We Study Billionaires - The Investor’s Podcast Network - TIP 065 : Yale Professor, Robert Shiller's Book, Irrational Exuberance (Investing Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 65 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is the Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish and Stig Broderson. Hey, how's everybody doing out there?

Starting point is 00:00:30 this is Preston Pish, and I'm your host for The Investors Podcast, and as usual, I'm accompanied by my co-host, Stig Broderson, out in Denmark. Today, we're doing a book, and the name of the book is Irrational Exuberance, and this book was written by Robert Schiller. And for many people in the econ, you're probably very familiar with Robert Schiller. He's a professor out at Yale University, just really renowned for his Cape Schiller ratio that we talk about on the show a lot. But he wrote this book called Irrational Exuberance.

Starting point is 00:01:00 See, this book came out right around 2000, isn't that right, Stig? Yeah, just before the burst of the dot-com bubble. Okay. So right before the burst of the dot-com bubble, he came out with this book. And the reason we're reading this book is because Wilbur Ross, who's a billionaire here in the U.S., I think his net worth's around $2.9 billion. He's the one who has endorsed this book, and so that's why we pulled it out. And we are also curious to read it for ourselves because we talk about the Shiller ratio

Starting point is 00:01:25 so much on the show as a metric for valuing where the market's at. So we're going to get to that later on in the show. First, what we're going to be talking about, and this is at the request of many of our listeners, they want us to talk about the current market conditions before we do our book review. So I've assembled a list of a couple different things to talk about. And I'm sure Stig has some things that he wants to talk about. So just between the two of us, we haven't talked about any of this stuff because our time is pretty limited together. Usually when Stig and I are talking, it's only whenever we're recording anymore. So Stig and I have not talked about this on email or anything. I have no. idea what he's going to say. So this is just a straight-handed conversation between the two of us on where we think things are at. And just so you know, right now, it's the 7th of December, 2015. So if you're listening to this, this probably won't even be released until the middle to the end of December after the Fed's going to make their decision on what they're doing. So it's going to be really interesting to hear our thoughts after the fact on what's going on. So just so everyone knows, 7th of December is when we are having this conversation. So Stig, let's open this up. Let's

Starting point is 00:02:30 Let's ease into this before we get to that Fed discussion. And let's talk first about, I have a real quick topic about China. Two different things on China. First, their market seems to be coming back a little bit of a recovery from where it was at in August. In August, it was sitting at about 2,900. And now here at the 7th of December, it's sitting at about 3,500. So it's gone through about a 10% growth, maybe a little bit more from their big meltdown

Starting point is 00:02:58 there in the summer. So any thoughts on that or where you think that that might be going? Yeah, Preston, I think we covered this a few times. Sometimes when you say macroeconomic things to me, which is like China falls into that category, even though we talk about the stock market, sometimes you just say, oh, Preston, that's in the two hard pile. No, but it's definitely a bad answer for me to give because like if you're guessing, which yield, for instance, is doing this book, you have to be really courageous because you can be wrong. And it's probably just too easy for me to say I don't know.

Starting point is 00:03:28 but I literally don't know what's going to happen with China. I think things still look ugly over there and whether or not you'll see a short rebound or a small rebound these days. I still don't want to be invested over there. I don't know what you think. I have the same opinion. So I have no idea what that means. I just know that it's somewhat stabilized from where it was at.

Starting point is 00:03:48 And I'm a little hesitant to get back in there. Most of it comes down to the accounting that takes place over there and whether I trust it or not. I think long term over the next 10, 15, 20 years, I think China is going to do fairly well. But in this short amount of time, like in the next couple months or whatever, there's a 10%, 15% increase from August. I have no idea what that means. I just know that it's somewhat stabilized.

Starting point is 00:04:12 And I know there's been an enormous unprecedented amount of government interference in order to stabilize that price. So what does that mean? And that's one of the reasons I'm staying away as well. The other thing that I wanted to highlight on China, though, was their RMB, their currency, was added into the IMF's basket of currencies. And I think that this is a really important thing to talk about. For everyone out there, if you don't know what any of that means, what I just said, you've got the IMF, the International Monetary Fund. And what the International Monetary Fund does is it has a basket of currencies and they've taken that basket of currencies to create their own currency.

Starting point is 00:04:50 So you've got Fiat currencies on top of Fiat currencies. what this is. But what they've done is they've taken the most dominant currencies around the world. The U.S. dollar was a very high composition of this. You got the UK currency. You got the euro in this basket of SDRs. SDR stands for special drawing rights. And that's a currency in itself. Now, this isn't a currency that, you know, if you go to the bank and say, hey, I want some SDRs, you're not going to be able to get it. What this is is the IMF basically lends their SDRs and they lend their currency, which is basically, if you were looking at it from a hierarchy, the SDR would sit on top, and then you'd have this basket of U.S. dollars and whatnot beneath that. So they would lend this

Starting point is 00:05:33 out to emerging market countries that might need the money, things like that. That's why the IMF was set up. And we could get into the whole history of the IMF. And this is a very long discussion. So I'm going to try to make this as short as possible and kind of simplified as much as possible. But that basket of currencies, China's R&B was not included in it. When did they make this decision? Like two weeks ago, Stig? Yeah, it's not too long ago, no. Yeah. So about two weeks ago, the IMF finally made the decision that they were going to allow the R&B, the Chinese R&B, into their basket of currencies. I don't remember the composition. I want to say it was like 15%. Is that right? Do you know? Yeah. I'm looking at some numbers here. It says just short of 11%. And just for comparison,

Starting point is 00:06:14 the dollar is 42%. And the euro. was 31%. So the idea here is, like right now, we've got the dollar really strong. So that's adding value to the SDR because it's a component, a subcomponent of it. Now, if let's say the dollar starts to weaken and then maybe the euro gets stronger, say that starts to reverse itself, which I don't see happening here in the short term. But let's just say that that starts reversing itself. That would basically offset and the value of that SDR would be remained to be unchanged, which is the higher level currency that oversees all these baskets underneath of it. You would see that offset, basically, the SDR wouldn't change value.

Starting point is 00:06:56 So the idea is if all these central banks around the world are printing through the nose and they're devaluing altogether, the SDR is really not going to change in value at all if that SDR is tracking all the main currencies in the world. So that's a discussion. That's what's really interesting about that. So you're probably saying, so what? China's currency is now an SDR or in the SDR. So what that means is that China's really kind of emerging as a global power here.

Starting point is 00:07:25 The IMF would not be including their currency in this basket if it didn't have some buying power and some staying power. So what you're seeing is that this R&B is now emerging as a global currency, which we haven't seen in the past. And I think that that says a lot about the direction that maybe the Chinese economy is going. So Stig, any thoughts on this, R&B, IMF, SDR, we got any other acronyms we can throw out there for people? Yeah, you know, Preston, in a way I was surprised. In a way, I wouldn't surprise at all. Because obviously, like China with the size of the economy,

Starting point is 00:07:59 they should be a part of that basket. But it's really hard to find a currency that is manipulated as the Chinese currency. So I was also thinking they probably weren't included because it would simply not be stable enough, also because it's tied so much to the doctor. and what they're doing in America. So I was thinking, they're probably not going to do that. This is IMF.

Starting point is 00:08:18 The whole thing about IMF is to bring stability to the financial system of the world. So inherently, they should not look at China, but still they are. I think this is just a new world order that we're seeing in currencies right now, and perhaps it's transition. I don't know. Preston, would you be surprised to see the dollar be less significant world currency in years to come? That's a really hard one. I think in the immediate term in the next year, definitely not.

Starting point is 00:08:45 I think the dollar is going to continue to do extremely well over the next coming, let's call it the next four months. I think the dollar is going to do really well. But after that, that's hard to say. I think that it is going to definitely have a turn here in the future within about a year from now. I think the dollar is going to eventually have a turn. But for the time being, I think that it's definitely the place to be these days. Over the next 10, 20 years, it's really hard.

Starting point is 00:09:12 to see what happens out of China. I think that, like we had previously discussed, the big concern is government intervention at what level is that occurring? If you pull back the blinds and take a look at their books, because they don't have like their SEC that's really kind of regulating them at the level that you see in the U.S. or anywhere else in the world for that matter. So that's where I'm concerned as an American. It's just a lack of knowledge. I don't think that it's anything more than my lack of understanding of how they operate over there. One thing I really want to talk about is what's happening in Europe right now because what the world has probably been talking about, like whenever you hear this,

Starting point is 00:09:50 is that what Janiel would do with the Fed and the interest rate. And so what I want to talk about is what we're doing here in Europe, what ECB, the European Central Bank is doing. And just to give you some context in terms of what the deposit rate here is, and the way to think about that is, what type of research. returns can banks achieve whenever they're depositing with the ECB. And so if that rate would be high, ECB would not provide banks with an incentive to lend that money out to customers because they will get a high return having it at ECB.

Starting point is 00:10:23 But right now we see a negative interest rate and it's even more negative now than what a week ago. So what that means is that they really want to give banks an incentive to lend out money to really spark growth. So basically banks are paying money to have no store it at ECB right now. This is not unprecedented, but it's rare that you see such negative interest rates that we see here in Europe. And what is even more interesting is that Drahi, which is the chairman of ECB, he has also extended the quantitative easing.

Starting point is 00:10:56 It should be stopped here in September 2016, but he extended that with six months. So right now here in Europe, we are running the program to March. 2017, and that is 60 billion euros bought back from banks every month right now. So that's really significant. And this is a really interesting concept. We talked about quantitative easing before, and just to give you a quick reminder, basically that is ECB rearranging the balance sheets for European banks. So basically, they're providing reserves instead of the bonds that banks are holding right now. And that is all in the hope that banks will start lending out, generating more credit and spark growth. But so far, it hasn't happened. Preston, I see you have,

Starting point is 00:11:41 definitely have an interesting comment to that. No, I just, I want to talk about quantitative easing real fast and how much I think that it's just maybe not the best mechanism to induce spending. And I mean, that's what they're trying to do. They're trying to add liquidity to the system. And they are. I mean, it's absolutely having an impact. It's just not flowing through all the channels. And I, I think that's my issue. So if you're Joe Schmo in town XYZ in the U.S., you're not seeing that money flow through your pocket. I guess my concern with quantitative easing is it's the wrong filtering mechanism. You need something that basically goes through all the people within whatever region it is that's their country that's executing this quantitative easing instead of just interacting with some major bank and buying back all the bonds on their balance sheet and providing liquidity that way because it's basically just coming into the system at the very top level of whoever owns that company. That's my concern. So, like, Like, why don't we take this approach where, you know, everyone files their taxes at the end of the year? Why don't you do this approach where you're providing liquidity through the system through all these people that are filing their taxes by, you know, providing refunds of some sort and flowing the money that way so that it flows through the entire breadth of the population of that country?

Starting point is 00:12:56 That's where I think they're making the big mistake here. If they need to provide liquidity, which is really kind of the issue here, I think they need to go about it in multiple directions. and I think they really need to focus more in the direction of getting it through all the population. And I just don't know enough about it. I haven't done enough research to speak more intelligently on it, but I think that that's where they're making the mistake. Yeah, and the way to think about quantitative easing is also that the liquidity that is provided, because banks have more liquidity is not the same as society will benefit from that. Because if there is not any credit worthy customers, they're willing to borrow money, it really doesn't matter.

Starting point is 00:13:32 like banks can be flooded with cash, but if you don't want to lend it out, and they won't, if they, I mean, they don't want to lend out to anyone who just say, hey, I need a loan. It has to be credit worthy. Then nothing is really happening. And that is what you have seen in Japan for so long now. It's not enough that you put out cash in the society if no one's going to spend it, if no one is going to borrow it and start investing it. And I think that's, you can't just force that.

Starting point is 00:13:58 And I think you just see the same pattern in Europe as in the US is that you might see soaring stock market, but you don't see the real growth in society from these initiatives. And I think that's concerning because that's what leads to bubbles. So real fast on the Japan, since you mentioned that. So back in August, the Japanese market, and this is, I think when we first started talking about this, the Japanese market was at 20.5K on their index. Now they're down at 19.6. So it's had a little bit of a pullback, not much, about a 5% pullback. But I do want to say that on the 16th of November, Japan, has officially slipped back into a recession. That's the fourth time they've been in a recession in the last

Starting point is 00:14:38 five years. So we've said it before. We think you should stay away. The PE ratios over there in Japan are very appetizing. Let me tell you, they're like at a 10, which means you might be able to get a 10% return. My concern is with the currency. I think they've got major, major concerns with that currency over there. And I think that that might be why you're seeing such a low PE in Japan, that I'm staying away, I am not getting lured in over there. Let me tell you, I'm staying away from that market. And Stiggs nod in his head that he's doing the exact same. Yeah, I've definitely not looking at Japan. If you look at the parishes, which is also a concert that we touched upon a few times, it might look like the yen is undervalue. So that would actually say that you should start

Starting point is 00:15:20 investing in the Nikai index. But still, that's not a game that I play. I usually don't play on currencies. But that was just an interesting observation I had with a colleague the other day that was doing some model forecasting on currencies. So I don't know. I definitely don't want to say that you should start investing in yen. But the parrots might suggest that all the long term, but that's a long time when you talk about currencies. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:19:34 sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. The last thing that we want to talk about on the current events, I'm curious to hear Stig's thoughts on what the Fed's going to do on the 15th. Now, here's the thing.

Starting point is 00:20:01 Like I said, people are going to be listening to this after we already know what happened. So let's just see how wrong we can be. We have no idea what's going to happen, but we're going to make some guesses here so everyone can laugh at our expense if we're right or wrong. So my opinion is that they are going to raise rates. I think they're going to change the federal funds rate by 25 basis points. And that's it. I'm not going to say anything else.

Starting point is 00:20:24 Now, I want to hear Stig's prediction. I think you might be right. Also with a new job report that just came out that was really positive. So yes, racing rates would probably be the right time. And now they have been talking about it for so long that the market almost expects that. So perhaps it was like a strategy is a very cautious strategy that they were flying for not to give any shocks in the financial markets. So I think I'm with you on this one, Preston. I can tell you one thing. If they don't raise rates, I cannot wait to see what the reason is. Because I mean, they've painted themselves in the corner. They said that, you know, they had to have international stability, all these other things. And I think that they've got that since that last report. So we'll see what happens. So the last thing I want to talk about is an article by hospital. I saw this really interesting article here the other day because Preston was actually sharing this article over LinkedIn.

Starting point is 00:21:14 That's sometimes how we communicate and exchange information. That's how we usually communicate. That's usually I communicate. Whenever I see Preston has uploaded something or shared something on LinkedIn. And it was really interesting because he was saying that the market valuation today is so high that he was expecting a 1% annual return over the next 12 years. And so since that will also include dividends, if you just look at the index, you might see a declining index from where we are today and the next 12 years.

Starting point is 00:21:45 And he might be saying, well, you might think that this is impossible, that we haven't seen this before. But look at 2000. It took 12 years in 2000 before the market. really rebounded. I think that's the best handoff to give to irrational exuberance, which was originally written just before the burst of the dot-com bubble. I just think I want to leave you with that. I don't know if he's right or wrong, but that is what he predicts like, this is the new 2000. Just my thoughts on Hussman real fast. So I love his writing. I really enjoy reading everything that

Starting point is 00:22:16 Dr. Hussman writes. And we'll have a link to this in our show notes in case you haven't seen anything that he's written before. He's very analytical. He really. really understands market valuations really well. You can tell all that in his writing and his research and things like that. Now, with all that said, his performance over the last, like six or seven years in his own fund has been very poor relative to the market. He has done very badly. Now, he hasn't lost money, but he really hasn't gained money either. So I think that that's a really important highlight for people to realize that when the government was doing all this quantitative easing, he was not buying it. He was basically sitting on the sideline.

Starting point is 00:22:55 is just protecting his principal and really miss this entire growth in the market over the last six years. That's important to highlight, and I think people should know that. But with all that said, I still thoroughly enjoy his writing. I think he definitely knows what he's talking about, and he's very good at laying out market valuations in a broader sense. Real quick, I want to go back to this Fed decision and potentially the impact of what would happen.

Starting point is 00:23:17 So let's just say that the Fed does raise rates. If that does happen, which we don't know at this point, and you as the listener right, now actually know what happened. But if the Fed raises rates, I think that the impact is, obviously, the dollar is going to get stronger relative to all the other currencies. I think that that's going to be bad for U.S. businesses. It's going to be much, much harder for them to compete in the global economy if the dollar gets stronger. I think that that's going to lead to earnings power and margins to decrease in the United States market. I also think that high-eal bonds are going to really start to go through the roof because I think that all these emerging markets that have a lot of dollar

Starting point is 00:23:59 denominated debt are going to have a harder time to repay their debt. I think that the fact that the European market is easing in combination with the U.S. market tightening is only going to make that strength of the dollar even more dramatic. I think that you have the potential to see oil prices actually potentially go down. I think that this is a hard one to forecast, and I think this one's going to be a hard one to call. But I think that you're going to potentially see oil even go low, when the dollar could potentially strengthen if the central banks decide to tighten more. I think you're getting to a real close breaking point with all this oil stuff and these commodities. I'm watching this very closely. I am sitting on my hands when it comes to the oil market.

Starting point is 00:24:41 I have a lot of people asking me what my opinion is. But as of 7 December, I still have not entered into the oil market yet. But I'm telling you, it's getting very close and I'm watching this thing like a hawk. and I'm getting very tempted to start diving in. So with all that said, the stick just gave me the thumbs up. Like, hey, just let's get going here, dude. So with that said, let's talk about the book that we read, Irrational Exuberance. This was a very good book, but I guess I didn't like the writing style. I'll be honest with you.

Starting point is 00:25:13 The content was very good. Like what he's talking about is obviously, I mean, this guy's obviously brilliant. Don't get me wrong. But I was not really a big fan of the writing style. It was a little dry. Very good points were made in the book. I guess just the way that they were presented was where I kind of struggled with it. And it didn't help that we were reading Liar's Poker at the same time, which that book is highly entertaining. So I was reading this one and Liar's Poker simultaneously. I was basically swapping back and forth between books. And I think it made this one a little bit more boring as I was reading it because Liars Poker, which we're going to talk about, not the next episode, maybe the episode after that, was very entertaining. That's going to be a fun conversation. But anyway, so let's jump into some of the key points that we pulled out of this book real fast. Before we start doing this, this is where this book and the name of this book really came from. So back in 1996, I believe it was, Alan Greenspan, the chairman of the Federal

Starting point is 00:26:11 Reserve, made a speech titled The Challenge of Central Banking and a Democratic Society. And this was the quote from his speech back in 1996. He said, clearly, sustained low inflation implies less uncertainty about the future. The lower risk premiums imply higher prices of stocks and other earning assets. We can see that the inverse relationship exhibited by price to earnings ratios and the rate of inflation in the past, but how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade. So basically what he's talking about here in 1996, he's saying inflation keeps going down. And it has since the early 1980s, whenever Volcker

Starting point is 00:27:01 basically put an end to the insane inflation rate. And as that's coming down, he's basically seeing a very similar thing playing out to what was happening in Japan. And if you know your history for Japan back in 1990s whenever the market in Japan basically exploded and has had trouble ever since. So he's basically saying at this point, Alan Greenspan is saying we're seeing the same thing happen

Starting point is 00:27:25 here. As interest rates go down, that's going to push asset prices up and how do we know where the top of this irrational exuberance is as those interest rates continue to push lower? That's what he's saying in that very fetish speaking paragraph that I just read, which makes people's

Starting point is 00:27:43 eyes glaze over. That was pretty much the premise of the book. That's where Robert Schiller wanted to open up this irrational exuberance, this discussion of growth, basically continuing to go down, inflation decreasing, which then pushes up interest rates. So whenever you go to our intrinsic value calculator on the Buffett's books website, and you play around with that a little bit, and you adjust the interest rate, which is how you're comparing the value of the business to, and you push that interest rate lower and lower and lower. What happens to the market price of your, asset. So if you don't know the answer, I'd highly recommend that you go to our website and you play around with this thing and see what happens. But what happens when you lower that interest

Starting point is 00:28:22 rate that you're comparing it to, the market price and the intrinsic value goes up. It goes higher. So when we think about this in a broader context, and you're talking about the market in general, and interest rates are continuing to go down and down and down. And like Japan, they're at zero percent. They've been there for like five to ten years. They haven't moved. When they bottom out at zero percent and everything's getting polarized at zero percent, it pushes asset prices through the roof because it's basically saying, I will buy this asset at a 1% return. But when you do that, it pushes the price super high. Now, let's say that we were using 20% or a better example, it would probably be 16% back

Starting point is 00:29:00 in the 1980s. The price that you would pay for that is much lower because the price and the yield are completely inversely proportional, just like a bond. So that's an important concept for people to understand before we go much further, because that's really the premise of the book and that's what Schiller's really getting at is what is causing this. What is causing this churn and what's going to be the impact in the future? So as we go through the book, I'm going to just highlight the first thing that Schiller talks about. And the first thing that he talks about is really his Schiller P.E. ratio in the first chapter here where he's talking about the stock market level performance in a historical perspective. And so what he says, whenever this is written back in the early 2000s, 1990 range, he's saying that, hey, at this current market, evaluation, you're going to pretty much not get any return over the next 10 years. And he was right. And he was exactly right. Yeah. So if we go to 2010 and we look at where the market moved over a 10 year period, it didn't move at all. And he was exactly right whenever he wrote

Starting point is 00:29:57 this book. And so that's what he's getting at. And that's what Stig was talking about with this Husman article. Husman's looking currently at the market prices. And Husman's saying, hey, at the current market level, and 10 years from now, you're going to get a 1% return. If you'd buy the market, say you'd by the S&P 500 and you just sit on your hands for 10 years, you're going to get a 1% return in 10 years from now. That's what Hussman is saying, Dr. Hussman. Yeah, and he's actually even using Shillis P.E. in his argumentation. Or apparently there's like a 95% correlation or something.

Starting point is 00:30:26 So it actually does explain or not that the Shill P.E. That person I've been talking about. I was really interested in this chapter. And also because he kept talking about 1929 and what we could learn from that time period, just as we're talking here in 2015 about what we were. we can learn from 2000. And what he's saying is that the market was so high in 1929 that it took 29 years for the stock market to recover. So after this chapter, he gets into this discussion of, okay, so why has the market pushed multiples so high?

Starting point is 00:30:58 And so the next chapter he gets into, it's called the internet, the baby boom, and other events. And what he does is he goes through and he's talking about all these external events that he thinks has potentially manipulated the mind of the market in order to drive these multiples, these valuations so high. And so he goes through each one of those, he talks each one of them in depth and talks about why something may or may have not really kind of led to the market valuations we saw. I think that the internet was such a game changer back in the 90s and, you know, looking back at that from where we're at right now, there was so much excitement and so much expectation built into the fact that, hey, you could start your own online business, reach a market of the world, and something that we hadn't seen

Starting point is 00:31:44 from, you know, previously where you basically had to have a brick and mortar store where your only market size was the number of cars that drove past the store. This was a game changer, and this is something that was definitely adding to the multiples that were being paid on companies. Now, one really quick highlight before I throw it over to stick is Greenspan didn't help things at all. If you go back and you look at bond yield curves from 1996, I want to say, or 1990 95 to the peak of the bubble in 2000, that yield curve was completely flat at, I want to say, like 6%, I mean, this is all at the top of my head, so I might be wrong, but it was around that number.

Starting point is 00:32:21 And he let it flat, he just let those interest rates stay right there. He didn't even raise them for like four or five years. He just let it sit. So what do you think's going to happen if you got all this excitement, you're not raising rates or tightening? It's going to continue to go wild, and that's exactly what happened. So I think Greenspan was very guilty in the fact that he was not tightening anything. He was allowing it to occur for a very long extended period of time.

Starting point is 00:32:44 Go ahead, stick. Yeah, before I actually transitioned into my point, I just have a quick note on Greenspan. I think I know it's easy to be a Monday morning quarterback, but I think his main mistake was that he wanted the stock market to be a driver. And that's definitely not how I see it. I don't see the stock market as being a driver for the economy. I see the stock market as being the end result of a well-run economy, not the other way around. And if you rely on the stock market to drive the economy, you're simply just creating bubbles, which will help no one in the long run.

Starting point is 00:33:18 But my main point was actually that what Shiloh does, and he doesn't do that in Chapter 2, but in Chapter 5, but that doesn't matter. He's really comparing what happening in 2000. Again, he's comparing that to what happened in 1928 and 1929, when he's a lot of the year. is saying this is a new economy because the arguments back then, and he actually quotes Moody, the founder of Moody's from 1929, who is saying, yeah, I know that the stock market is really high right now, but we're transitioning into a new era, a new economy. So that's why we can justify having these high valuations that had back then.

Starting point is 00:33:55 So he was saying that, well, we have new techniques for production. So he was referring to forged production lines. We are starting to advertise differently. This would create demand. And he was also saying that we have tax cuts. All of these changes justifies that we have the high multiples that we have right now. Now, if you rewind back to 1999, like people didn't say Ford's production lines, but they were saying something different, right? They were saying the internet and banners and clicks.

Starting point is 00:34:28 and everyone thought that, hey, this is a new economy. That's why we can justify having 100 PEs multiples. And what she was basically saying is that, no, we can. If we had a single company that had access to the new technology and other companies haven't, he might want to invest that company. But it's not like you can say, if everyone starts to use a new technology, then the world will just, you know, from one day to the other justify more than a doubling in stock prices from an average level.

Starting point is 00:34:58 That's just I'm going to happen. Stig brings up a great point. And this idea of multiples is such an important discussion for people to have if they want to understand any type of expectation that they have on getting a return. So let's look at today's market. Let's talk about Amazon, which is usually a topic that we enjoy going over. What's the multiple on Amazon right now? So if you own Amazon and you can't answer the question, that's not a good thing.

Starting point is 00:35:22 You need to know this. So Amazon, the multiples close to a thousand, I would say a normal. multiple on a stock is a 15. So what do you get when you have a multiple of a thousand? Okay, that's a 0.1% return. 0.1%. That's like nothing. Now, the reason people are paying so much for Amazon is because they have this expectation that the revenues are going to continue to go wild and that's going to continue to get bigger. So it's not in a steady state condition. But with Amazon, you would really have to have some just insane amount of growth to be able to justify a multiple of 1,000.

Starting point is 00:36:01 I think you bring up a good point here, Preston, when you're talking about Amazon and how it might be valued based on revenue instead of how much money they're making. And I just can't help thinking about PayPal, which is another one of these companies that emerged back then when they were making no money at all. Actually, back then, PayPal paid $10 for every new customer.

Starting point is 00:36:20 You were actually getting paid to become a new customer of PayPal. And that customer generated, I don't know how much revenue. and then PayPal was sold based on that multiple. I'm not saying PayPal a bad company or anything. It's just a problem if you start valuating a company based on the revenue and not on the bottom line because in the end, it's the profit that company is generating that flows back to you as an owner. Revenue is great, but if you have higher cost, what does it help?

Starting point is 00:36:45 At the end of the day, it all comes back to, you know, you can hold on to a company for five, ten, but eventually it will always come down to what's the net income profit of this company. and that's what it's going to be traded on. So real fast with PE ratios, I want to give people a little tip. So if the PE ratio is a 15, what does that mean? What in the world does that mean? So it's actually 15 over one. So that means that you're paying $15 to own $1 of earnings in a one year period of time. That's what that means. So if the PE is a 25, that means you are paying $25 to earn $1 of earnings one year later. So Amazon, a P.E. of a thousand. You're paying $1,000 to earn $1 of profit one year later. That's what that means, folks. So when we're saying these multiples, a lot of the times we just throw these things around and we don't really break it out for you. But for the beginner who's out there listening to us, that's what that stuff means. That's why it's so important for you to know your

Starting point is 00:37:47 terminology before you get involved in any type of financial market because it will eat your lunch if you don't know what you're talking about. So that's really important stuff for people to understand moving on because we talked about that one probably way too long. But let's go to the next chapter. And we're just kind of just picking through this is the high points that we saw real fast. In chapter three, he talks about the amplification mechanisms naturally occurring in Ponzi schemes. I felt like this chapter resembled a lot of the alchemy of finance by George Soros, who's also

Starting point is 00:38:17 one of the billionaires that we talk about from time to time. George Soros wrote this book. It's called The Alchemy of Finance. And really kind of the whole theme of the book is that success breeds more success and the psychological piece of that. Fallbacks or shortfalls breed more shortfalls. And that's what he's really getting into in this chapter is if a company's doing really well or the perception that the company is doing really well, that means that they can now

Starting point is 00:38:43 go out and get additional funding, even though they might not be doing all that well. If the perception is that they're doing well, they can now procure more funds. The fact that they got more funds means that they now might have the opportunity to actually perform better, which then would allow them to even grow more. That's the whole theme and the whole thesis of the alchemy of finance by George Soros, and that's what he's really talking about in chapter three in this Robert Schiller book. The next chapter he talks about is the news media. Love this discussion because I totally agree with him, where news media has this ability to basically amplify things as well. It's really funny to me when I'll pull up, call it Fox Business or the Wall Street Journal or whatever. And in the morning, they'll have this theme that's tied to how the market's performing.

Starting point is 00:39:28 Let's say the market's way up. They'll say, oh, this news event or whatever was what caused the market to go screaming higher. Later in the day, the market will just out of nowhere start moving low or maybe, let's just say it goes into the negative territory. Really no news story whatsoever. And you'll see these journalists go, start tying, oh, the negative performance of the market was due to event whatever. And that event might have happened before the other event, which brought it up. And so you can see that the media is literally looking, what's the performance? And now let me backfill that performance with whatever story has happened in the last 24 hours. Let's take a quick break and hear

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Starting point is 00:43:07 current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund fund fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. It's a really cheap way of producing journalism. He compares this to sport. He said, well, you can always come up with some kind of stories you're saying. You know, it's because we have a great linebacker or a great quarterback, whatever. That's the reason why you see these swings ups and downs.

Starting point is 00:43:43 And it's just like a game where you consistently have a new score. And it's very easy just to spin a new story on that and put it as something that is new and something that's important. And he's basically just blaming the media for a lot of the hysteria that you experience in the financial markets. So I'm going to jump to this chapter six, new eras and bubbles around the world. And this is where Schiller's talking about how the market basically values businesses and how these bubbles definitely exist.

Starting point is 00:44:15 He gives some proof on why bubbles exist, why bubbles will continue to exist. I think my personal opinion, I think Ray Daly has one of the best discussions on this where he talks about how credit cycles are the reason the bubbles exist. but Schiller gets into it a little bit differently. The thing I would like to discuss, though, as we look at the current market condition, and I really want to throw up a chart on our show notes to show people one of these ideas, is the idea of margins and how when you look at a company's margin, it's actually a very good indicator of how the market's performed over the last 10 to 20 years

Starting point is 00:44:50 and an expectation moving forward. So let's talk about this in a little bit more of depth so that people understand where we're going. So let's say that your top line revenue is $100,000 on a business. And your bottom line revenue is $10,000 on that $100,000 of sales. That means your profit margin is 10%. So everything that you brought in from your sales, you're able to pocket and profit 10% of that. So across the board, when you look at this margin, if you go back to the 1980s, the margins

Starting point is 00:45:23 were a lot thinner. Now the margins have been growing. and expanding with each credit cycle and each boom bus cycle. So in this last one, margins got as high as 12%. And now it's looking at it from an entire index. If you go back to the 80s, I want to say that the margins were around at the high, 6%, 7%, around that level. And so what you've seen is that these margins have actually grown through time.

Starting point is 00:45:49 Now, as we think about individuals buying businesses, why is somebody going to pay a bigger premium for a business. Well, they're going to pay a bigger premium because that margin is growing and expanding. Now, if that margin starts to contract on a macro level, that margin starts to contract, what are people going to do? Are they going to continue to boost up the price and pay more and more and more if the margin's dropping? No, and I would argue that that's a very good indicator that you might be seeing the exact opposite and you're starting to see a contraction occur. So the thing is, is with a 60 basis point movement down, with margins, it has always been a precursor in the last like 20 years to a recession that's coming. And right now we're actually seeing that with margins

Starting point is 00:46:35 on the income statement. And so I've got a chart. We're going to put that chart up on the show notes so people can see that, and this has usually been a pre-indicator by about 15 to 18 months before the recession actually occurs. And we're about, I want to say 10 to 15 months from where margins peak, and they peaked it around 12%. And now they're, I think they're actually below 10% at this point. But we're going to throw that chart up there so you can actually graphically see this and see what we're talking about. I think that that's a really good discussion to occur based on chapter six of the book

Starting point is 00:47:05 where we're talking about these boom bus cycles and how margins play into it. And Schiller talks about it a little bit. We probably talked about a lot more here on the show than in the book. But I think it's something very important to highlight for people. For the remaining of the chapter, I think I just have two points I want to highlight. The first one is that Ziller is saying, well, I don't think I am wrong when I say that we're in the bubble right now. But obviously, I could be wrong because as to say, it's hard to read the label inside the box. And he's saying, it's so easy looking back at past events to say, oh, it was so very clear that you saw a bubble here or there were no bubble or whatever.

Starting point is 00:47:39 But when you're in the middle of it, it's really, really hard. And then he's actually saying that if you look at all the busts in the past, it's not like it's a linear progression. And it's not like, yes, the stock market went up for 30% like that year and there were no months, they were down. It wasn't like that. The stock market was going up and down every day for like long periods, even though you were building up a bubble. So even though that you will experience a bubble right now as he projected and as what he was completely correct in, it is not so easy to see when you're the middle of it. That was basically just what he's saying.

Starting point is 00:48:13 And that's also what I think Preston I is saying right now that we might be in a bubble, we might see a crash. But even so, it's hard to see because then we have the strongest October, but September was bad or whatnot. It's just really, really hard depending on which type of time frame that you have. My last point, and that's the point that he has in the final chapter, is that he is saying to the Fed back then, and this was like in the 1999-2000 time frame, I would really suggest that you hike rates and address specifically that the reason why you should hike rates is because the stock market is overvalued. because that might be the only thing that could not prevent the bubble, but make the transition more smooth. And if I could give like one advice to Janet Littieln that would probably not listen to it at all, I would say the same thing. High grades and say this is to avoid speculation.

Starting point is 00:49:02 Okay, so here's the thing, guys. We went through the book really quickly. There is 11 chapters in this book. We have an outline of all of our notes from each chapter. If you want to get our outline of our notes for this book, and for any other book that we read, go and sign up on our email list. We don't send any marketing, you know, spam, any of that stuff. We basically send out our book summaries, and that is it with our notes on the current

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Starting point is 00:50:14 play a question from our audience. So this week's question comes from Yi Yi. Hi, Preston and Stegg. My name's I'm a big fun of your podcast and website. I learn through the lessons and I think I learned a lot, but I'm still a very new investor. So I'm wondering if you guys think using automated investing service like Betterment and Wellfront is a good idea to start with. I know they mainly deal with ETFs and they manage $10,000 of your fund for free. My question is I don't know if they can give you a good return. And also, I don't know if it's going to be actively managed and the choice of ETFs they make for you. Is that going to be? It's going to get the return I want, but I want to know what you guys think about this kind of account and what kind of suggestions you have for new investors like me. Thank you.

Starting point is 00:51:17 All right, Yiji, fantastic question, and Stig's going to take this one away. You know, this is something that's really been on a rate of quite some time because I had quite a few emails from people saying, what are you thinking about something like betterment or wealth runs? So I'm really happy that we had a chance also to respond here on the podcast. think that whenever I look at the website, something is just wrong. And I don't want to like pick on a specific company, but I think something seems to be off whenever you start to, what I would like to say, manipulating with math. So on one of these sides, you could see that because the company is using a passive investing strategy, it beats the benchmark by 1.25%. Now, so I looked into what the benchmark is, and that is active managed mutual funds. And that just, and that just

Starting point is 00:52:05 It just doesn't make any sense to me that you can say, I have a service that will beat the market, but my benchmark is active managed mutual funds. This just seems like such a random benchmark to choose. And also it's a benchmark that obviously is not random because active management mutual funds performed really bad. I would never ever start up a fund saying, okay, so this is my performance compared to Japanese bonds. if I knew that the yen was dropping and bonds was selling at a really, really low interest rate. So I think that might be misleading. So that was like my first red flag. I also think that if you want to invest in ETFs, I'm not really sure it really makes any sense to have someone manage that for you.

Starting point is 00:52:50 I think it's somewhat easy to do that yourself. I just found another study. And this was actually written by Colin Roach that we have on the podcast a few episodes ago. And he's actually looking at, I think it was Betterman. He's actually saying that the performance of the Better Man aggressive portfolio is 95% correlated to the Vanguard total world index. So I'm just thinking, why would I pay anyone to manage a pool full of ETFs when I can just buy a world market index? I'm not really sure I see the value added. Like I'm not saying that you shouldn't use advisors.

Starting point is 00:53:25 I'm not saying you shouldn't be using active manage funds or whatever. that you're doing. But if you buy into something because you want to use ETFs and you want to do it cheap, why not just do it yourself? Because it's so easy to do. My advice would be if you want to buy the market, you can actually do that for seven basis points. Yeah, I see it the exact same way. I really do. So, Yee, thank you for the question. That was a fantastic question. I know that there were people out in our audience that were asking a very similar question. So we were happy to answer that for you. We're going to send you a free signed copy of our book, the Warren Buffett accounting book. And for anybody else out there, if you want to get your question played on our show,

Starting point is 00:54:06 go to Asktheinvestors.com and you can record your question there. If you've got any questions about this episode on Twitter or Facebook or whatever, be sure to use the hashtag TIP65, and that's where we'll go ahead and answer your question there. We truly just love interacting with our audience on Twitter and Facebook and wherever else. So great to see you guys out there. That's all we have for you guys this week. We really enjoyed talking about this book, Irrational Exuberance with you, and this was at the recommendation of billionaire Wilbur Ross. So with that said, we'll see you guys next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www.com. Submit your questions or request a guest

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We Study Billionaires - The Investor’s Podcast Network - TIP 065 : Yale Professor, Robert Shiller's Book, Irrational Exuberance (Investing Podcast)

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