We Study Billionaires - The Investor’s Podcast Network - TIP174: Billionaires Ray Dalio & Bill Gross and Their Expectations for 2018 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, so how's everyone doing out there? So on today's show, we discuss some interesting comments that billionaires, Ray Dalio, Bill Gross, and even Warren Buffett had said at the start of 2018. Although we've seen one of the biggest bull markets that has lasted nine years, some of their comments suggest there could be even more to come. Now, whether you agree with that or not, I think some of their points are interesting and important for people to think about.

Starting point is 00:00:27 And so that's why we're going to play a couple clips and we're going to discuss. us what we heard on the show today. Additionally, Stig was visiting family in Denmark, so I asked my longtime friend Brian Rutherford to join me for the conversation today. Brian is a graduate of West Point and MIT, and he's previously worked as an economics instructor at West Point. All right, so I hope you guys enjoy the show. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, Brian, awesome to have you back on the show.

Starting point is 00:01:15 I don't know how long ago it was. I think it was 2015 that you and I had a chat about. What was it the seven biggest mistakes that investors make? Was that what the episode was? That's right. I can't believe two and a half years ago. Yeah, we chatted. I can't remember what episode number that was, but we had a nice chat.

Starting point is 00:01:30 I'm pretty sure there was a glass of wine somewhere in there. But I think it's a popular episode. Yeah, we talked about. investors, investor mistakes for young investors. Yeah. Hey, so back whenever you and I, because we had a lot of conversations that summer back in 2015 and we haven't talked too much since, but the market has changed, in my opinion, the market's changed a lot since 2015.

Starting point is 00:01:53 I know back then the thing that you and I were talking about on a daily basis was, hey, I don't know if the Fed can actually raise rates. You know, they kept saying they're going to raise rates, they're going to raise rates. And then they just kept delaying it. And then eventually, I think it was that fall that they raised rates for the first time at a quarter of percent. And, you know, we were all positioned for just doom and gloom to hit because the Fed had been acting so weird. They'd been doing so much quantitative easing. And then they finally raised rates.

Starting point is 00:02:25 And, you know, that Christmas, the market had a pretty big pullback compared to anything else we've seen since 2008. And then it came back up and then had another punch. fall of like 10 or 15 percent. I can't remember what it was. And then it, that's when Dragy and everyone came out and they said that they'd do QE till the cows come home and the thing just went nuts. And that's where I think I was very suspect when that started happening and I was still kind of sitting on the sidelines like there's no way this is going to hold up. But it did and it just kept going and going. And, you know, it's, it's been a pretty interesting scenario ever since.

Starting point is 00:03:05 So much uncertainty in the market, and we saw that, you know, in a couple of different ways. It laid in 2015. And then, again, when Trump was elected, I think that we talked that night during the presidential election about uncertainty and market, you know, pricing things in. And it was really unexpected. So we saw futures go way down. And then if you remember, the next day, the market was already up because there was some anticipation of what deregulation might mean and whatnot.

Starting point is 00:03:31 And yeah, we've seen just people work in concert since then. And I think it just goes counter to what, you know, we thought was going to happen when we were chatting over a year ago and then even even a couple of years ago as well. I think that the central banks, particularly over in Europe and Japan, and the amount that they've been printing with their quantitative easing has been the main catalyst for the global markets that just kept on running. What I think, and I'm going to play a clip here from Ray Dalio that was recently recorded here. And I think that Ray's take has changed substantially because I know back in 2015, he was somebody I was following very closely and he was coming out and saying things like, I think the Fed can only raise rates one time before maybe we start to see a correction here because we have zero inflation and they're paying too close attention to the short term cycle and not enough attention to the long term cycle and all of that. That's what he was spouting back in 2015. But let me play a clip from Ray Dalio here. And this, just so people understand the timeline, this was recorded in October, October 26th of 2017.

Starting point is 00:04:43 So just a couple months ago, he made this comment. And this is what he said. Are you predicting a bear market? It seems like every Friday, all the doom and the gloom comes out of higher interest rates, lower stock prices. Can Ray Dalio predict negative 18% on the end? equity markets? No, we've been long equity markets, you know, without getting too much into our positions. Anyway, I'm saying, no, the answer to your question. I mean, eventually it comes along, but we're in a different environment now. From 2008 until 2017, we were in a certain type of

Starting point is 00:05:18 environment. And that environment, it was one in which there was the pushing of interest rates down to the point of creating negative interest rates. And with a positive carry, by doing quantitative easing to push money into the system. 2017 is the transition of an ending of all of that all around the world. And we are entering a new era in which there is going to be, and there is the raising of interest rates and the reducing of quantitative easing. That action that they took in that produced significantly bad real interest rates. I mean, today, 10-year real interest rates.

Starting point is 00:06:00 are about a half a percent, next to nothing. And the break-even inflation rate for 10 years is about 1.8%. So those numbers are very low because of, let's call it, repression in order to get the economy to do that. We are now in a transition, a whole different environment. That's the equivalent of entering the late stage of the cycle, and that's when there's a tightening. Tightening's become progressively more concerning because as you move along, they're more and more difficult to get perfect. So as we're progressing, we're entering a period of greater risk and the nature of the market. So when you look at the bond market, there is risk in the bond market.

Starting point is 00:06:40 There's looks to me as a significant amount of risk in the bond market. So he ends up getting cut off there at that point in the interview. And just so people know, that source where we are pulling this from is on YouTube, the Bloomberg interview that Ray was on. And we're going to have a link to that in our show notes. So if people want to hear the whole interview and also to give credit to Bloomberg for this piece of media, it's in our show notes. We're providing a link there. So if you guys want to watch the whole thing, we highly encourage you to do that.

Starting point is 00:07:11 You know, Brian, so whenever I'm listening to this, what I find interesting is kind of raise change and position from, you go 2015, where he was saying, I think the Fed can only raise the federal funds rate one time before things start getting squirrely. and now he kind of seems to be like looking at the market very differently. And I have no problem with, you know, how can I have any kind of problem with anybody changing their mind? I think it's, I think it's very important for people to continue to update and change their mind. But it seems to me like Ray is looking at this a little bit differently than he was two years before. And I think that he's more comfortable leaving his positions on as the Fed is unwinding their balance sheet slowly. where, you know, some people would say they're not unloading it slowly. I think it's just getting started.

Starting point is 00:07:57 But he clearly signaled that, you know, the Fed is now tightening. And they're tightening much different than the tightening they've seen in the past, right? You're exactly right. Yeah. So they're tightening. But I think what is part of the other part of that interview is he's talking about doing it in concert with other national banks, other nationalities, right? So we're not doing something by ourselves where we are going to. going to turn ourselves into, let's just say, the United States is a less good investment than

Starting point is 00:08:27 other places. So it's happening in concert. It's not just happening in the United States, but it's happening with the rest of the central banks as well. And I think that that's what we could not have predicted in 2015 when he said, hey, maybe one time we're going to be able to do this. But then there's going to be this race to the bottom and who's going to make their, you know, their interest rates the lowest. The fastest, we actually, we actually, actually saw a lot of work together. And that's, I think, what we could not have predicted. And what any of his models probably would not have shown is that all the central banks working together.

Starting point is 00:09:04 Yeah, that's the thing I think that was really surprising. Now, what I find, this is something that I cannot understand at all. And we were just talking to Richard Duncan last week about this is here's the U.S. tightening. And tightening in a major way when you compare it to any other country out there. But yet the dollar is weakened. And like, I can't for the life of me make any sense of that. That doesn't make any sense whatsoever. But, you know, this trend, what I do notice is that the dollar started weakening as soon as the Fed started unloading their balance sheet.

Starting point is 00:09:38 As soon as they started making changes and they started instead of, you know, being a buyer in the bond market at any price to being a seller in the bond market. And now that selling is accelerating each month as we go forward. forward, it's appearing like that's, you know, weakening the dollar and it's also causing inflation. My thought on this is just the telegraphing by Yellen of what we're going to be doing. I think that's another thing that is different than what I have watched in the market for the last 15, 18 years is, you know, when there was a Fed announcement on, you know, 10 years ago, let's say on whether rates were going to go up or down or stay, same that really moved the market. Well, now that's not the case, right? Because they, they telegraph exactly what they're going to do. We parse the minutes and the Fed statement so,

Starting point is 00:10:32 so much that we know exactly what's going to happen. So I think those things get priced in the market. The shocks, I think we've largely reduced the shocks of the Fed announcement and whatnot. So so that investors can get a handle on where they're going. They're certainly not scrambling to change a position after the after announcement comes out. So, you know, it's interesting. It's no one thing, I believe, that that moves these markets that, that moves inflation. It really is about, you know, short-term versus long-term expectations. And Dahlio talks about that quite a bit. So I wonder what you think about that in terms of telegraphing moves. Well, back in 2015, the Fed was signaling that they are going to raise the federal funds rate signaling and then they wouldn't do it and then they wouldn't do

Starting point is 00:11:18 it. But what's interesting, that's exactly. Yeah, but now what's interesting is they've published this timetable of offloading their balance sheet. And I think the real story here is the balance sheet, you know, unwinding the balance sheet, not necessarily the federal funds rate. I think that's important, but I don't see that moving at the pace that's going to be nearly as significant as the unwinding of the balance sheet or what people are calling quantitative tightening. And what, when I talk to various people, every one of them seem to just buy the schedule. Like, and what I mean by buy is like they buy into the idea that they're just going to stick to the schedule. And I find that, I guess, surprising because of how they've acted for the last three or four years where what they said wasn't necessarily what they did.

Starting point is 00:12:02 But, you know, listening to Ray in that discussion there, he seems to buy it 100 percent that they're just going to kind of stick to that schedule. And other people that I've talked to kind of buy into the idea that they're just going to stick to the schedule until maybe things start to fall apart. So then it becomes Exactly right When does that happen? You know? When does that happen? So the schedule works great

Starting point is 00:12:25 Until the schedule doesn't work great, right? Until there's a shock in the system that unloading or the selling of more bonds would create Another like a worse movement in the wrong direction And then hey, we're going to throw out the playbook. We're going to throw out what we did because You're right.

Starting point is 00:12:42 Back in 2015 they said, Hey, we're going to raise rates. And then the stock market took a tumble then. right? And then even though the Fed's not supposed to look at the equity market by itself, you've got to believe that they did. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:16:55 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Well, let's, so there's more to kind of raise thoughts on this. So what I want to do is I want to play another clip. This one was recorded in December of 2017, so just last month. And this was with E.T. Now was the company that he had this interview with.

Starting point is 00:17:25 So here I'm going to go ahead and play this one. It's not overvalued in that all of these assets today are not expensive in relation to each other or in relationship to cash. So equities are not expensive in relationship to cash rates or bond interest rates. And so there's lots of liquidity. In other words, they put out a lot of money, there's $15 trillion worth of purchases, and the world has quite a lot of liquidity, and it all has to compete to go into something.

Starting point is 00:18:06 And so equities are not expensive, even though their multiples are high, any more than the multiples of bonds or the low cash interest rates, which they compete with, you know, in relationship, they're not high. So that's where we are. The key when we go forward is what happens to liquidity through central bank policy, because if they pull it back for one, they'll pull it back for them all. those expected returns start to change. You have to understand that when asset prices go up, a lot of that price rise is having a present value effect. In other words, it's the equivalent of pulling future returns to the present. Because as interest rates go down and those present values go up, it means that the future returns are going to be lower. And that'll have a big effect are on producing this squeeze that I'm talking about. So yeah, the multiples are high,

Starting point is 00:19:12 but it doesn't mean that it's risky if the asset, if the interest rates don't rise faster than discounted, and that if liquidity is there, because the liquidity has got to go into investments. So I found that to be a pretty interesting discussion. And really, I think the really interesting part about it is the amount of buying that he said, $15 trillion of quantitative easing buying that occurred, not just in the U.S., but globally. So he's saying, hey, all these central banks, they bought a bunch of bonds, and they put all this cash out into the economy, all this liquidity, and that liquidity has to go somewhere, and it's just chasing yield.

Starting point is 00:19:53 And so what he's really saying here is they start to tighten. And this is another interesting thing that he said in there, is he said, if one titans, they've all got a titan. And I found that really interesting that he said it that way because the U.S. seems to be the only one that's unwinding their balance sheet right now. They're the only ones that are selling those positions. And you look over in Europe and Japan, they're still in buy mode. But I think that what the concern moving forward, and maybe this is a case for why the market can continue to run more, is because until you see Europe and Japan start to stop their, quantitative easing efforts and then start to pull in their interest rates and start to do what the U.S. is doing, all those, all that money and all that fiat in those locations is going to be chasing yield. Is that the, is that the reason why Ray is kind of saying that, and I think this is also important. If you read, and this wasn't in any of the interviews, but something that Ray had

Starting point is 00:20:54 recently published on LinkedIn in one of his articles, he said, you know, the Fed is tightening and they're not doing what they've been doing for the last, call it eight years. And we think that the punch bowl isn't going to be spiked much longer. And so we're still dancing at the party, but we're dancing closer to the exits, is the way he kind of described it. And so although you might hear that little clip that we just played and think, oh, my God, Ray Dalio is a huge bull in the market. He's saying it's not overpriced.

Starting point is 00:21:25 I think that if you read some of the other stuff and you listen to some of the other interviews, I think what Ray is really saying is if you're invested in the market, maybe you just continue to hold your position. You might want to tighten your stops a little bit tighter than normal and just be prepared for, you know, you could still make money with this thing running higher because everyone's trying to chase the only yield that exists. And that's 3% in the U.S. stock market. So I'm curious, Brian, with all that said, sorry I went so long. What are your thoughts? Yeah. Hey, Preston.

Starting point is 00:21:57 Great point. As I was preparing for this tonight, you know, this is one of the notes that I took about Dahlio's point about equities, you know, and in relation to other investments. And the way I saw it was like a tide, right? He's like, this is a high tide moment. So if we were to look at the PEs of the equity market in a vacuum, we'd say, oh, they're historically high. But if you see it in context with the high liquidity environment, then maybe they're not really that high. And I bet he's got a way to factor in and, you know, his algorithm to factor in the liquidity environment and probably gives a more real look at what the PEs are, say, you know, in a different type of liquidity environment. So your point about, you know, chasing yield and maybe this is really prescient of the U.S. of the Fed to tighten right now when nobody else is.

Starting point is 00:22:53 that that could see, that could, you know, drive in future investment in the United States. Yeah, I definitely could see where that, where the United States would be the place to be. And I actually think about something else that's not just monetary policy, but really the regulatory environment that we have seen over the last year, at least there's a belief that we are deregulating our businesses. we've already seen a lowering of the tax rate down to 21%. So I think that we're well positioned, actually, to see that investment come to U.S. companies. Now, as Buffett said, and I'm sure you'll play this here in a little bit,

Starting point is 00:23:37 you know, it's hard to understand exactly what the competitive environment is going to be with the change in the tax laws. But none of these things happen in a vacuum, right? These all happen together. And so I think you just see enough signs or enough arrows pointing in one direction that I do think that you can see more move up in the stock market because of this. Yeah. And then the question becomes like how much more? Because when you look at the amount of buying and I mean, it looks and feels like it's going parabolic right now, which is usually a sign to really put your guard up and be worried.

Starting point is 00:24:16 You're exactly. Yes. I mean, when it moves of, I mean, I think the market just this last week was up 500 point, you know, percentage wise, that's a smaller percentage. But I mean, you're right. We have just seen the up and up and up. And that usually is a signal of the, it's reversal, you know, but who knows, you know. I think the thing that's that has to be said is this is not norm. Like what we're experiencing in this last cycle is so different than, than anything we've experienced in the 30 years. years before this. And most of it just becomes, because it's so heavily manipulated, the markets are, for anybody to think that the markets, especially in the bond markets, that what we're seeing is just free and open, they're just totally kidding themselves, right? I mean, is that just me being a pessimist? Or is, do you see it the same way? I'm curious if you see it the same way.

Starting point is 00:25:10 No, I think you're 100% right, Preston. I think that, I think you are 100% right. I think we're seeing, you know, a lot of a lot of free money entering the market. And that is what's holding prices up. You know, I still believe that there will be some event that is not, the unpredictable event will be the thing that is, that will cause this to turn. But I think it will cause people to look inside and say, hey, we've had a huge run here. This doesn't make sense. And then there might be a storming for the exits. And, you know, but that's, is usually preceded by the parabolic movement up that we were just talking about that you just mentioned. You know, I read something really interesting. This is probably just a couple weeks ago. And the new Fed chairman, who's replacing Yellen here, he gave some type of testimony back in 2012 about the effects of quantitative easing, how he had concerns about quantitative easing. And the terminology that he used for his concern is that quantitative easing was short, volatility.

Starting point is 00:26:17 Okay? So if quantitative easing equals short volatility, what does quantitative tightening mean? And so, you know, just doing the inverse of that means that would be long volatility, meaning things are going to become quite chaotic if you start doing quantitative tightening. Now, I don't think that we are far enough along this quantitative tightening. I mean, heck, we've only been doing it for a couple months at very low selling points. that the Fed's doing. But as we ratchet this up six months later,

Starting point is 00:26:50 we might see some of the craziest amount of volatility. If his statement and how he was testifying before Congress back in 2012 is a true statement that this is also combined to the volatility, mostly just because they're buying in such huge numbers. You know, they're buying and selling, I guess I should say selling now. They're selling in such huge numbers. So I think that right now things are, I mean, things couldn't look any rosier, could they?

Starting point is 00:27:22 I mean, it started 2018. It's just every day the stock market goes up. Now, the bond market's been a disaster, but, you know, from the equity standpoint, this thing has been one heck of a ride. This is, I want to tell you something that I've done personally with my own portfolio. So I, my big mistake is I haven't left enough on this thing because this thing has just run like crazy. But one of the changes that I've made here at the start of 2018

Starting point is 00:27:48 is I've moved a lot of my equity position into an ETF that is very low volatility relative to everything else. And I've moved out of a lot of my individual stock picks because they're so volatile in the price action.

Starting point is 00:28:04 So my thinking on this, and I'm curious to hear your thoughts, that's why I'm bringing this up, Brian, is I'm thinking, let's get into something that has very low volatility so I don't get spooked in the price action. And if I do see something that steps outside of that price action, that's within its standard volatility, like I'm in the Russell 3,000, I have a large position in the Russell 3,000. And like the volatility in that thing's like 8%. So I know if I see some type of 15% volatility out of that thing,

Starting point is 00:28:31 there's probably something that's not normal happening because when you look at how that thing's performed over the last eight years, it is rarely stepped outside of that volatility range. and yet it's had tremendous returns. You know, it's gone right there with the S&P, but it has very low volatility. So I'm curious, do you think that that's a smart approach? And I'm curious if you have other ideas on how to maybe handle this thing moving forward. One last thing. This is really important.

Starting point is 00:28:57 And I'm setting my stop, you know, on the position very tight because I'd rather just get stopped out of it and not risk the chaos that could potentially come with all this. So I'm sorry, go ahead. No, no. Hey, that's a great lead in to. to using stop or stop loss orders, right, where you can bracket your position or make sure that your downside's limited. And, you know, I think this is what we've been talking about for a couple of years now is, is, hey, don't know how much further this thing's going to run, but it seems

Starting point is 00:29:27 like the upside is smaller than the downside risk. So to put those stops in, and, you know, I think it was described to me when I was a very young investor, is hitting a bunch of singles. will get you where you want to be and just always going for the home run will lead to despair, right? No, when you talk about going to low volatility, I think that that's pretty smart in this environment, because I think that what we're going to see over the next 12 to 24 months or even longer, we're just in uncharted territory. So we can't look back and say, hey, well, the last time we unwound a QE position, this is what it looked like because we've never done that before, right?

Starting point is 00:30:08 Exactly. Everything is uncharted territory. So when Powell says, hey, you know, quantitative tightening is going to be, is going to equal, you know, volatility. That's a, that's a pretty safe bet, right? Because we've never done this before. And we know that central banks generally when we try to hit targets, when they try to hit targets, they, they overshoot them or undershoot them. And then they don't get it quite right. And that's why we have recessions. This is such a strange credit cycle. And I think that you're seeing record. number hedge funds closing in the past three years because this thing has just head faked so many people. And I think the duration of how long this credit cycle has run is just, you know, fooling everybody. But, I mean, you got guys like Ray saying that the equity market isn't expensive. And that's just, that's crazy, you know, but I mean, it all comes back to what's interest rates.

Starting point is 00:31:06 And I think, you know, two years ago, he wouldn't have said that, right? And I think that this is what's fascinating about his book. And it's a must read is that it's really principles of life and really talks about what happened in 1982 when he bet, bet wrong. And then, you know, made him look at underlying assumptions and taking, you know, information that was contravening to what, you know, his position was and really downplaying that. You know, so I think that what he's better at now is, and this is probably, something just as you just age, you may get better at this, is to looking at the world through different eyes. So in the audio that we listened to when Ray was talking there, he made the comment that the bond market was not a good place to be. And I think you'd have a hard time arguing that point. I think anybody would have a hard time arguing that point. So what I did is I pulled up a recent audio clip from Bill Gross, who's, you know, the bond king is what people call him, and he's a billionaire investor that primarily focuses in the bond market. And this recording came from January 11th, and this is him talking about the bond market in 2018. So let's play this.

Starting point is 00:32:20 That's March. You know, the bear is starting to wake up growling a little bit, but not significantly. It means, in fundamental terms, that 10-year treasuries, which are now at 2.55, probably, over the year we'll go to 275 or 280 for a number of fundamental reasons. And that, yes, that's a bare market, but it doesn't really significantly affect total return in a negative way for bond investors. It leaves them, in my opinion, flat for the year of 2018. I think 10 years have broken a number of technical barriers in the last few days in the last week or so. And, you know, some of the fundamentals are working against them.

Starting point is 00:33:02 For instance, the nominal U.S. GDP is probably entering closer to 5% than 4. And typically, ever since the era of financial repression beginning in 2009, you know, the spread between nominal GDP and 10-year treasures has been about 140 basis points. So if we got the 5% nominal GDP, which I think is possible in the next two quarters, then, you know, a 360, 10-year is possible. I don't see it going on, but 3% is possible, yes. So I find that comment really interesting. So first off, he's saying that even though we're in a bare market with the 10-year treasury specifically, folks are going to basically break even because of the interest that they're going to receive on that versus the price change. But if the price jumps up over 3%, which he said he thinks is possible but not likely,

Starting point is 00:33:58 that might cause trouble for the equity market because it starts moving too fast. We were talking with Bill Miller a year ago, and Bill really said, you know, it really depends at the speed at which you see the bond market change. And that was a really profound point that he made to me that I didn't necessarily think about before that interview. And he brings up a great point. And it's interesting to hear Bill Gross say something really similar right there. So, Brian, I'm kind of curious what you think about Bill's thoughts here on the bond market and kind of how that impacts the stock market.

Starting point is 00:34:36 Yeah. So when I heard him say that as well as I was preparing tonight, you know, I thought that was fascinating. I didn't know that the 10-year tends to lag the nominal GDP by about 140 basis points. So he thinks that the nominal GDP could approach 5%, meaning that the 10-year T-bill could go to 3.6, which is, I mean, that's almost a 50% move up from where it is right now. And I absolutely, if that happens, then I do think we're going to see spillover into the equity market. Again, the key is how fast. And again, this is in an era of quantitative tightening, again, something we haven't seen before. Are the, is the Fed going to stop, stop selling their bonds?

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Starting point is 00:39:01 do their big reversal, it's when we looked at the bond yield curve, it's always been flat or inverted. And I think that this time around, it's going to be interesting because I don't necessarily know that we're going to see that. And I don't think we're going to see it because the Fed is now, you know, unwinding their balance sheet where in the past they were never doing that. They, they were always just adjusting the federal funds rate. And what you typically see in the past, as you'd see the short tail of the, the short end of the bond yield curve come up. But you'd also see the long tail kind of come down and meet the short end, the federal funds rate, kind of in the middle. And we saw this in all the previous credits.

Starting point is 00:39:43 But I think this time, if you're expecting to see that again, I think maybe we're kidding ourselves because not only is the federal funds rate going to be going up, but I think that you're going to see the midterm bonds kind of go up with it. And I think it's still in question whether we'll see the long end, the 30 year bonds kind of increase in yield and have a sell off as well. And I think that the reason why the Fed might be reluctant to sell the long end, the long Duration bonds, which were done through the Operation Twist. When was that, 2013? I don't, I don't necessarily see them unwinding the long duration ones because that's going to really play around with housing and the real estate market because they start adjusting that. They start selling those long term bonds off. I think you get yourself in a world a hurt with what's going to happen in the real estate market because you're going to see the value of homes and all sorts of real estate really go down if you start to see the long term. long end of the tail start to sell off. So that's where I think this really all gets interesting is what duration is the Fed selling off

Starting point is 00:40:54 on their balance sheet? How much of the long tail do they actually own and how much are they willing to sell? And I would be willing to bet that they're not going to sell off too much of it. And I think that you're going to see the 30 year kind of stay fixed. I think you're going to see the 10 year kind of bump up because I think that they're going to be selling that duration and shorter. And then I think you're going to see the federal funds rate maybe go up by a percent, assuming nothing bad happens in the market. If something bad starts playing out in the market, then all that goes out the window and it's going to go down.

Starting point is 00:41:24 Would you agree with that as far as how you're seeing it moving forward, Brian? A hundred percent. And back to your comment about if something weird happens in the market, I think that we're ripe for that. I mean, you just look at the last 12 months, 25 percent move up in the market is really. a is a huge move and uh you know i've read read articles on both sides of this hey is 2018 could 2018 be 2018 be another 2017 uh you know man that looks like the consensus is no but i guess if you were to ask in 2016 what 2017 would have looked like to move up like this so how much of how much is of the tax the new tax plan is uh is already factored into prices of the market i i think that they're already

Starting point is 00:42:10 pretty well um factored in but we'll see we'll see we'll see how things go. Again, it's all about expectations of the future. So I'm very interested to see what earnings are the next quarter or two. Yeah. No, I agree with you. I mean, how many, how many more times can we price in the tax cuts? Right. Right. I mean, it's interesting as to what price, what were we pricing into the market? And it looked, you know, we heard as low as maybe 15%, and then it looked like, okay, it's definitely going to be 20. And then at the 11th hour, it became 21%. And, you know, I remember a few years ago at business school and in my tax class talking about and listening to different CEOs discuss what should it be, you know, because it's even at 15

Starting point is 00:42:56 percent, there are tax havens that are lower than that. So it's a kind of a race to the bottom. What I think the question was posed to John Chambers, then the president or CEO of Cisco, So, well, what would it need to be for you to keep, for you to onshore your profits? And he wouldn't commit to a number. I thought that was really interesting, not committing to a number because, you know, who knows? You want to say yes at 20? Well, there's always something lower than 20. So, you know, an aside about tax policy, but you're right.

Starting point is 00:43:27 I think it's been priced in time and again. And we'll just, we'll see what happens. You know, when I think through the, let's say we go through a scenario here. Okay, so six months from now, the Fed is still, they've done all their quantitative tightening. The market continues to run. It goes crazy. But then six months later, into the summer, we start to see the equity market really struggle. Let's say we see a 15 or 20 percent downturn in the stock market.

Starting point is 00:43:55 At that point, I think the Fed takes their timeline and they're selling their balance sheet, unwinding, their quantitative tightening schedule. and I think they throw it right out the window and they say, hey, we're going to pause all of this right now. Okay. And we're going to leave the federal funds rate fixed at where it's at until further notice. I think that's how they would respond to something like that. And I think that you'd see a similar response. I mean, heck, who knows? Is Europe still going to be doing QE and is it Japan still going to be doing QE?

Starting point is 00:44:30 I don't know, but I guess maybe they would. So how does the market then respond from there? and do they do they do kind of the routine that they did back in 2015-16 where they basically come out and say we will we will print and we will keep this thing afloat at all costs do they do that again you know like that's what i that's what i ask myself uh whenever i think through this and then the i guess the question after that is will it have the same impact that we saw two years ago whenever they said that where they were able to reflate this in a major way yeah i think that that's a great point, right? And then getting back to the psychology of the market, right? We all have these recency bias. So the things that happens most recent is the thing that, you know, is as first and foremost in your head. And so I think that, I think that, you know, they might go back to what worked last time, and let's try that again. But what worked last time and when a certain set of conditions may not be the conditions that we see at that point in time. So, and again, we know

Starting point is 00:45:33 over time that central banks tend to either overshoot their targets or undershoot them. Rarely, if ever, have they got it right on. So you're right. Or there may be some other unprecedented thing that you and I'll be sitting talking over a beer about, wow, can you believe that the Fed is doing this? Or what is the newest name of the newest program that they have that we've never seen before in an unprecedented time, as they'll say, and taking extraordinary measures? And then what will the impact be?

Starting point is 00:46:06 So the last thing I wanted to talk about was really kind of the unemployment rate. So when we talk about central banks and we talk about what their major role is, and I think if you go in there and you read their mission statement, it's really kind of to create stability and make sure that the unemployment rate is within a reasonable level and that they don't have excess inflation. And so when we look at the unemployment rate today at the start of 2018, we're sitting at 4%. And when you look back since 1990, so you're almost going back 30 years, the only other time we've seen unemployment this low is back at 2000. The peak of the 2000 bubble was when unemployment was this low.

Starting point is 00:46:54 no other time in the last 30 years, probably even 40 years, have we seen unemployment this low. And so for me, that's concerning as an equity investor. That's very concerning. And so how much further would the Fed be willing to push that rate? Or I think the Fed gets themselves into a tricky situation where they are saying that we need to have loose monetary policy in the event that the market would start. start to, you know, show signs of trouble, I think they have a hard time justifying their stance that, oh, we'll just go back to QE or we'll just throw the whole thing out the window and just keep monetary policy loose. I think that that gets hard for them to justify that when,

Starting point is 00:47:42 assuming unemployment would stay low as where it's at. And I'm kind of curious to hear your thoughts on some of that stuff, Brian. Yeah, sure. So we were talking two or three years ago, we would be talking about the shadow unemployment, right? So as the unemployment rate went down, we would, we would say, hey, economists really believe that the unemployment rate is maybe double whatever figure is actually reported because of people who are underemployed. You know, the person who doesn't qualify for unemployment because, hey, they've got 20 hours a week of work, but they really want to work 40. So they don't show up in that statistic. There's still probably some of that, right? and people who are not working as much as they'd like to.

Starting point is 00:48:25 And then the thing that I think that the Fed points to, whether they do it overtly or really with their policies, they're pointing and making a nod to this is wage growth. So in all other instances of really low unemployment, you've seen then wage growth. And that makes sense, right? that when the market for labor, the market for people, tightens and it's a basic supply and demand, that when the demand for labor goes up and the supply is relatively fixed, that you must see the price of labor or wages go up.

Starting point is 00:49:02 And we really haven't seen that. I mean, maybe we'll start to see it. You know, Walmart just said that they're going to, and they're the single largest employer in the United States behind the postal service actually. So the total, for the largest private employer is going to raise their minimum wage to $11 an hour. And they're really a leader in the labor market. So we might see other companies do the same sort of thing.

Starting point is 00:49:29 So we'll see if that has an effect on wages. And if it does, then we would expect then for inflation to go up. So people making more money, there's more money in the market, you know, all these bonuses that were announced right after the tax cut, you know, assigned into law. You know, I think that that's the thing that the Fed is going to watch really closely is you're right. I think we're at full employment, but they're going to watch really close to the inflation number over the next 12 months. And should that start to creep up, I think they're going to, you know, be increasing the Fed funds rate. But in concert with all the other things we've talked about for the last hour or so,

Starting point is 00:50:07 none of these things happen in a vacuum. So you pull one lever and it has, you know, multiple effects or some tropical down effects, and that's the thing that they're going to keep an eye on. The reason I pay close attention to the unemployment rate really was triggered by a billionaire Jeff Gunlock, who's also a huge bond guy. And Gunlock, he uses this as one of his big criteria for understanding where he's at in the credit cycle. And ever since he said that, I've always paid very close attention to this. And whenever I look at it, and you kind of look at how the unemployment rate has moved,

Starting point is 00:50:42 historically at the top of credit cycles, you get a good six months to a year where you see it really flat, where the unemployment rate goes flat, and it actually kind of starts going back up before you're pronounced inside of a recession. And so I'm paying close attention to this. And whenever I look at it, the trend is that this thing is still going down. And the way that it looks, it looks like it's just going to push straight through, you know, the rate that it's at right now, we're not seeing any type of plateau on this. We're not seeing it coming back up. We're definitely not seeing it come back up. So it's interesting because

Starting point is 00:51:20 the longer that I think the Fed allows their quantitative tightening to just be not very significant. And as it slowly trickles in and gets stronger and stronger, it seems like the unemployment rate might even set some records here for, you know, 40, 50 years of performance. But I like your point there, Brian, about although we're seeing really low unemployment numbers, the wages are just stagnant. And I think that that's why you're seeing, although the whole country's employed, I think that you're seeing dissatisfaction. You're seeing the whole political landscape mature the way that it is because you're seeing

Starting point is 00:52:04 this major divide where the middle class is just getting obliterated. But I don't even want to go down that path. Well, that's one of Dahlio's main points, as you well know, to talk about modeling two different economies. And you want to talk about a shock to the market. Something like that, the class warfare that you're right, you know, is a discussion for another day. But definitely when you see, you know, the market doing what it's doing, yet wage growth completely stagnant as the market's, you know, done so well over the last eight or nine years, something's got to give, right? Hey, so Brian has a really cool thing that he did. Typically, at the end of the show, we'll give the guest a chance to give a handoff to their Twitter feed or whatever.

Starting point is 00:52:51 But Brian has a small business, and this is the coolest thing ever. This is a really neat story. He created a small business around selling wine because him and his brother absolutely love drinking wine. And so they went out to Napa Valley and they started their own wine company around, you know, it really just started with you and your brother just buying a barrel because you liked certain wines out there so much. And then you guys would bottle it yourself. And then you had so many friends like me who would come over to your house and rave about your wine. And then you were just like, you know, I just need to start a business around this. Tell Brian, if you don't mind, I don't know if you mind telling the story or not, but if you don't mind telling the story. Tell the audience about and give them the five-minute version of this business that you started because this is so cool. Well, my brother and I were really interested in the wine market. And I got interested back when the wine market tanked with every other market back in 2008 and 9. And I started buying high-end wines that were for pennies on the dollar.

Starting point is 00:53:57 So I got an opportunity at a younger age to drink some nice stuff. And then as we visited out to Napa Valley more often, and actually my brother lives. in San Francisco right now, you know, we figured out that even high-end wineries always had a few extra barrels in their sellers, right? So even wines that would sell normally for $150 or more, we realized that because of supply and demand, that the demand for that wine year over year really didn't change that much, but that the supply might change as you have really good vintages, which produced more wine. So those wineries, had an option then to bulk out their wine.

Starting point is 00:54:40 So basically sell it by the barrel. Then there's well-established markets that if you had 50 extra barrels where you could go, a broker might buy it and it would show up somewhere else. But there's not a great market if you had two to four extra barrels. So my brother and I hatched this business where we would go in to high-end wineries and taste that wine. Make sure that we're not getting the stuff that they just didn't want to bottle themselves because it was not any good.

Starting point is 00:55:05 So we'd taste it and then make a touch. deal on the spot. We'd send it to our bottler, label, cork capsule, the whole deal. And then we sell it through our own website, where we provide high-end wines to our customers, which really started as our just close family and friends, for literally pennies on the dollar. So we take all those savings that we find, and we just don't say where we get it from. That's our only stipulation. I can't tell you the winery that it came from. But the deals we've done over the last 18 months really range the gamut of, I think, the most expensive retail from that winery was $155 a bottle, and we sell that for about 70% off of that.

Starting point is 00:55:50 So, again, bring in good wine to our family and friends. It is a little side business that we do, and it just, it's opened up so many doors. I think Preston, you and I've had many great conversations over a glass of wine. It's a fun story. And again, we try to let people who would never buy a $100 bottle of wine. You can have that same experience for a whole lot less. So for the audience, so I was very, I guess, suspect is probably the right word of a bottle of wine that costs more than $100. I thought that, you know, for the most part, my impression of that was the whole Robert Chaldeenie,

Starting point is 00:56:33 psychology because it's an expensive price. That's what you're really paying for is because you feel like you're getting higher quality. But Brian, he taught me something. I didn't know this. So we sat down and he said, this is a $20 bottle of wine. This is a $150 bottle wine. Taste the difference. And so I taste and I said, wow, like, yeah, I know I probably sound really cliche, but I felt like I could taste the difference. Then he explained to me why there was a difference. And I, I didn't know this. Brian, correct me if I'm wrong because I want to tell this story the way that you told me. So he told me, he said, when they press the grapes in the wine, if it's a cheap bottle of wine, they're not cleaning the grape off of the vine or the leaves nearly as much as they are for a very expensive bottle of wine where they're very particular that they only get the grape whenever they press it.

Starting point is 00:57:27 And so what happens is, is you get kind of like a tang or like a sour kind of taste in the cheaper. like a red wine, you'd get it, it tastes more sour, where if you taste something that's $150 a bottle or higher, that the, that it's been much cleaner and you don't get that sour, like tangy taste in the wine. Is that, did I remember it correctly? Because you told me this like years ago. You're exactly right, Preston. So the process by which they make some of that more expensive wine is, it's much more hands-on. They're looking at literally each individual bury as it's going down to be pressed and they'll take out twigs and leaves and everything else. Still, even with all that, there's still a lot of marketing dollars and there's a lot of cash in a

Starting point is 00:58:13 $150 bottle. Yeah, no doubt. So that's exactly where, you know, where we come in and say, hey, look, you can have that experience without paying for all that marketing, you know, so you can buy that $150 bottle for, for much, much less and actually get what you're paying for. put it all in the bottle, right? We think that the product should really stand on its own. But you're right. I tell everybody, hey, get a bottle of our cab, our 2014 Diamond Mountain Cab, which is kind of our flagship right now. Drink that next to whatever it is that you drink on your random Tuesday

Starting point is 00:58:47 night. And if you don't taste a difference, then I'll buy that bottle back from you. So I'm confident that everybody needs to have that experience. All right. Awesome story. You didn't even say the name of the company. What is the name of the company in case people want to check it out? Yeah, you're right. It's clotting wines. If you guys are listening to this, just go to our show notes. I'll have a link in there to take you to Brian's company. All right, that's all we had for you guys, and we will see you again next week. Thanks for listening to TIP. To access the show notes, courses, or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com and win a free subscription to any of our courses on TIP Academy.

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