
The rally I think has surprised a lot of people, myself included. And I’m always excited. I can’t wait for the next year. I can’t wait to see what stocks do. I can’t wait to see, I can’t wait to see. I really can’t wait to see it. You have a 30-year breaking out for real, which is good, right? It’s good in the sense that it’s reflecting economic strength, I think for the most part. I would have to imagine that the overall asset allocation of investors in the aggregate is going to shift even a marginal shift, even if it’s… I’m making this up. Even if the average investor is 63/37, whatever it is. Even if you go from 63/37 down to a 59/41 or whatever, these dollar amounts could potentially move where the market heads in the future. So I’m excited to see it.
Ben:
Well Michael, you made the point on a blog post this week. You were saying the 60/40 was looking so awful before when rates were essentially at zero or 1%. That the stock market had to be way higher in terms of returns to get you to a decent 60/40 return. And now you just did the simple napkin math of if you’re starting from 5% or 6% bond yield, the stock market doesn’t have to go up as much for you to get a decent return on 60/40.
Michael:
Yeah, I love it. So my main thing here is like listen, if you tell me that stock returns are going to be lower because bond returns are going to be higher, I’ll take that all day every day, right? I know there’s a million like well… But it makes the bogeys more realistic. Like getting 8% when your bonds yielding 2%, you could do the math. That requires a heavy lift from the market and guess what? It did it. The market did it for us. The Fed pushed people out on the risk curve and people that did that were actually rewarded because stocks did deliver.
But now it’s a different world. 80% on the BlackRock earn call, 80% of all fixed income is yielding over 4%. That’s probably stale data now. It’s probably 85% or whatever. And that’s a beautiful thing. And now if that means that stocks don’t do 13% and they do 6%, 7%, 8%, I’ll sign up for that all day every day and twice on Sunday.
Meb:
So, why are you shortening bonds then? It sounds like you want to be long bonds.
Michael:
Yeah, I was teasing.
Ben:
Well, the other thing about that is the behavioral aspects. We’ve talked on our podcast in recent months, there’s all these Wall Street Journal studies showing that baby boomers over time have had a slow shift upward in allocations to stocks. And part of that is probably because we had 15 years of 0% short-term rates and they were forced there by the Fed. And part of it I think is because baby boomers have lived through a bunch of crashes that every time they’ve seen stocks come back.
So I think that drift higher made some sense in terms of their experience. So I think a lot of it’ll depend on how long T-bill rates stay high. Call it above four or 5% if it will be a behavioral change. Because baby boomers, in terms of individuals, hold the vast majority of wealth. I think it’s 55% of the wealth in the US.
So to Michael’s point, if they make a small shift in their stock allocation to safer bonds, especially right as they’re all retiring, it will be interesting if that will be a little bit of a headwind for the first time for stocks in terms of allocation.
Meb:
So are you guys seeing that across any of your clients? Are these boomers requesting it? I imagine you guys have a slightly younger cohort than most, but is the cinnamon indicators firing on bonds for you guys? Are there people more should?
Michael:
Our 60/40 was 70/30. That’s just what it was for most of the last decade. Now advisors are able to downshift. And again, I think it’s great. It makes the financial plans a lot healthier, makes volatility lower.
Ben:
I’ve had a couple of conversations in recent months of people saying I went to 70/30 or even 80/20 because I wanted those higher expected returns. I think I’m going to live longer and now, “Okay, I’m ready to downshift back to a 60/40 because I think that makes more sense where I am.” So those conversations are being had.
Michael:
All over the country. Meb, we spoke about the behavioral aspect of it and if you can’t comment on this or don’t want to, we could punt to something else. But Ben and I just had Bruce Bond from Innovator ETFs on the show that was a bit of a third rail topic on Twitter. There are ETFs that offer 0% downside with a capped upside. So I love the idea from a behavioral point of view that you can put this in front of a client or an individual could put this in front of themselves and say… Because the markets are all about trade-offs. I want less risk. I want more risk. I’m willing to accept higher volatility. No, I can’t stomach that. I know myself and I don’t want to do that, be in that position.
So there’s trade-offs between risk and reward. But the trade-offs are a mile wide ’cause you don’t know what the outcome is going to be. You just sort of have a range of outcomes. With something like this where you can very specifically define the outcome on your own terms and maybe this isn’t attractive to you. But when you could say, okay, over a two-year period or whatever it is, I know that I will get my money back at the end of this period. However, I’m capped out at wherever the cap is, 14, 15, 16, whatever it is. And so if the market is up 30%, I’m cool with 16. To be able to define your outcome for wherever your risk tolerance is. I think behaviorally that’s a wonderful thing even if it means you leave returns on the table.
Meb:
Yeah, a couple comments. One is, there’s a lot of products out there that if you’re looking for what we’d call product market fit as a big VC term. Thinking about a service or a product in VC land, that’s the magical product market fit. Well, I think there’s a lot of products that they’re not actually seeking a product end investor fit. They’re seeking a product advisor fit and I would lump annuities into this category. Decades long product, a lot of the products that old school brokers would get paid a lot to sell. Is it good for the client? I don’t know maybe. But it fits all the boxes for the advisor. These type of structures… And again, annuities are similar to me, I think can be fantastic. I think coming up with more certainty, investors hate uncertainty. This concept I think is wonderful. The question is does the investor really want it or is it something the advisor wants and is it something that they understand?
And then, of course, the big one is always how much are you paying for it? So how much are you paying for it in expenses, right? Traditional, the problem with annuities, the reason Ken hates them is usually because super expensive and there’s a hundred layers of fees, much like the traditional mutual fund industry.
But then second is, which I think you are more alluding to is, what is the actual cost of the hedge? The problem with a lot of the hedges that you pay for the insurance is when you hedge away all the market risk, guess what? You just turned into T-bills, right? And that’s kind of where you end up. And so I think if you can design it thoughtfully, the investors on board and it’s low costs, God bless them. They’ve certainly been popular. The challenge I think historically has been complexity, the costs.
Michael:
So to me this strips a lot of that away because you mentioned annuities. The prospectus is 190 pages. They are so non-transparent. They are so expensive. You don’t know what you’re paying for. And with these sort of products, whether it’s innovator or whoever, I think the category is going to continue to expand because investors hate uncertainty. They just do. And nobody’s saying… At least I don’t think anybody’s saying that this should be all of your portfolio. Only an idiot would say that you should have all of your money in annuities.
But I think that people are willing to overpay for certainty not on the expense ratio in terms of opportunity costs. If you miss a RIP Warren bull market, “Oh the market’s up 30%, then I’m only up 15. Cool. The rest of my portfolio’s in stocks, or part of it. I’m good.”
Ben:
Meb, you make another good point on the gatekeeper aspect of financial advisors though. The fact that they are the bouncers now in a way that brokers probably were in the past and advisors have probably never been more powerful. Michael and I talk to FinTech firms all the time who… It’ll be a technology. They have an idea, but they come from the technology world. And they’ll come to us and they’ll say, “Listen, the advisor TAM is enormous. Can you guys teach me how the RA world works?” And in our thought processes, that’s never going to work. If you want to really make it into this business, you have to have someone on your team from the advisor side. But advisors have so much control these days. And they are that gatekeeper that I think it’s almost underestimated from certain people who are outside of the industry, how much power and money that advisors control these days.
Meb:
Yeah. We did a thread on Twitter the other day where one of my trigger tweets of the past year was, I hear a lot of people describe how they invest. They say, “I just put all my money in the S&P. It’s boring. It’s index. It’s boring. And to me that’s a very strange phrase because I say there’s a lot of things you could describe. Indexing is cost efficient, great exposure to the stock market, low fee on and on and on, tax efficient. But putting all your money in US stocks to me is not fit as the category is extremely risky to me. And so when we look at some of these strategies, my always takeaway is once you have a diversified portfolio… Obviously my take on diversified is a lot different than most. The question is, how much do you need these sort of other bells and whistles, right?
If you have a beautifully globally diversified stocks, bonds, real assets, hey throw in some value in trend following. Do you actually need some of these products? I don’t know. We had asked a question on Twitter where we said the successful entrepreneur who’s actually a podcast host sold his business and he basically did the buffet portfolio. It was like 80% in SPY and the remainder in T-bills. And I said, if you could add one thing, what would it be to this portfolio? You’re allowed to make one change.
Do you guys have an answer to this? Because to me, this is something that’s like it’s attacking that problem. Where this entrepreneur spent all his life made 10, 20, 50 million bucks, whatever it is. And then it is like buying a TV. It’s like, “Ah, I’m going to buy it SPY and be done with it.” And theoretically could go down 50%, 80%, but to me that’s not boring and it’s super concentrated. What would you guys say to that entrepreneur? What would you add first? You can only add one thing by the way.
Michael:
Can I just say one thing just to finish? Close the loop on the behavioral stuff that we just spoke about. If you are able and if you have demonstrated to yourself the ability to sit through drawdowns, then you do not need products like that. Kudos to you. But a lot of people have crossed their own line one too many times and are self-aware enough to know that I can’t sit through a 40% drawdown because of the last time I freaked out. So if you don’t need this, God bless. And I’m not saying everyone does, it’s certainly not the case. But only for those people that know that they can’t stomach all of the equity risk.
Meb:
I wonder how many of those people only have one side of the behavioral barbell. Meaning there’s the people that freak out when they have the drawdowns, but there’s the people that also get sucked into the jealousy of an envy of things ripping. And if you have a product like this, we’re like, well, the market’s up 30 this year and my hedged innovator fund is only up five because I’m capping the upside. What the hell?
Ben:
Yeah, if you bail, it’s useless then.
Michael:
That’s a great point. I tend to have more. I tend to err on the side of FOMO. I don’t get scared of drawdowns, at least in my real long-term money. If I’m picking stocks, I won’t take a deep draw down. I don’t trade stocks that way. But I don’t care, my 401k that can go down 60% and I wouldn’t blink. Not that I want it to obviously.
Ben:
To your other question, we get that same thing all the time where, “Why do I need to hold anything beyond US stocks?” And as someone who’s studied market history, I think if you held just US stocks and your time horizon is 20, 30, 40 years, you’ll probably end up fine in the end. I think that the problem is if you do run into those 10 year periods like 2000, 2009 where you have a loss decade… It’s funny, it wasn’t that long ago. People were like US stocks are the worst place to be now. And it’s flipped because of the last 15 years. And US stocks, especially large caps, have been the only game in town.
On a relative basis that people are, “Well, I can get 40% of the sales outside of the US and why do I need to invest internationally?” And every time I show a long-term chart of the US stocks saying over the last a hundred years, this is how it’s done. Someone give me the now show of Japan. And now show Japan is the perfect reason to not have all your eggs in one basket for the US. Because you just don’t want to have the worst possible thing happen at the worst possible time when you need the money.
That’s my whole thing about diversifying beyond the US. It’s funny to me. I think my attitude has shifted. If for someone who’s sold a business and has a lot of money, I actually think that real estate probably has better behavioral benefits than most other asset classes. Even though I don’t have a good strategy for that space. I think the fact that it’s illiquid and it ties up your money and makes you stay there and has tax benefits. I think for ultra-wealthy people, it’s actually probably not a bad idea. I had a wealthy person that was like 80 years old a couple months ago telling me about how his favorite asset class is a house on the water. He goes, “A house on the water will literally never go down in value.” And he was being tongue in cheek, but I think he was kind of halfway serious. And I think if you had a good strategy in real estate, I think that’s a pretty good diversifier from an inflation hedge. And the perspective of it forcing you to hold for the long-term.
Michael:
Just to echo both of your points. If you go through a lost decade… So if you had a hundred investors say to you, “Well I own these is S&P 500s and that’s all I will ever own.” which by the way, let’s be real. Who says that? I mean, yeah, I’m sure they’re out there. But I think that if there were a hundred people that said that maybe seven or eight could hold for 30 years. It is so boring, most of the time. You will have lost decades and not only during the lost decade will you hold if some of that goes not even sideways for 10 years. You get zero return and you have to eat a ton of risk and a ton of anxiety, right? There’s crashes in that flat 10 year period.
But worse than that, you had other parts of the world doing really well. So to think that you wouldn’t be looking over your shoulder at emerging market value and small value whatever. And REITs that did well, you’re fooling yourself. Of course you’re going to bail. Just of course you are. We’re all human beings. So getting back to the person who sold their business, what’s the exact question?
Meb:
Well, you get to add one thing to that portfolio and it could be nothing. You say, “No, you’re perfectly fine, 80% S&P 20% T-bills.” But you essentially have 100% of your net worth. You took it out of this company, your life’s work, boom, and you don’t currently have a job. You may do something again.
Michael:
So first I’ll say that if you were 80/20 global stocks tables, you’ll be just fine. But let’s actually answer your question. Maybe I’m placating the host here, although I do believe this. Let’s talk about trend following. So I’d be curious to hear your thoughts. So we were heavily influenced by your white paper and employee trend following models in our business in similar ways to the ones that you laid out. What I’d be curious to hear from you is how your thoughts have evolved on trend following with the lens that markets move a lot quicker these days. And so maybe the answer to quicker markets is actually doing less. Not being whipsawed even though you can’t eliminate whipsaw. So how have you thought about the speed at which markets change these days through the lens of trend following?
Meb:
Yeah, so listeners, my answer to this and we got a lot of wonderful ones. And I was actually surprised to see a lot of the trend responses, but again, I think you’re correct in that my audience is biased. But when I do do the polls, it’s consistently everyone puts all their money in US stocks. That’s about it. So you have some other stuff on the fringe, but really it’s a US stock game. My second answer was Ben’s answer, which was real assets, but that could also include tips. I think it could include global REITs, it could include commodities or farmland, but it’s the same general thing.
And lastly would’ve been global value equities. So trend, I think the answer to this is actually probably gone in reverse, meaning I don’t think people over the years got thousands of questions. Have you thought about this parameter? Have you thought about this, that and the other? I actually saw… It is humorous. I found an old post that Barry did. I mean this has got to be 10, 15 years ago where he was talking about a certain econometric model about trend following. I’ll send it to you guys. It’s pretty funny. To me, the simplicity of it is the parameter doesn’t really matter.
So whether you use something like a 10-month moving average, which is what we published. We published a follow on paper which no one has read called, is investing at all time high is a good idea? No, it’s a great idea. And that one, instead of looking at moving average, looks at breakout. So we use the longest metric possible, which was all time highs in history. So, you only invested if the market was at an all-time high and then you sold it when it went down. I can’t remember, it was like five, 10%. So some sort of… And it turns out it does fantastic. It’s the dumbest trading system in history and it does wonderful. It does much better if you do a 12-month look back, which was published was the Nicholas Darvis book 80 years ago at this point. He talked about these sort of range breakouts.
So I don’t think it really matters. What does matter to me, I think there’s two parts to this. One is, if you were asking, “Hey, what is the best risk adjusted way to do a portfolio on its own?” And I think doing a long flat, meaning you’re in the asset and you sell and move to T-bills or tenure, is the best way. But if you’re saying what can I add to a traditional long only portfolio to make it better? And to me that you probably want some form of long short.
And the reason being is that if you’re just doing the long flat, you’re really just adding the long component. The short component is what really helps balance out. So a year like last year, why did manage futures and trend have such a great year? It’s because they’re all short bonds. And so a flat one would not have had that sort of return. It would’ve done fine and much better than buy and hold.
We get so many questions on my DMs where people are like, “Hey man, there’s these managed futures funds. Which I was looking at CTA versus CAM LM and DBMF and blah, blah blah. Which one do you like better? This one does that.” And this is the least satisfying answer. I said, “Why don’t you just buy them all?” Which is not what I really mean, but I’m saying people… I was like, I want the beta of trend following, not really this quote alpha. And it’s hard to be independent here and non-biased. But I think trend following to me, if you blind out all the asset classes and strategies, this is an asset class strategy. To me, it’s the best one you can add to a traditional diversified portfolio. But it’s not for everyone and it goes through a lot of periods that suck.
By the way, Ben, I was going to mention, we just finished. It was like the worst period of global buy and hold returns ever versus the S&P. As far as years in a row at underperform, it was like 12 or something in magnitude. It was massive where the S&P just massacred everything on a globally diversified portfolio and it doesn’t matter which one. Whether it’s endowment style, risk parity, whatever, S&P was the place to be.
Michael:
Being different is hard. And when we say different, we’re US citizens, right? So different than the S&P 500. That’s what we’re judged against for better and for worse. And so in a year like 2022, our trend following strategy got shot to hell and it reduced volatility dramatically. Because there was a couple of really nasty months that we were out, but then we got whips on and gave it all back. And so it was challenging. And then the thing that I love about trend following is that it removes the emotion. Because my instincts for getting in and out are almost always wrong. And when we got back in earlier in the year, I was like, “Oh no. Oh no, it’s going to happen again.”
Ben:
We both said we felt like no one felt like it was a good time to get back in when the rules were saying too. And no one could have predicted like, oh, the market’s going to take off eventually after you got back in because you did get chopped up so many times. And that’s why you have to follow it, come hell or high water basically, or it’s not going to work.
Michael:
It’s easy to get out. Getting into the market, it’s the most natural thing in the world when you get scared. Getting back in for a million reasons is super difficult. Meb, one of the things that we looked at, and I agree with your statement. So when we did all of our research on trend following was primarily… We did globally, but we really honed it on US stocks. And we did a lot of economic overlays. You mentioned Barry’s thing and just… Yeah, it could probably maybe easier to convince a naive investor to give you their money if you’ve got all these bells and whistles. But we threw everything out and Josh said, “Come on. Come on. If this works, why isn’t everyone doing it?” And my answer was, “Because it’s not bullshitty enough.” It’s hard to sell because it’s so simple and it’s elegant in that way.
One of the things that we looked at very deeply was what about selling or trimming in an extended market. Whether you’re looking at 1, 2, 3 standard deviations above a 50 day, 200 whatever. We couldn’t find anything and we tried. So there’s nothing to say like, “Oh, well in 2021 or 2020, you should have known that the trend was going to reverse.” Oh yeah, how? Go through the data and find anything in there that not once or twice… Yeah, once or twice it worked that more than 50/50 is going to add to your portfolio minus all the costs and all the bullshit and all that sort of stuff.
Meb:
I think if you listen to a lot of the old school trend followers, the Jerry Parkers of the world who’ve been doing this for like 50 years. And I always love my friends on Twitter when they’re talking about, well, trend following doesn’t have much of a track record. And there’s all these CTAs that have been around for 50 years. Dunn is probably my favorite that just have had these phenomenal track records and have sustained for decades. But to me, I think some of the portfolio management decisions to me are more important than the individual trading rules.
And part of that is what markets do you trade? And you never know where the trends are going to come from because sometimes you look back and it’s wheat. Or the Eurodollar or last year being a weird one, short bonds, but there’s really no other way to have hedge short bonds in your portfolio. People try to get long commodities or inflation type of assets, but that doesn’t always work.
Michael:
I don’t think people could stick with long short portfolios. Even professional investors who really know what it’s doing, it’s too different.
Meb:
You get twice as many chances to be wrong.
Michael:
Yeah. It’s just too much for the… Forget about the average investor. I think even really people that get it. I think they just end up throwing in the towel probably usually at the wrong time. I just think it’s really tricky.
Ben:
The blow up risk is higher. It took me a while to convert to the idea of trend following and Meb, your paper helped. And people like Wes and AQR. But I think the great thing about it is, I think it’s the one true strategy that you can actually believe all of the back tests because price is the one key. Because if you look at… Michael and I looked at other stuff and I knew a guy who had an earnings model and he used it as a market timing thing. And the back test was great. It was some sort of thing like earnings rolling over and the back test looked beautiful. And it worked great until 2008 and 2007 and 2009 when the bank earnings essentially went negative. And it completely threw his model out the window and totally messed with his timing rules.
And I think anything economically like that that the environments or the regimes could change so much to effectively reduce your back test to being meaningless. Price is the one thing that you can say, it’s always tied to human emotions and no matter the environment. It’s the one thing that you can say is the constant, is price. And that price tells you… All that other stuff is baked into price regardless of the environment.
Meb:
Any of the multifactor models we’ve ever done, usually price is the key lever As far as for trend. Batnick, you’re talking about trying to add all these other things. We’ve done some, where we look at the US stock market, we talk a lot about this on the cheap, expensive, up and down trend. It’s still the majority muscle movement from our buddy, Wes quote, is the trend part. Now it helps to add some of the valuation stuff and then you can add on interest rates and so then it becomes this full econometric. But really to me, at the end of the day, you want trend to be the final arbiter. Because you have times like last fall or whenever and you see, wait a minute, why are my momentum and trend models getting back in? I don’t want to buy these things. Oh, I’m so bearish. I feel like everything is going down the toilet.
But one of the reasons I think on the behavioral side, most investors will never in professional actually implement a trend falling portfolio. They need to allocate it through a fund. They need to buy a basket of funds, hopefully quantitative that do it. And that to me is slightly more palatable. It’s not totally palatable, but it’s slightly better than trying to do it on your own.
Now the one thing I do tell all my equity friends and none of them like to hear this or agree with it is I say, “Look, what do you own for your stock exposure?” And they say, “It’s market cap weighted index.” I said, “That’s the ultimate trend following algorithm. It literally is price based only.” And it’s always fun to actually ask people, “What do you think market cap is based on?”
And you say it’s literally… The algorithm is you buy and you hold it, and the more it goes up, the more you own. And the more it goes down, the less you own and eventually you get stopped out at zero or whenever the index kicks it out. That’s it. That’s market cap waiting. That’s one of the reasons it works. And the beauty of market cap waiting… Now it’s key flaws that has no tether to fundamentals. Topic for another day. But market cap waiting is trend falling at its essence, which is hard for people to hear.
Michael:
I think one of the themes of this conversation is it’s hard, right? We’re saying holding the S&P is hard. Adding this behavioral thing is hard. Yeah, it’s all hard. Making money in the market, whatever you’re doing, none of it is easy.
Ben:
Well, it’s also funny because back to your market capitalization piece. All the factor stuff you read about, especially in the early to mid 2000s was like market cap is one of the worst factors you can have. And then it goes beta is one of the factors. The original Fama French Three Factor Model, right? Beta was one of them and it turned out to be the best performing thing of the past 15 years.
And it’s funny, you talked about getting tempted to do something else. People who held the S&P were fine, but then the temptation then was to look at the NASDAQ 100 and go, “Wait, that’s the real benchmark index now, because look at how much better that is doing than the S&P. I should have been in that.” And the concentration risk there is even more, even though that has just been lights out because of technology doing so well.
So even if you’re in what seems like the best asset class is like the S&P 500 or total stock market index beta, you always think you can do better because there’s always going to be some sector or subset that is beating it.
Meb:
I heard Kathy say within the last year, at some point that ARC is the new NASDAQ as far as the benchmark. So it went from S&P to Qs to ARC. About that, everything is hard. There’s a great stat, which sounds like a shit post, but it’s true. Which was Chris Bloomstran had a quote, I had to go test this ’cause I didn’t believe it. He’s like, “Berkshire Hathaway since inception can decline 99% and still be outperforming the S&P.” I was like, “There’s no way that’s true.”
Ben:
Really? I’ve never heard that one.
Meb:
And so I went and tested it and sure enough, it’s true. And then he mentioned it to Warren and Warren’s like Ben Graham would be proud, but let’s not try the math. And I was thinking about this as Batnick was talking about, is like, look, my 401K could go down 60% and it’s not going to be a problem for me. I was like, “All right, well, let’s not try the math ’cause that’s a hard thing to try to experience or to go through, right?”
Michael:
I shall say I’m 38 years old. If I was 50, I would not be saying that.
Meb:
Yeah, well, the youngins man, they haven’t been through a big fat one yet. All these little dips… Let’s see how they do. What else you guys got?
Michael:
What do you think about what Sean Payton said? Does that fire you up as a Broncos fan? Or you’re like, “Why are you doing that?”
Meb:
I mean, I don’t think anyone would disagree with him. I mean, I think they lost probably three to four games last year solely due to coaching blunders. By the end of the year, they had to hire someone literally just to manage the clock. They couldn’t get plays in. Like watching it… Everyone watching the game being like, “Well, why are you not calling a timeout?” I mean, there’s very, very basic stuff. So it seems quite reasonable to me. Now there’s sort of the, everyone’s getting whiny about there’s a coach’s code and you’re not supposed to say these things. But if everyone knows it to be true, I don’t know that it’s that crazy of a statement to make.
Michael:
Oh, I’ll throw one last topic for you as we wind down, Meb. Dividends. Let’s do dividends real quick. I saw a great tweet the other day from… Actually I spoke about it last night on, what are your thoughts with Josh? There’s a global X dividend ETF. Is it DIV? Yeah, yeah. Global X super dividend. That’s gone. The total returns for the last decade are really bad, 35%, whatever. Even though we’re also 1000 value is up like 140%.
So I think we mostly agree. I think that if you are investing a dividend solely on the yield and the higher the yield, the better, the more excited you get. Horrible, horrible, horrible strategy. But I think getting back to the behavioral piece, if people own an individual stock portfolio of Coca-Cola, Verizon, bad example. Pepsi, whatever, not these super high yielding dividends, but these dividend oriented stocks because behaviorally they know that come hell or high water, Coca-Cola is paying in their dividend.
So this gets back to a reasonable strategy is better than the perfect one that you can’t stick to. So I think there’s a lot of behavioral benefits to value of a dividend based strategy like that. I know you have a lot of thoughts on dividends.
Meb:
Yeah, I mean how you squeezing this in the last three minutes of the show? I see you’re also trying to get me to do a Sean Payton on Global X. Like come on man, you’re going to get me to shit talk this?
Ben:
He doesn’t need to… We can take it one step further. I think the leap a lot of people made from dividends in the 0% rate world were then call options. I don’t know how much work you’ve done quantitative and call options, but I think that’s even people… Look at call options and say, “I’m getting a 14% dividend yield.” Which is of course not the same thing. But I think people thought call options were even a better form of dividends.
Meb:
They like to claim it’s income, which is a bit weird. You got a lot wrapped in here, guys. The first comment was thinking about you’ll do fine investing in Coke. I mean that reminds me of the Buffet late nineties. I mean, Coke was kind of the Nvidia of that time, not Nvidia. Maybe it’s like Apple, right? Where it’s a great company, but pretty darn expensive. And sure enough, Coke went nowhere for… What is this, like 12, 14 years or something, right? So that’s a lifetime. I mean that’s longer than the S&P has creamed everything this cycle. So it can be… We were debating this on the podcast the other day where I was talking to somebody. I said, “Look, it is per bribe.” [inaudible 00:45:44] said, “Do you think Buffet should be selling Apple Ear? It’s got a lot of vibes similar to Coke, late nineties. It’s getting up there. Couple trill.”
But look, you guys know my schtick. I mean, I think it’s crazy to look at dividends in isolation. I think they have an amazing brand. If you’re going to do dividends, there’s two massive things you have to incorporate. So God bless you, do dividends. I’m fine with that. But there’s two things you have to incorporate, and if you don’t, you’re going to end up at that minus 30% return.
The first one being you have to incorporate buybacks. You can do a dividend strategy, but needs to incorporate buybacks. Not just because of the buybacks, but also because of the share issuance. And look at the tech sector the last five years. Snapchat, which is basically just a vehicle to transfer wealth to the executives. I mean, the amount of stock-based compensation is insane. If you own that stock-
Ben:
We just talked about that one. It’s a crazy amount of money.
Michael:
I think it’s 8 billion since it came public was given to insiders.
Meb:
So buybacks is one, but people focus on the buyback part. But it’s equally if not more important to focus on the share issuance average company in the stock market’s, an issuer shares. But the second is valuation, right? And this is basic Ben Graham stuff like, “Hey, I bought a four 8% yield.” Or hurrah well, you probably just bought a really junky company. And then sometimes you’re also buying a company that’s really expensive, which is crazy. Why would you ever buy a stock that’s a high yield or that’s expensive? But also a buyback company, a company buying back stock, that’s expensive. That’s nuts.
And so the dividend only focus… People love this concept much like the selling calls, which makes no sense of, hey, passive income, the fire movement, writing checks, sitting on the beach, drinking lava flows. What’d you call them?
Ben:
Miami Vice.
Michael:
Miami Vice.
Meb:
Miami Vice. Drinking Miami Vice, baby. I’m just getting this passive income. Great brand doesn’t work out in the long run, in my opinion. There’s ways to do it, where it’s fine. But if you ignore price valuation, if you ignore shareholder governance, meaning the buybacks issuance, I think it’s a recipe for failure.
Gentlemen, any last thoughts on Future Proof? What are you most excited about? M-E-T-H-O-D man, go and do CrossFit workouts with-
Michael:
Well, that’s not happening.
Meb:
… Justin crew at 6:00 AM.
Michael:
Ben might. I’m bringing my dad bod. I gained five pounds in the last couple of days. I’m not happy about it.
Meb:
How do you gained five pounds in the last couple of days? What does that even mean? What’d you do?
Michael:
Don’t ask. There are ways.
Meb:
You doing a Chipotle sit in?
Michael:
There are ways. I’m excited to see you, Meb and everybody else. So thank you for having us. We can’t wait to see you.
Meb:
All right, guys. Thanks for joining us today.
Podcast listeners. We’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at feedback@themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show, anywhere good podcasts are found. Thanks for listening, friends, and good investing.
