Animal Spirits Podcast - The More You Pay, The Less You Get (EP.03)

Episode Date: November 17, 2017

We discuss what do in an environment of lower expected future returns, how can investors protect themselves from complacency, what would cause us to sell all of our stocks, and whether reading investing books make you a better investor. We also get Ben’s reaction to Jack Bogle quoting him in his new book, The Little Book of Common Sense Investing. 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, the podcast that takes a completely different look at markets and investing. I hate the people who talk about it all the time, so I didn't want to be one of those people. From two guys who study the markets as a passion. Can I count on you to talk me off the ledge partner? Yes, and that's what this podcast is for. And trade for all the right reasons. That's my due diligence. I'm in. Dude, if you're in, I'm in.

A line of thinking is the higher the volatility on an asset, the higher the volatility on the opinions. so I feel like you have crazies on both sides. Here's your host of Animal Spirits, Michael Batnik. I can say that I was never driven by money. So you were trading three times leveraged ETFs for the love of the game. Exactly, man. I'm a purist. But anyway, and Ben Carlson.

This is true. I do not drink coffee. I've never been on Facebook. I've never done fantasy football. Oh, one last thing. Michael Batnik and Ben Carlson work for Ritt Holtz 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 Ritthold's wealth management may maintain positions in the securities discussed in this podcast. Now, today's show. This is our first live podcast doing this together. We should probably mention that. We're in Michael's studio, podcast studio, a.k.a. his office he shares with Josh Brown. because usually this is Ben Carlson. I'm based in Grand Rapids.

Michael's based in New York City, but I'm in town for a conference, so we're actually doing this together for the first time. So one of the big things that I've been writing about lately, and I wrote a piece for Bloomberg on recently, is a low return environment. And people have been predicting this for years now. You know, future returns are going to be lower because valuations are higher, interest rates are lower,

which makes sense. But there's a huge difference between, expected future returns and actual future returns, because people are calling this a low return environment, but it's not. Stocks are up almost 20% this year. Stocks have been up huge for the past seven or eight, nine years. Best low return environment ever. Right. The S&P 500 is up 16 or 17% this year through November, so you can't call it a low return environment. Yeah, so I guess the big question for investors is do lower expected future returns dictate a change to your portfolio allocation? Right. Yeah. The way that I look at it is does a change

in expectations require a change in allocations? Right. Which is hard to say. So I looked at the worst 10-year returns going back to the late 1920s for the 60-40 portfolio. And there were, the crazy thing is, is that this is just based on calendar your returns. There were no negative 10-year returns for the 60-40 portfolio, which is pretty great. The worst 10-year returns were basically the worst ones were about 2% a year, and this was in the 20s and 30s. I'm sure real returns were negative. Yeah, on a real basis, probably, especially around the 70s. But the funny thing is, is that every single one of these periods of ridiculously low returns was based on a calamity in the economy. So they were in the 1930s around the Great Depression and the huge recession we saw

in 1937. They were bookended by the 70s where we had the huge crash in 1973, 74, and, of course, the tech crash in 2000 or the great financial crisis in 2008. So if you're expecting lower future returns and you are either getting more active or making more frequent changes to your portfolio, isn't the margin of error much smaller in a low return environment? Yeah, well, yeah, and that's one of the points I'm making the piece is that the crazy thing is, let's say returns are lower. That means a lot of people are going to do even worse than those low returns because

they're going to try harder, they're going to turn their portfolios. yeah so like you said the margin of error in a bull market underperforming is not quite as big of a deal i think because you're still making money hopefully unless you're a perma bear and your fund has been down eight years in a row but if you're in a like we talked about before if if you're in even a marginally decent fund you're probably did okay and people can accept underperformance i think in a bull market so i think you and i would agree that in an environment of lower expected future return you should probably adjust your expectations rather than adjusting your portfolio. Right, and there are certainly small things that you can do on the edges, I think,

that can help you a little bit. But for the most part, yeah, people doing nothing is a decision. And you can, like you said, adjust your expectations and find other ways to increase your returns. Save more money. Amazon calls. Obviously. So there was two interesting stats I saw on Twitter yesterday. One of them is from Ryan D.trick, and it's funny that people have been talking about a lower-returned

environment, but we're in a rip-warnable market. So this is the stat. 58.1% of the days in 2017 have closed higher. So 50.1% of the days in 2017 were positive. Since 1990, only 1995 and 2013 had more green days. And then the other is from Charlie Bellello. The S&P 500 is up 12 straight months for the third time in history. That's insane. Yeah. I looked at the stats for this on a piece of a while ago. So there hasn't been an up or down 2% day the entire year. I think the numbers were in 2011, even we had like 35 of them. In 2008, it was like 55, either up or down 2% days.

Yeah, so not only has it, have stocks been going up, but they haven't been doing anything to get there. It's been such low volatility. Yeah, I think Charlie also tweeted something that there hasn't been a 1% intraday move for 52 days, which is the longest ever. Wow. Which is quite confounding because, There is arguably more political volatility than we've seen in our lifetime, and stocks are just not responding.

Yes, and I've been promised second half volatility that it's a second half story for six years now. It's a third half story. Somebody was lying. Obviously. Yeah, no, so it is crazy. But someone asked me this, I was on Bloomberg recently, and they said, what is causing this? And honestly, there's no good answer, right? Who knows?

Yeah. Right. My sort of stock answer is, well, the way momentum works, people have this recency bias where they assume whatever happened in the past is going to happen in the future indefinitely. That's the best I could come up with because I don't know how else can you explain it? Yeah, so that's an interesting point. So how should investors protect themselves from being complacent because it's impossible not to get conditioned by the recent market environment, even though we know this can't continue forever?

a few days or weeks ago, I woke up and I checked the futures as I do every morning for no good reason. Is that the first thing you do in the morning? Yeah. You check the futures? Yeah. Okay. And S&P futures were down like 0.3%.

I'm not a fan of saying 30 basis points. Okay. And I was 30 bips. And I was like, holy shit, what happened? Yeah. And I was thinking, like, what's the news? Well, to your point, I think you said this in a post a while ago. like every time stocks fall a little we think they're going to fall a lot right and we we got conditioned

to do that in the past too so now it's kind of swung the other way we're conditioned to think every time stocks fall a little they're only going to fall a little and someone will swoop in and we'll have this v-shaped recovery it's crazy i think that's called the plunge protection team yes did you do you know what i'm talking about fed manipulation yeah yes there was a guy there was a guy on cbc a few months ago literally talking about something called the plunge protection team, which we're huge advocates of, right? I don't think we can rule it out. Now, there's obviously an Illuminati that is controlling these things. So getting back to the low-in-term environment, one of the reasons why people think that we should have lower returns in the future is primarily,

not just because returns have been so high recently, but primarily because valuations are where they are. And valuation, I think we would also both agree they're not predictive in terms of timing the market, but they do a pretty good job telling you of what you can expect. The more you pay for something, the less you should expect to receive in the future. So with the cape at 30, we should expect low returns going forward. It just stands to reason that that should be the case. So Meb Faber had a really interesting poll on Twitter a few months ago, said, if U.S. stocks got to a cape of 50, would you sell? I think that was a gist of it. And then he did, what if they got to 100? So what's your take on this? Which is basically where Japan got,

right, which was, I think, like, the greatest bubble of all time. Yeah. Japan got to Cape ratio or P.E. Rations that were 80 or 100. I think the P.E. got to 90. I think if that happens, that's probably a good problem to have because that means you wrote a piece on this. How much do stocks go up to get to that point?

Obviously, it depends on the fundamentals and earnings. Nobody wants that, though, because Japan, 30 years later, is below its 1989 highs. Well, true, yes. In the short term, it's a good problem to have. But if the Cape gets to full. 50, then you are pulling forward a lot of returns. Right. It's sort of how do you survive a melt-up?

Right. Which everyone always tries to figure out, how do I survive a meltdown? But how do you survive a melt-up is another way of looking at this? Is there a level where you would say, this just doesn't make sense, I can't? I've never been a fan of using valuations as a timing tool. Again, it's more of an expectation thing. But I think at that point, if it's especially, I think it depends how things would happen on a relative basis, too. What are global stocks doing? What are foreign stocks doing in comparison?

Is the U.S. the only thing going up? So I think you have to look at it on a relative basis, too. I wonder if the U.S. can get to a cape of 40 with the rest of the world doing nothing. But I think that's an easy answer, is that you just go more global. But, yeah, I think I like the idea of, I think this was maybe a Rob Arnott phrase of overrebalancing. And this is something that we've been doing in recent years, is overrebalancing to foreign stocks. and emerging markets, because the U.S. stocks have just been crushing global stocks. All right, Ben, answer the goddamn question. What would I do?

At what cape ratio would you no longer invest? 55.6, no. I don't know that there is one, but it's, I honestly, I would put this time stamp out there. We're not going to get to a cape of 50. I will say that. How's that sound? Okay. I don't know.

If a Japan happened in the U.S. again, it would be absolutely insane, I think. It's hard to imagine what that would look like. Yeah, I mean, people are crazy and anything's possible. But, yeah, I think at that point, would I severely want to lighten up U.S. stock exposure? Sure, but you could do it at 50, and then it goes to 60 or 70, and you're kicking yourself. Yeah, so I think that the answer for us is probably we would just maybe put more exposure in our trend following model. Yes, that too.

Yeah, have a plan of attack for the other side of it. Because screaming about stocks being expensive doesn't help anybody. Having a plan in place, if stocks go up a ton and eventually fall a lot, I think that's probably the better approach. That's a good point. Yeah, I like that idea of the trend following because then you can hopefully still catch that wave and not get hammered too hard on the other side when it eventually comes back to Earth. Yep. This is a true story. It happened right here in my town.

One night, 17 kids woke up, got out of bed, walked into the dark, and they never. Came back. I'm the director of Barbarian. A lot of people die in a lot of weird ways. You're not going to find it in the news because the police covered everything all up. On August days. This is where the story really starts. Weapons.

So switching gears, this is pretty incredible. I don't really think it gets bigger than this. You were recently quoted in the little book of common sense investing, which was written by Jack Bogle, founder of Vanguard. When you found out that you were in his book, do you, like, show your wife and call your parents? What do you do? Well, the funny thing is that it's,

I think only investment nerds like us would appreciate it, right? I don't think my wife knows who he is. Did you tell her? She asked, she said, I saw something on Twitter, what does this mean? And I said, oh, I was in this book, and that's about the extent of it. but wait that's it pretty much my dad knows and he called and said hey this is pretty cool but the way i found out about i had no idea that that i was in this and someone on twitter posted a picture of the page said hey you're in the new and i didn't realize that bogle even had the new book

coming out if i was quoted by jack bogle i would call up people that i went to elementary school with how do you like me now so i heard it through the grapevine that bogle liked this piece i wrote and it was about how a simple vanguard portfolio had beat the majority of the college endowments over the past three, five, ten years. And it got back to me that Bogle had liked a piece and it shared it with Vanguard employees, which I thought was pretty cool. And then, yeah, he did an updated version of the Little Book of Common Sense, which honestly is one of my favorite investing books that there is. I love that little book series because they're so simple and easy to read. But I remember reading that in 2007 and being like blown away. Yeah, Bogle is a really, really underrated author.

He really, and you've read a lot of his books too, right? Yeah, yeah. He's a good, right, yeah, and he backs it up with statistics. He's got great stories. Yeah. He's got great analogies. He really is an underrated writer. One of the funny stories that he shares was in Clash of the Cultures, maybe, he bought shares in an active management company.

I'm trying to remember which one it was. I forget, but he crushed it. He put $100,000 or something like that into. Oh, Charles Schwab, I think. it was or something one of his competitors right just just to get in that sense of yeah yeah and when i'll perform and made him a ton of money right yeah exactly yeah which is funny because he's totally against that yeah he's he's he's a lot more to him than than like a buy and hold guy he is a smart guy and he has you know he's not he doesn't just say buying a hold he backs it up

too so what exactly did he talk about in the book when he quoted you he actually had a thing where he in the in the end of each chapter because i went and read the book again because i wanted to see what the context was he in the end of each chapter he kind of said okay don't take my word for it here's other people writing about why the stuff works and how it works and so he referenced my piece saying he was talking about the institutional world and saying ben carlson have a wealth of common sense has written about this so yeah it was it was pretty crazy to me it was i'm always kind of floored by this stuff and don't really know what to do with it or what to say but i mean this is one of the you know one of my favorite investing books that when i read it it kind of blew my mind about

the simplicity and keeping cost low. Did you buy the book? Yes, I bought a copy to look at it. And it's, uh, yeah, it's pretty, yeah, it was pretty, it was pretty cool. That's, uh, so speaking of books, we both have read a lot of investment books, but does reading investment books make you a better investor? Or can't, like, can it make you a better investor? I think it probably could. I think it can also get in trouble because you, if you read the wrong ones or trying to get rich quick and assuming that you can do what these people do, it's Probably, you know, if you read all the Warren Buffett books that you can get your hands on and assume you can invest like him, obviously that's not going to help.

I think investment books have been a huge part of my education as an investor. Has it made me a better investor? In some ways, what do you think? I don't think you can make you a better investor. It could probably make you a more aware investor. If you read books that were written a while ago, it just gives some context to what was actually not just happening in time, but what people were experiencing. Yeah, a lot of it has to do with when, yeah, so I just read this book called Only Yesterday.

It was called an informal history of the 1920s, and it was written in 1931. So I think if you read a book that's a historical book and it's written decades later, I think it loses a little bit of its luster because that person probably wasn't there. They're looking at other sources of information. It's still probably helpful, but this guy was there. he had a really great quote and you know we think of this behavioral economic stuff as being pretty new but i think people people realize it in the and you know at the time too so he was writing about the roaring 20s bull market and so he talked about the other side of it and again he wrote this

in 1931 so the worst of the great depression wasn't even over yet but he wrote about you know he said prosperity is more than an economic condition it is a state of mind and he said the big bull market has been more than a climax of a business cycle it has been the climax of a cycle in American mass thinking and mass emotion, which I thought was a pretty cool way to explain it. And the fact that he wrote that book at the time gave me a really cool view into that little window and history of that period.

But I think just reading about history is not enough. It's, you know, experiencing it in the real time is much harder. I agree. Yeah, I think reading definitely helps. You know, I was almost something of a solo education on investing. I thought I did it through books, and that was definitely helpful to me,

but without that real-world experience to actually feel what's happening in the time, I don't think that it just reading can work. What's the, what's the Buffett? Quote, if the past history was all, there was to the game, librarians would be the richest people in the world. Yeah, didn't we quote Buffett in the last episode?

Okay, one more, and we're done for the year. We have a 20 punchhole rule with Buffett. Yes. Okay, what else do we got today? So, okay, this was kind of interesting. I wrote a piece recently, and I used an example from this book called The Simple Rules, which is one of the better books I've read in a while. And it was just, it was right in our wheelhouse.

It was why Simple Rules beat Complex Rules. And I wrote a story about the White Stripes and how they use constraints to make their albums and how they did an album in like 18 days because they placed constraints on themselves. And so this reader emailed me and he said, you know, this reminded me of a phrase that I've used throughout my career. I think he was like a marketing and design guy. And he said strategy is about sacrifice. It's the dumbest thing I've ever heard. Yes.

Next. But I thought that was a great way to view, you know, not just business strategy, but investing it, because if you want to have a successful investment strategy, at some point you have to be able to let go all the other bullshit out there and understand that there's other investment strategies that are going to be working better than yours, but you have to, like, let them go and be okay with that, that you're accepting your own strategy. And I think that's, I thought that was a good way of putting that. Yep. So I'm going to bring back Buffett just for one more sec. So Morgan Housel just wrote a piece that was excellent called the Freakously Strung Base. And the gist of the post was how powerful compound interest was, interest is. And he said, quote, what if Buffett got serious about investing when he was age 22 just out of college instead of age 10? Imagine he spends his 20s learning about investments and his net worth at age 30 was still in the impressive 90th percentile. Using today's net worth percentiles and adjusting.

in the 1960s, ever's inflation, that would mean he'd be worth about $24,000 at age 30. And then from there, we can do some calculations. If at age 30, Buffett was worth $24,000 instead of the $1 million, he actually accumulated and went on to earn the same returns, how much would he be worth today? $1.9 billion instead of the $84 that he's worth or something like that. Not bad for a closet indexer. Isn't that nuts? Yeah.

Huh. So Morgan, another point that he made was there's 2,000 investment. books, winning on Buffett, talking about being the best stock picker of all time. But the real secret to Buffett success is just time. He's been investing for the last 80 years. Right. Yeah. And the majority of it has come after what his 60th birthday or something. Yep. Yeah, which is crazy. Yeah. And so I read, I wrote a piece recently on the 401k market and they showed a stat in there where they showed different financial goals by age. And they broke them out by 20s and 30s, 40s and 50s, and it basically showed that people don't really think about retirement

saving until they're in their 40s or 50s for a number of reasons because they're trying to spend on their family in their house and get more liquid and have a cash savings built up. Obviously, the huge problem there is that they miss out on all that compounding. So obviously, we're never going to be Warren Buffett. But people starting early, that's a huge mistake if you don't have that wind at your back. And so if you don't start into your 40s or 50s, you have to have a huge extremely high savings rate to be able to retire and you don't have the compound interest from your 20s and 30s that you can use to build on basically.

Charlie Ellis has some great stats about that. I think he was talking with Ted Citey's on his podcast about the damaging effects of starting a little bit later. Do you remember that? Yeah. No, I don't have the exacts. I might happen on my blog somewhere, but yeah, no, it's true. And I understand why that's the reality for most people.

They have other priorities when they're younger, and it's hard to do, but that's something that if I could change, I would. I would have started saving much more right out of school if I could have. But reality is, a lot of people actually don't have the ability to, which kind of is tough, but that's the hope. So tomorrow is our second annual evidence-based investing conference in New York, and Jason Zweig, who is the blog father, did a really, really good interview. with ETF.com, and one of the things he said that I loved was how people behave is a matter

of percentage points. We kind of know that from many studies that have looked at what a lot of people call the behavior gap, there's not much doubt that's roughly a percentage point and a half or more compounded over the course of an investing lifetime. We focus a lot on the basis points and probably not enough on the percentage points. Ooh, that's good. Yeah, so people focus on the minutiae and not the big things. Right. Yeah. I think that's the thing that, trips up a lot of people as the minor details instead of focusing on the big wins because it's

you know people want to talk about and this is probably a fault of ours too in the investment industry we debate about things like passive versus active in which smart beta funds are the best and how useful is that really to people not at all right it's yeah it's the big things what's your percentage of money you're saving

are you making more money over time are you behaving with your investments instead of flip-flopping and going into different things all the time what makes is your portfolio between stocks and bonds. Right, yeah, the big, yeah, the big, yeah, asset allocation. Those are the things that matter. The individual pieces that you select to get that exposure, much less important.

Yes, I agree. Yes, get those big things right, and you're 80% of the way there, and then you can worry about the minutiae from there. But, yeah, most of those things don't matter. So in holy shit news, Bill Miller, the investor from Leg Mason, who beat in the market, he's not at Leg Mason anymore. He started his own thing, I think? I think he's still technically, did they spit him out?

or, anyway, they did something like that. Yeah, he has his own, yeah, he has his own investment for Miller Value Partners. So he beat the market for 15 straight years, which I don't think that has ever been done. Nope, that was a record. Pretty remarkable. So anyway, he has a hedge fund where a third of his assets are invested in Bitcoin, which is insane. I think he's up 75% year-to-date that fund. And the article from the Wall Street Journal says, in his latest letter to the hedge fund investors released this week, Mr. Miller said the fund paid an average price of about $350 for its Bitcoin, which traded on Friday morning above $5,700, which is hilarious because today it's, what day is, is today Wednesday?

$6,500, it broke today, I believe. Right, so on Friday it was at $5,700, and on Wednesday, it's at $6,500. Yeah, I think the hedge fund is a smaller piece than his other one, but it's pretty remarkable. I think he said he started off at like a three or five percent position. So if you do the math, basically the growth of that since he bought it, he just hasn't trimmed it, I think. I mean, that is incredible. He bought Bitcoin at $3.50. Did you ever read the book about him?

No, what is it? But it's called The Man Who Beat the S&P investing with Bill Miller. No. It kind of talks about how he calls himself a value investor, but he's very unconventional. He takes more concentrated positions. His idea of quote-unquote value is much different than the traditional Benjamin Graham thoughts of it. Hold on. I think it's time. We put some money with Bill Miller. Okay. It's an interesting book, and he's had his hits and misses over the years. Remember, did you hear the story about him in Bear Stearns during the crisis where he was at an investing conference and he talked about how he should put a bunch of more money into Bear Stearns?

And that was the day Bear Stearns went bankrupt and got sold to J.P. Morgan. Wasn't that in the big short? That might have been in that book, yeah. I saw it in a few different places, which is a great and classic story, I think. But yeah, so he's had his hits and misses, but credit to him. him for sticking with this so long, whatever you think of the asset. It's pretty, it's pretty impressive. Let's talk about one more thing before we go. Catastrophe. Oh, yes. That's a great show. So catastrophe is the perfect style TV show. It's on Amazon, it's three seasons, and here's why it's perfect. Six episodes per season, and each episode is only 24 minutes. Yes, it's the perfect binge watching show. So you were on this train pretty early, right? Yeah, we binge the first season, and we've done all three since.

And you just watched it. I just watched it. It's a hilarious show. It takes place in London by an American guy, Rob Delaney, is the guy's name. He's a comedian. I think he actually became a big comedian through Twitter. Yeah. Is that the story?

That's right. And he ends up falling for a girl in London. They have kids, and it's just all sorts of bad things happen to them. And it's really funny. And it's a really easy one to binge watch. 24 minutes. It's perfect. Yes.

My wife likes it. I like it. It's a good one for couples, I would say, right? Yeah, perfect for couples. All right, let's get a place to leave it. Thanks for listening. You could reach out to us at Animal Spiritspod at gmail.com. Ben is on Twitter at a wealth of CS, and I am at Michael Batnik.

Tune in next week to get our year-end S&P 500 price target. Yep. Thank you.