Animal Spirits Podcast - Talk Your Book: Momentum Investing With Joe Terranova

Episode Date: December 25, 2020

On today's show, Michael and Ben talk with Joe Terranova of Investment Partners about the lessons from 2020, and the launch of his new investment ETF.    Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's wealth management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain positions and the securities discussed in this podcast. Ben, when people are having debates inside of the market, especially these days, it's growth versus value. What is never or rarely

mentioned is momentum. Why not? I'm blaming Morningstar. Half kidding. But if you look at the style box thing on Morning Star, it's growth value, large, small in terms of equity. There's no momentum on there. I don't know if that really matters, but it's never been a factor that people think about that much. And I think it's only in recent years people have really talked about it enough because it's one of those ones that is so hard to just understand intuitively. I know it was a concept for me that was hard to grasp and it never really made sense until I had people like Meb Faber or West Gray that could explain it in a way that I understood it. I think most people think that's not investing, that's gambling. What do you mean? You're going to buy something

and sell it higher? Why? Somebody else is going to pay more. Where's the due diligence? Where's your research? That's the idea where you're a lemming and you're following the herd. But if you do it in a quantitative way with rules-based approach, then it starts to make more sense. It's not just following the herd. But being part of the herd, guess what? Most of the time, the herd is right. So if you look at like flows into value or growth to say that they dwarf momentum as an understatement, today we spoke with Joe Taranova, who has a relatively new ETF out. And this has done really well in terms of gathering assets. I think it's almost already at $100 million right off the bat, which is a successful launch by any measure. I told Joe in the show that his book sort of

open my eyes to this concept. In 2012, I think I read it. I had been reading a lot of value stuff, Ben Graham, Buffett, whatever, you know, if you Google best investment books, that's what you find. And then I read his book and it was like, oh, would you say it's fair to describe momentum as the opposite of value? Yin and yang kind of thing. In the sense that you buy a stock, when you're a new investor, you don't look at the 52-week low list, but you go bottom fishing because you think you're getting a bargain. In your mind, you say, oh, this can't possibly go any lower. Right now is a good time to buy. I think momentum is the opposite in the sense that it's the people who want to buy but didn't. Oh, man, this thing's 170. I was looking at it when it was 100 and then

120, one 30 and I couldn't pull the trigger. Now it's 170. I definitely can't buy now. And then it goes to 200 and the story goes on. You've heard this that Fama himself has said the premier market anomaly is momentum. He's stated that in the past, which is probably something a lot of people don't realize. But it's just not as easy to grasp. And the fact that you can now do so in a quantitative manner certainly makes it probably more appealing for those people who are willing to have that. Because I mean, certainly if you've died in the wool value investor, if you had momentum to offset that these last 10 years or whatever, that's helped a lot because it's helped offset some of that pain in the value side of the equation. And I like the quantitative approach because

I wasn't able to do it. I tried the style of investing and these charts always look easy in hindsight. If you look at Microsoft or Amazon, it always looks easy. But the ride, my personality is not suited for it. So I like the idea of having a quantitative way to capture this to remove some of the emotions from the equation. So please enjoy our conversation with Joe Taranova on some lessons that we learned in 2020 and his new momentum ETF. We're joined today by Joe Taranova, senior managing director at Veritas Investment Partners. You probably recognize Joe from the halftime report. Joe, you've been on that for a while now. I've been with CNBC as an ensemble member, rather, since 2008. The halftime report I joined,

I believe, Mike, somewhere around 2011, we started as a seven-minute segment to get that launched. And it ultimately became the show that it is now. Awesome. All right. Well, today we're going to talk about the Vertus Terra Nova, U.S. Quality, Momentum, ETF. But before we do that, let's take a stroll down 2020 lane. You did a post recently for Veritas talking about some of the lessons that you learned from 2020. I thought this is a good way to kick off the conversation. So the first lesson, discipline. The roller coaster ride is worth it if written correctly. What do you mean? Understand that all of these lessons, they're not unique to me. These are lessons that I have observed in the 30 plus years that I've been on Wall Street and

working with some very successful investors and traders and whatever it is exactly you're trying to accomplish within the market. You need to make sure that you're eliciting. extreme discipline. So I thought about coming into 2020 and about so many people that talked about rich valuations and those rich valuations were the reason to move to the sidelines. And I use this analogy, Mike, which was being in an amusement park. And being in the amusement park, you've got two things you could do. You go on the roller coaster ride, which can be a little bit scary. Or you could step into the ice cream shop. That's the safe way out. You can enjoy the ice cream cone, right? But be careful. because if you don't eat that ice cream cone quickly,

it's going to melt on you. And that's exactly what cash is going to do in your portfolio. It's a 2% depreciating asset. So I said the roller coaster ride is worth it. It's all about how you ride the roller coaster. So I want to make sure that I'm sitting in the middle, surrounded by others, and that I'm riding that roller coaster the right way.

I don't want to give in to that rush that you're going to get from eating that ice cream cone because that's just going to depreciate on you quickly. And that's implementing discipline, which is inherently one of the most important traits and characteristics you could have to be successful in any financial endeavor. This year was more like the thing that spins than the roller coaster. What was that thing that you puked after you got out? Ramatron.

Yeah, that's right. And it happened so fast you couldn't get up off of that. Your second one is be observant of the fact, which I think is great because there probably were a lot of investors who just had a narrative going into this whole thing, couldn't really get it out of their head. you talked about the fact that there's a difference between the Great Depression and now, and I think a lot of people probably miss that. But what I want to ask you is, do you think that the fiscal and monetary support that we've seen this year, is that just going to be a feature of the markets going forward? Is that just with us for good now? That actually leads to lesson number three, which we'll get to in a second. There is a lot that we need to be knowledgeable of and understanding that there was an actual mosaic of coordination, which was a very well-defined response to the heightened sense of urgency in which risk assets were pricing in February and March. The Great Depression, as you guys know, was not caused by equity market declines.

It was because policymakers folded their arms and looked the other way. Well, okay, is that anything that is different in terms of this response that we've enjoyed in 2020, that what we've enjoyed since the better part of 2008? Since 2008, the same policy that's benefiting us now has been the policy that has been in place since the great financial crisis. So you have to be able to provide context and understanding the environment, have that knowledge you'll be able to make better decisions. We'll get into this in a second. But before we move to lesson number three, or maybe this is lesson number three, actually, truth is in the data and myths are often found in the chase for performance. put that to the side for one second.

Do you ever worry about the size of the Fed's balance sheet? Is that something that enters into your equation when you're managing risk and thinking about where to allocate dollars? So I look a lot at what's on the balance sheet. And I look at what's on the balance sheet and then what's the probability that the assets, all the Federal Reserve is doing is a tradeoff. They're basically saying to the speculative community, okay, we've got a volatile environment in which we're pricing risk assets currently,

you've got assets that are somewhat illiquid that are now even more illiquid in this environment. Here's what we're going to do. We're going to accept those illiquid assets. We're going to put them on our balance sheet. You're going to raise capital, and then you're going to have to reinvest that capital in a search or a chase for yield, so to speak.

So what I'm observing is what's on the balance sheet, and are they able to hold those assets towards maturity? And the exhibit from the great financial crisis is that the answer to that, Michael, is yes, they can. Now, does that dictate the size of the balance sheet exactly my investments and my decisions surrounding the investments? No. But I need to have an awareness. I need to have the knowledge base to understand the environment. Because I think, again, that is going to keep you in a very balanced emotional.

capacity, which I think is becoming far and more important as we move forward in modern day investing. What do you think the impact is going forward on that? Does them taking a lot of this risk off the table, is that effectively my hypothesis is, could it possibly mute returns going forward to the long term because you don't have that left tail anymore because they took the depression off the table? Does that make sense or not really? Make sense. And always expect I did this on a call recently. I was asked the question about the future and what would you tell clients and I said well I would tell clients to spend less save more and to be totally prepared to be disappointment in terms of what you realize returns will be lower the expectations

in doing that you'll allow yourself to actually surprise to the upside I think ultimately Ben this experiment that has gone on now since the great financial crisis reaches the endpoint when we're able to see a handoff. And by the way, monetary policy makers have done an excellent job, in my opinion. Where we have failed is the responsibility of the 535 plus whoever it is occupying the Oval Office into understanding the climate in the country since the great financial crisis and the need for there to be fiscal policy that work towards organic economic growth. When you reach that point, when you reach that point that monetary policy makers will be able to step back from this historically accommodative policy. And I will tell you that organic economic growth is going to correlate, it's going to correlate to the millennial and Gen Z economic participation. They are the ones that are going to be the catalyst in achieving it. I love this quote. When you rely solely on the knowledge

of others. You only know what they know and not what they don't know. Go on. There are so many. It's interesting to me that there is always this chase for performance in particular as you get towards the end of the year. And then we just formulate the narrative as price moves higher. That's all we're basically doing. So when you're relying solely just on the viewpoint of another, or if you're relying solely on the Goldman Sachs conviction buy list, or the best, ideas list from Merrill Lynch or wherever the entity might be. Yes, that's a great reference point. And these are very knowledgeable individuals that are providing that resource to you. And I'm not saying that their expectations and consensus are wrong. But I think you have to do

the due diligence process on your own and seek out an understanding of where potentially the risk might lie, where exactly the risks might lie in what they're bringing forth for consideration. And I use that word risk and I want to introduce it to both of you because that's the most important word to me in the 30 years that I've been working on Wall Street. Not understanding risk is where I've seen so many have a detrimental return or ultimately no longer even being able to participate in this investment game. Can you just elaborate? Like, what exactly do you mean? Because I think that a lot of people think they have a good handle on risk. It's either volatility or it's you not being able to meet your financial goals. Like, what do you mean by risk exactly? I always think of risk in the most important capacity, which is mental capital. So there's financial capital and then there's mental capital. How much mental capital are you exhausting on a particular investment? I don't think people fully are aware of that sometimes. And then in addition, to that, I always want the flexibility for future opportunities. What do I mean by that exactly?

So there are so many that don't properly measure the value of time in terms of their investments. They're not thinking exactly towards, well, I am specifically allocated to a particular asset class. And I am designating, I am designating over a three-year period. that it is going to help me achieve a specific goal or an outcome. So I've got a time determinant. The tradeoff for that is inherently, what is my risk in affording for that three-year time? I need to define that not as you're going along, but in advance. Before you assume whatever the asset allocation might be, I want to understand the risk.

You can't make the risk up as you go along. along in the investment process. It has to be defined in advance. And so many people, they always ask, before they get into a particular investment, how much money can I make? That's the wrong question. It's how much money can I lose? If the three of us were going to open, let's say, hypothetically, a bagel store, and I was going to be the investor, I would want to know before I give you the money, not how many bagels you're going to sell or what kind of bagels you're going to sell or what my realized return is going to be on an annualized basis. I just want to know my initial investment. How much of that is at risk? How much can I lose? Well, Ben has terrible taste

and food. He's not a bagel guy. I'm going to open a donut store right next door to your guys is bagel shop and put you out of business. That's your risk. Your lesson four is about humility and you talk about it in terms of the economic recovery. But I like to think about it in terms of you said you've been doing this for three decades. Everything always looks obvious in hindsight. Of course, the stock market rallied. They throw this money at it. But is there anything that happened this year in a year, those full surprises or anything that surprised you in terms of how fast the markets moved or any crazy moves? Anything surprised to you that sticks out that you go, wow, that was crazy. What's interesting is that I'm really not surprised how fast markets were moving this year,

pricing. And one of the reasons why is because there is such an increase in quantitative participation. And I don't think people properly respect that enough. I talk about lesson number four being humility. And I use the example. I don't know how Ben you feel or Michael, you feel about this, but right away, this V became evident to everyone, right? We had to have a letter. And it was kind of like, wait a second, we've got a whole alphabet here. You know, I could think of a V. Sure. We've got a V recovery and growth stocks and manufacturing and to a certain extent. labor. But there's also a U, which has been inflation for the last 12 years. There's also an L, which has been participation from monetary policy makers. There's the K, which again,

goes back to the great financial crisis, and the 535 in Washington, D.C., don't really understand the disinflationary impact from technology and disruption, because that's hollowing out jobs and it's contributing to the K that's visible in the country. And then maybe you can make the case for a W. That relates to small caps and emerging market allocation as well. So it bothers me that we have to have this one single letter to define everything. Well, there's a lot of letters in the alphabet, respect them all, be humble enough to do it. Lesson number five, diversification. This was certainly a good year for that. Well, I guess depends where you were diversified. A market correction does not have to equate to a portfolio

their correction. Exactly. That speaks for itself. Everyone says, oh, S&P's down over 30 percent. Well, where's your portfolio? Tell me, was your portfolio down 30 percent? By the way, if your portfolio was down 30 percent, let's talk because we're doing something wrong. But no, the S&P 500 for a very short period of time in 2020 was down over 30 percent. Yes, I understand that. That's a great headline to grab, but that does not equate to what matters to you, which is your portfolio, because that's the vehicle. That's the vehicle. The portfolio is what's going to transport you to exactly it is you identify that you want to be. And that's what you should worry about having a correction. In terms of diversification, what is your answer for people that are just hitting

their head against the wall because they can't figure out what to do with the bond portion of their portfolio? Because obviously, we saw this March that government bonds remain probably the best hedge against the stock market from falling in terms of the short term. But what do you tell people that are just so yield-starved and can't manage being in bonds or can't handle having that in portfolio. There's something called a multi-sector approach, and I encourage everyone to give consideration to it as it relates to taxable fixed income. I don't think people often think enough about investment grade and high yield.

I know both of you guys listen and watch our halftime report shows, so you can see the star of the show, the reform broker on it. but we had Mark Lazarion quite a bit. And back in March and April, what Mark was strongly communicating is something that I believe, the real opportunity that presented itself as it related to the very stressed or strained industries surrounding COVID-19, whether it was casinos or cruise ships or maybe an airline, the opportunity was in the debt market. It was the same thing in the wake of the great financial crisis. When subsequent to that, the debt of financial institutions outperform the equity of financial institutions. So I don't think people properly think

about taxable fixed income and the multi-sector approach that presents itself in a diversification mannerism, whether it be for high yield or investment grade or municipal bonds or the senior loan market or whatever it might be. But it still has a purpose. There's the expression. It's ballast in a portfolio, and that's the part of it. I think that we should be emphasizing. I think a lot of people, unfortunately, because of the aggregate bond index, they focus too much on treasuries. All right.

That was great. Let's move on to the Taranova U.S. Quality Momentum Index. There's an ETF for this. Great ticker. It's Joe, as in J-O-E-T. Joe T. A lot of people come to investing, particularly new investors, having heard of Warren

Buffett. And if you Google, like I did, like so many, other people do best investment books, right? If you want to get into the market, where do you start? You Google best investment books. And what do you find? The first thing that you find is the intelligent investor. So you find value investing or some derivative of that. And it's intuitive. You understand the concept of paying 50 cents for something that's worth a dollar. It doesn't always work out that way. Usually doesn't. But you understand the concept of buy low, sell high. If you know nothing about investing, about the market, you've heard buy low, sell high.

I was in the library reading these books, and I remember very clearly reading your book, which is the antithesis. It's buy high, sell higher. And ostensibly, this momentum index that you've created is a way to quantify your investment beliefs. I'll let you speak in just one second. One final thing is that that also got me. When you were writing about that, I said, okay, this is sort of like the opposite of value.

I understand why it works, like, behaviorally. I understand why stocks go higher, more demand, but then I tried to do it. And it's very hard to implement, even though you understand that if you want to buy a stock because you want it to go higher, well, buy a stock that's already going up. That makes sense to me, but actually implementing it and buying high and selling higher was very, very difficult for me personally. So this is a way to maybe remove the emotions to let momentum do its thing. So I guess the first question is, why do so many investors reject the notion of momentum,

just out of hand. First, let's begin by understanding to be successful in this business. You're going to have to recreate yourself. You're going to have to change multiple times. If you are adverse to doing so, you're going to position yourself to fail. In January of 2012, when I wrote Buy, High, Sell Higher, the publisher at the time insisted that I add something that was provocative to the cover. What they added was why buy and hold is dead. I was against it. I was against it. I was absolutely against it. And I was unable to really fight back against them, not allowing that to be on the book. So you're correct that it's difficult just to think about, okay, I've got a stock that's moving higher and I want to purchase it on the belief it's going to move higher and stay in that

game. We needed more. And what I've observed over the last few years is that there's two factors that you can combine and put together, and what do they do? They take where you can most identify confidence in each of a technical condition and a fundamental condition. I could observe technicals. I can observe fundamentals. But in that observation, I want to be certain that there's confidence displayed at the end result of the exercise of looking at that.

When I look at momentum, Michael, and when I think about it. why people unfortunately reject the momentum of it, they automatically equate it to high volatility. So as example, they think about a crowd strike, they think about a Zoom video, they equated to high beta, high volatility. What they don't understand is that what you can do is you can accept momentum as a representation of confidence and understand that it's supported by significant contribution by quantitative funds. What I then want to do is introduce this quality fundamental factor that will give comfort to investors about that hyper-volatile environment. And I'm just going to give you one example. You think about momentum, you think about high volatility in the

stocks that I just mentioned, well, month to date in the Teranova U.S. Quality Momentum Index, I've got a double digit return for a stock. You know what that stock is? Progressive Insurance. To date, the month of December, it's up double digits. Now, we know financials as a sector. We know what they're doing. So there's something unique. There's something visible in a confident capacity about combining momentum technicals with quality, fundamentals, and there you've got that progressive as an example. What was the point in your career where you came around to the idea of using a quantitative approach?

Because Michael talked about he wanted to do it trading individual stocks, but really couldn't bring himself to follow the rules. So what was it about that? That maybe would allow you to buy a stock like progressive, even though if you were just doing your own bottom-up analysis, you might not do so if it wasn't in the rules, big. into your index. 9-11. Great story if you're ready for it.

I was just working on the oil exchange. I was running Mark Fisher's company, proprietary trading firm, that we had about 300 people there, 75 or 80 traders. Unfortunately, we had 28 traders who were members of the exchange who lost their lives on that horrible day. I was there for it. And it was important that the oil exchange and then chairman Vinnie Viola, who unfortunate enough to call a dear friend. He was communicating with President George W. Bush's

administration. They wanted the oil exchange symbolically to be open. So they were able to get the oil exchange trading on the floor the following Monday, which I believe it was the 17th. But what they were also able to do in advance of that was to get the exchange open electronically before that. And I remember we were in Mark Fisher's house with all these computers set up in his kitchen and his living room. And we were ready to go live for this electronic opening for the oil market. And after about 20 or 30 minutes, when everyone saw how flawlessly we were able to execute and price, we turned to each other and we said, we realized that this was the change. change. This was the moment where technology was going to take over what previously existed

was that human specialist element that existed on the trading floors. And I knew at that moment, the quantitative approach was the approach. Wow. That is a good story. Two things on the momentum thing. One is that I think it's hard for investors. If they see something at 100 and then 150 and then 175, when you see something that's up 60% year to date, you think, think, I missed it. It's hard for people to buy, which is maybe why the momentum persists. It's people coming in late and gradually coming in. And then on the other side, it's dismissed because that's not, quote, investing. That's gambling. Well, we know better. That's how some people think is that it's not fundamentally driven. It's based on a greater fool. I like the quantitative

approach because it's very difficult. It's easy in hindsight to see a stock that's going higher, but in real time to ride a winner in my experience has been very difficult. So here's what your index does. It screens the 500 largest U.S. companies, with the highest positive momentum, calculated based on the last 12 months total return. The top 250 stocks are included in the selection list. Then each security in the selection is graded on three quality factors, return on equity, debt to equity, and annualized sales growth over the past three years. And then it's ranked by a composite score.

And then that's boiled down to 125 holdings, which is equal weighted and rebounds quarterly. So what happens if you get a stock like Tesla, where it is a, I guess every position is whatever, 0.8% or whatever it is. What happens if this grows to like 4, 5, 6%? Could you do an ad hoc rebalance or are there caps? Like, how does that work if one stock absolutely takes off like a rocket ship? I thought a lot about that in the creation and development. What I could not find was any evidence to support that within the 90 days, the quarterly rebalance and reconstitution, that violating the rules-based mannerism of this index and making a decision based on observing a particular price action, I couldn't find the probability that that outcome was the right

one. And I think that's the problem, Michael. We tend to intuitively suspect that these variables within the market if we were to address them, that that's the right strategy. But yet the reality of the evidence, and if you're going to be evidence-based, if you're going to be rules-based, you've got to rely on that. I couldn't find the evidence to suggest that what the index is designed to do, which is rebalance quarterly, that there would be a significant benefit by in advance of that acting. When you put this together, is this your collective years of investing and you said, all right, this is what I've always wanted to do. It's the quality momentum. These are the two things that you've sort of whittled it down to. Is that the idea here? Basically,

you've said all my years of investing has shown me this is the way to invest. First of all, I believe in high conviction investment opportunities. I believe in confidence. I believe that so many people I've witnessed that can tell me about the future, it's remarkable to me. I often say I have observations of the past and therefore I have expectations of the future. I never predict. One of the things I've never done is addressed clients and say the S&P 500, 12 months from now will be here or the U.S. 10-year treasury will be there. I don't understand that process. I like to observe the past and understand in that where I could find exactly confidence. It's the equivalency of a basketball player who in the first quarter of a game takes four shots and they all clank off

the back of the rim. Is he or she confident to take that fifth shot? Not so much. But in the second quarter, if she steps out into the corner and hits a deep three, got to jump in the step, and she wants the ball again. That individual, he or she in the second quarter hits three or four baskets in a row, they're playing with confidence. Why can't we invest with confidence? What's wrong with that? And by the way, how high is high? Just like how low is low.

Does anyone know the answer to that? It's 1221. It's December 21st. And I'm looking at a list of some of these stocks. And in your head, maybe you would think that high beta and momentum are synonymous or momentum and technology are synonymous. Not always. So, for example, the top stocks in this index right now are applied materials, lamb research.

Okay, technology. Square. Okay, technology. Xylinks. Exxion, KLA Corp, AbV, Take Two Interactives, Zebra, Cadence. I mean, these are not names in my mind that are front and center when I take momentum. So I guess the question for you is, do you view this as a core holding like an S&P replacement or more of a satellite factor to go alongside of a core holding?

100% core equity holding. What I've tried to do, I've listened to the binary debate over growth versus value. This is not the solution. this is a compelling alternative to that debate. This is a modern day strategy that ultimately, Michael, I believe, will result in a better index core equity holding for all investors. Well, you've got your name on it now. Do you feel any pressure for this to perform?

How could you not? Well, I'll tell you this. By the way, first of all, don't let Josh know, but Josh is available if he wants to gather that symbol for himself. Not sure what he would put in there, but J-O-S-H would be perfect. He put in Shake-Shack. The pressure, Michael, that I feel is this. And I truly believe this. I look at this. This product, if successful, will outlast me. This will be something that my children will participating with in terms of the index. This will live beyond me. But let's say five or 10 years from now. In my travels on Long Island and in 388 restaurant in Roslin,

someone walks up to me and says, I utilized your index methodology seven years ago. And I have to tell you, it did exactly what I wanted to do in my portfolio. To me, that's success. If someone says, I utilized it in my portfolio and it didn't do what I expected it to do, then that's failure. And that's how I'm looking. at this product. Yeah, that makes a lot of sense. Joe, before we wrap up, was there any softballs that you wanted us to lob, anything that we didn't go to? No, no softballs. Okay. All right. Joe, this is so much fun. Thank you for coming on. I've learned a lot from you over the year, so I really appreciate you taking the time. Michael, Ben,

thanks for having me. Appreciate both you guys and the work that you're doing in financial literacy and talking about the markets. I love reading your stuff. All right. Thanks again to Joe Taranova from Virtus Investment Partners. Send us an email Animal Spiritspod at gmail.com and we'll see you on Wednesday.