We Study Billionaires - The Investor’s Podcast Network - TIP595: Stock Market History & The AI Bubble w/ Jamie Catherwood

Starting point is 00:00:00 You're listening to TIP. On today's show, I'm joined by financial history expert Jamie Catherwood to discuss market forecasting, interest rates, and the efficiency of markets from a historical perspective. Jamie Catherwood is a client portfolio specialist at Oshonnessy Asset Management, and also the author of the popular blog Investor Amnesia. During this episode, Jamie and I chat about why history suggests we shouldn't rely on market forecasts, psychological biases that play into why investors are prone to market forecasting, Jamie's thoughts on the AI craze of 2023 and where interest rates may head from here,

Starting point is 00:00:35 broader consequences of 0% interest rates and loose monetary policy, historical examples of governments restructuring their debt, how investor access to information has impacted the efficiency of markets, Jamie's favorite history book from 2023, and much more. We always enjoy bringing Jamie on the show as he brings a wealth of historical information and how it applies to today's markets. With that, I hope you enjoy today's discussion with fan favorite Jamie Catherwood.

Starting point is 00:01:05 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. Welcome to the Investors podcast. I'm your host, Clay Fink, and today we bring back Jamie Catherwood. Jamie, such a pleasure to have you back.

Starting point is 00:01:32 Thank you so much for having me on. Jamie, you've recently had a write-up on forecasting, and this write-up was actually quite timely. Going into 2023, I think just about everyone saw trouble ahead, and yet here we are speaking in late December. The S&P 500 is up around 22% on the year. What if your studies of market history taught you about forecasting? That is really difficult, and most people are not equipped to do it, and it's a kind of just irony that even though it's something we're not very good at, we continue to try and perfect it,

Starting point is 00:02:07 especially each year, this time of year, especially people tend to really start believing in their forecasting abilities because there's just something about that turn of year idea that makes us want to predict what's going to happen in the next year, as if it's, you know, any different than the last 365 days or, you know, if you did it one year outlook in March of next year, something about just a clean calendar year makes us want to predict what's going to happen. But it's very difficult, and history is filled with examples. You can cherry pick very ludicrous ones like Irving Fisher's famous quote right before the 1929 crash that stocks have reached a permanently high plateau or Paul Krudman saying that the internet was going to be a fad in the 1990s.

Starting point is 00:02:46 So there are countless examples from history of proving just how difficult forecasting is. And I am reminded of a JP Morgan quote. He was once asked what the market would do and he responded that it will fluctuate. And it's just so funny because, you know, people like to feel. that comfort and feel that certainty of they feel like they know what's going to happen in the future. But, you know, there's something about market predictions where we just have to accept that there's a tremendous amount of uncertainty in the markets and predicting these types of things is really difficult. Yeah, exactly. I think there's the comment quote about the takeaway that

Starting point is 00:03:21 we should learn from history when something surprising happens is that it's like life is surprising instead of trying to predict when the next pandemic is going to happen and then forecast that going forward because now we've just been through COVID. The takeaway should be that forecasts always have to bake in a certain element of unpredictability because nobody predicted COVID was coming. That took everybody by surprise. And I think that one of the best examples of why forecasting is so difficult and why the kind of annual forecast and outlook cycle this time of year from the big investment banks

Starting point is 00:03:55 and asset managers putting together their targets for the next year in markets is just kind of ridiculous. Is during 2020, when at the end of 2019, all the same institutions put out their 2020 outlook and forecasts. And then within two months, they were all shot to shreds because of COVID. And it just shows, you know, the stuff that you think you are forecasting can be totally just sideswired by something completely unpredictable that nobody could have seen coming. There's a great, great quote from a 19th century edition of the.

Starting point is 00:04:25 spectator magazine that was talking about this kind of problem about how you really can't predict anything because you never know what's going to happen. And the article writes that the best chess player in the world can see a certain checkmate, but he will never make that checkmate and win the game if a chandelier crashes from above their table. And, you know, it takes out the whole chess game. And that's, I think, just a good analogy to keep in mind as people make these forecasts and predictions is that there's some stuff that you just can't control for.

Starting point is 00:04:55 Yeah, and I'm also reminded of Charlie Munger. He's very top of mind as of late. And I've actually, before this conversation, I revisited the psychology of human misjudgment. And this is all outlined in Peter Bevelin's book, Seeking Wisdom. It's such a great resource for understanding our psychological biases. And I wanted to mention a number of these biases that I found that I think tie in really well here. The first one was the authority bias. If someone has fancy credentials, or they sound really smart, it's really easy to believe that they know what they're talking about. And when it comes to macro forecasting specifically, it's just such an extremely complex subject. So naturally, people don't understand sort of that subject very well.

Starting point is 00:05:41 And the less you understand something, the more likely you are to trust an authority on the subject. And then the second point I had here was impatience. You know, if people see pain coming in the near future, then, you know, unconsciously, they just really don't want to feel that pain so they think they can try and time it. And they might know that they're better off just sort of sitting on their hands, but they, you know, are just really impatient and want to feel like they can do something about that uncertainty. Then the third point was the recency bias. I'm definitely reminded of the great financial crisis here.

Starting point is 00:06:13 I think about people who had the opportunity to invest in, say, 2010 or 2011. I can only imagine the sort of hangover they felt from the great financial crisis and how much pain that crisis caused them. And that recent event likely led many people to not invest. And then a couple more here, the do something syndrome where people have a bias to tinker around with things and feel like more activity is going to, you know, improve their investment returns. And then I also pulled in loss aversion here as well.

Starting point is 00:06:44 People just hate the idea of losing money. And if they think they're going to be losing money over the next year, then they're going to try and, you know, work their way around that, even though it's really not. not in their best interests to do so. And then I also pulled in a Charlie Munger quote here. When you get two or three of these psychological principles operating together, then you really get irrationality on a tremendous scale. So I don't know if any of those really stand out to you there.

Starting point is 00:07:09 Yeah, I mean, they all do. And the fascinating part about all of it, which is why I love financial history so much. And history in general is I probably mentioned it on a previous appearance on this show. But there's a book written in 1688 called Confusions. Day Confusions and it was written by this guy, Joseph de la Vega, and he was writing about the Amsterdam Stock Exchange and he is essentially laying out in this book, it's like less than 100 pages, the modern kind of translated edition. You can find online for free, but he is essentially

Starting point is 00:07:42 explaining through this conversation between an investor, a businessman, a philosopher, how the stock exchange works and what the kind of personalities and characteristics of people that trade on the market are. And a lot of what he talks about is the behavioral finance component. And it's considered to be the first behavioral finance book. And what's fascinated about it is that pretty much every bias that you just outlined is referenced in that book. And it just underscores the fact that no matter how much technology and everything changes

Starting point is 00:08:14 and the way we invest changes, these biases that have persisted for four. 400 years don't seem to be going anywhere anytime soon. And so having that understanding is important because it can influence your approach to investing if you can pretty much on a whole guarantee that these behavioral forecomings are going to persist in the future because if they're the same as the traders in 1688 we're exhibiting, then there's a strong likelihood that in 400 years from now, people will still be, you know, succumbing to those behavioral biases. The next question I had is if we aren't able to forecast other than studying these behavioral issues, what use do you see in studying history in the first place?

Starting point is 00:08:57 So I think with forecasting, there is a delineation between, you know, here's a S&P 500 target for next year and those kind of very specific outcomes where you're boiling down really complex systems into a nice, like, kind of tied with. with a bow, just a price target, you know, just a single number, when there's so much that gets factored into that, that it's almost impossible to predict with any level of certainty, what those specific outcomes will be. But then with history, the way I always think of it is history is kind of a compass, whereas that type of specific outcome forecasting, people try and treat history like a GPS where, you know, if you just study some past examples from history, then you can come to a very specific route instead for navigating the future when in reality the practical and useful approach

Starting point is 00:09:52 with history is to use that as a compass where you can look over hundreds of years to see what themes have repeated, what patterns persist when you have a much broader sample set. And then in that case, you can at least make sure that you are orienting yourself directionally correct when you're navigating uncertain times. And so in that sense, you're not so much, you know, banking on a specific past event playing out again in the future, but more so, you know, making sure that you understand when you have an extended period of low interest rates, for example, that there's going to be a lot of market froth. And a lot of the companies that get floated during those periods are going to be very speculative and risky. And so just having that understanding,

Starting point is 00:10:38 you can position your portfolio accordingly so that you're not getting swept up by some of those speculative companies. In that vein, I'm sure a lot of people saw the news this week that the Nicola founder and chairman Trevor Milton got sentenced this week for his role in the fraud that occurred during COVID. But that was one of the very widely celebrated stocks when the first went public as being the next big Tesla kind of candidate and people flocked into that. And I think that's a good example of the type of company that can get floated during those speculative periods. And so if you study practically any period of history since this, even the 17th century, when you have these kind of prolonged periods of low rates, those are

Starting point is 00:11:19 the types of companies that get floated. And for brief periods can seem like very exciting opportunities because stock price is going up, which makes people on a herd into that investment, but then it works out poorly. And so I think just using history as a more general and directional tool for forecasting rather than looking for a specific price target or something is a more valuable approach. And in tying in history with this behavioral finance, I'm also reminded that so many people are prone to taking this wait and watch approach when they feel like things are more uncertain. And the problem is that the best opportunities come when people are panicking and things feel really uncertain. And once the coast is clear, then investors have a sense of things being a better

Starting point is 00:12:10 environment is when investors really have missed most of the best performing days in the market. It actually turns out that a significant amount of the market's gains overall come out of the initial recovery out of the bear market and you really can't predict when that's going to happen. And if an investor is sitting on the sidelines at that point in time waiting until the coast is clear, then they're really setting themselves up to underperform. Yeah, I just put in my newsletter yesterday, I'm going to pull up here in the background, but I was looking at this chart that I saw that was showing the distribution of S&P 500 returns from 1928 to 2022 and something like 73% of calendar years providing investors with positive returns

Starting point is 00:12:55 in that period. So over 95 years, 73% of those were positive. But what was really interesting in the chart is it shows kind of by band, you know, each year what the return was. So like what number of years fall between, you know, positive 10 to 20% return 20 to 30, et cetera. And what's interesting is if you kind of find the sequence of calendar years, you can see just how much variation there is.

Starting point is 00:13:19 And it really underscores kind of the difficulty of anticipating when that big rally is going to be. So for example, in 1931, that's the worst calendar year on record in this sample period from 1928 to 2022, the market fell more than 40% obviously during the Great Depression. And then in 1932, market down again, some like 10%. But then in 1933, the market rallies more than 40% and it's one of the top five calendar years in a 95-year period. And so if you had been an investor that was understandably scarred by the 1931 to 33 period, you probably wouldn't be trying to get back into the market, but then you would have missed out on a fantastic rally,

Starting point is 00:14:05 and then the market continued to go up from there. And it's just, again, to your point, it's so important to kind of stay invested in the market and ride out the storms because if you're just continually waiting, then I'm going to miss out on a lot of exciting opportunities to generate serious wealth. So investing involves some level of forecasting inherently. You know, whenever you make an investment, there are assumptions baked end of that and we're making some sort of forecast, especially if you're choosing individual companies. So how do you think about differentiating between which forecasts we can rely on and which you know are nearly impossible to predict? Yeah, I mean, that's I guess the nature of the game is

Starting point is 00:14:48 figuring out what forecast to use. I think that the way that I think of it, especially working for quantitative fund and one that was founded by Jim O'Shaughnessy, who is a big fan of base rates, I think that using statistical approaches like base rates, which people can read a lot about that from Michael Mousin as well. He's done a lot of greater work on that. I think that base rates can be very helpful in determining kind of how useful a metric or tool is for forecasting and how persistent it is over the long term. And I think similarly to that, expanding your time horizon.

Starting point is 00:15:21 So like I said earlier, instead of trying to forecast a very specific outcome in a shorter time period, that's very difficult. but trying to get a sense of, you know, more broadly, you know, companies with high share or older yield, for example, over time, like how often do they outperform the market? You know, look at the base rates over one, three, five, 10 year periods, etc. You can quickly see that a lot of these kind of predictive factors, you know, over the long term is pretty clear that they work over time. But the base rates over shorter time periods is much lower because it's just so much, there's

Starting point is 00:15:54 so much more variability. And so I think paying more attention to forecasts that are broader and scope over a longer time horizon, which can make it sound like they're less useful. But I don't think that's the case. I think it's just the reality that any type of very specific forecast is going to be riskier to follow because it's just so tied to a specific outcome rather than taking a general approach of having these broader themes that are moving markets over the next few years going to play out more generally. So instead of predicting like what Nvidia's price target is going to be, how does the general kind of AI transformation that's going on play out over the coming years and how does that

Starting point is 00:16:37 factor into various industries? Kind of like working in recent, you know, software's eating world whenever he wrote that in 2010. That's something where that was a very accurate prediction where he was betting correctly that over time, non-software tech companies, we're going to start heavily relying and using software and technology to improve their businesses. And that's exactly what's played out for the last decade and a half. And so I think those types of forecasts are better choices for investors to follow just because there's kind of some degree of error baked in. 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

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Starting point is 00:21:31 First come the innovators. The innovators essentially see the opportunities that other people don't. And then come the imitators who copy what the innovators have done. And then come the idiots. And of course, Nicola was a type of company that was really capitalizing on, oh, Tesla's having this massive rise. They're doing really well. They're attracting all this capital.

Starting point is 00:21:50 And then all these other EV companies are trying to imitate that. And it also reminds me of, you know, 2023, the highlight of the year in many ways has been AI in the rise of that theme. I'm curious if the craze of AI has reminded you of anything from a historical standpoint. I think less than a specific bubble or kind of period of market craziness. I think that it's just representative of most speculative kind of periods and manias, if you want to use that term, and describe what's happening today, where you see this kind of typical progression where very quickly everybody becomes an expert in the new innovation or industry. There was something written about this in a 19th century investing book where the author lays out how in that period he was discussing mining stocks.

Starting point is 00:22:44 And he was talking about how when Wall Street became obsessed with mining stocks and investors did too because share prices were soaring, suddenly all these brokerage offices started having like, you know, pieces of geology and rocks in their offices and things to kind of highlight their knowledge of the industry and entire newspaper. articles were being dedicated to, our newspaper sections rather, were being dedicated to the mining industry. And suddenly every brokerage firm on Wall Street was a mining industry expert, whereas previously that never really covered or mentioned anything about mining stocks. And then suddenly, all these prospectuses flood the market for mining stocks and investors, we've got the opportunity to buy them up. And then, as always, you have, you know, a mixture of, you know, a mixture of, companies that were formed purely to take advantage of that hype and kind of fleece investors and some genuinely exciting companies, you know, that returns profits to investors and,

Starting point is 00:23:46 you know, worthwhile investment. But I think that in periods like this, it's just very important to remember that this cycle has played out many times. And when something is so transformative and exciting like AI, it's easy to quickly, you know, assume that it's just going to change change everything all at once. And those forecasts like we've been talking about can start getting a little more outlandish. And people, I think, tend to underappreciate some of the time that it takes for these things to be implemented. You know, I mean, chat GPT is incredible.

Starting point is 00:24:22 And a lot of these AI tools are amazing. And it's crazy what has happened just in the short span of time since chat GPT was released, whatever it was now, a little over a year ago. But still, you know, it's not like AI is going to change the world tomorrow. tomorrow and all these predictions of taking jobs away in basically, you know, every industry, et cetera. And there's just some wild predictions going on. And I think that during these types of periods, it's very important for investors to do more meticulous research and discern kind of who are the players that are like those 19th century brokerage firms that are suddenly

Starting point is 00:24:58 AI experts and making a lot of predictions and whose research and opinions you should probably value less than people who have been working in the industry for a long time, you know, and are putting out valuable insights that investors can use to inform their investment decisions. And so, yeah, I think that this is just playing out very similarly to most kind of exciting innovations and ensuing speculative periods in history where kind of get this wave of, you know, just everyone's only talking about that innovation. And there's a lot of companies claiming to be kind of the medium to access this AI revolutions, you know, through purchasing their stock or their product. And you just have to be

Starting point is 00:25:39 more careful in these periods because it's easy to just kind of be swept up by buying anything AI related because you can maybe sometimes find out that a lot of these so-called AI companies are really just marketing AI as a buzzword rather than genuinely being a informed player in space. It's funny how we talked about behavioral biases at the start of this, because I'm reminded of a, I think, a behavioral bias I sort of had when I first started investing. You know, when you first get started, it's easy to think, hey, what are some of the key trends that are playing out that are going to play a key role in our economy over the next, say, decade? And nowadays, people naturally get attracted to AI, electric vehicles and such.

Starting point is 00:26:22 And I think that there's a really important lesson in that. In these key trends, it can be really, really difficult to, you know, earn an adequate return in a lot of these companies. Because when a industry is really hot, it attracts a lot of money and investment into that. So it's really difficult for companies to make out well in the end. And Buffett always references throughout the 1900s, we saw the growth of the auto industry and the growth of the airline industry. And you could have seen those trends, seen those industries and all the growth they're going to see. but very few companies ended up being high-quality investments. And that's sort of something I wanted to mention related to AI and people who get attracted

Starting point is 00:27:03 to these hot opportunities. Obviously, Nvidia and Tesla and companies like that have done really, really well. But that doesn't mean that necessarily there's going to be a next Invader or next Tesla coming ahead in the 2020s. Yeah. Sometimes there's just that company that is so good because it's standalone, kind of among the rest, you know, to your point, like maybe. The reason Nvidia is crushing it so much is because there's only going to be one company that can do what Nvidia does rather than in just two years there's going to be another Nvidia.

Starting point is 00:27:34 I mean, look at Amazon. Yeah, and the Magnificent Seven have also been at the front of the headlines in 2023. They've really carried the index. Last time I checked, they were up 71% on the year. And then the remaining 493 stocks and the S&B 500 are up only 6%. So with the Magnificent 7, combining that with the other 493, that gives them an overall return. I mentioned 22% on the year earlier. And when I saw the statistics, it was actually 19%.

Starting point is 00:28:04 So it's roughly the same. And given the size of these companies, many investors are really concerned about, you know, just the index really being overweight, these really big magnificent 7. So talk to us about the research you've done in relation to, you know, how overweight these are. in relation to how this has looked historically in terms of the index being carried by these bigger companies? Yeah, so there's actually a really interesting chart from DFA that they put out maybe two years ago. That went through 2020 and it's not focusing on the top seven, but it does show the like level concentration of the top 10 stocks in the U.S. since 1927. And it's pretty surprising how concentrated, how consistently concentrated U.S. market has been at the top since the 1930s. So, you know, outside of 1980, so they looked at the top 10 at the, you know, first year and new decades, so 1980, 1990, etc.

Starting point is 00:29:05 And only 1980 and 1990 and 2010 were under 20 percent since. then like in 1950, the top 10 stocks were counted for 26.7% of the index and it was 31% in 1960, 25% in 1970. And so while obviously the market is definitely concentrated at the top today, it is not that unusual historically, at least in the U.S. to have that kind of top heavy concentration. I mean, in 1940, it was at 33%. And what's really crazy is that for four straight decades, AT&T was the top spot as the number one, number one largest stock in the index. And so that's just kind of an interesting side note. But despite what we might think, I was surprised to see that myself, that it's not unusual historically to have this level of

Starting point is 00:30:00 kind of top, top heavy concentration. I wanted to transition and talk a bit about interest rates. As you know, I've been reading this wonderful book called The Price of Time by Edward Chancellor. I'm not sure if you've read this book, but I'm certain you'd probably enjoy it. One thing I quickly realized in going through this was just realizing that this period that we were in of easy money and 0% interest rates, like it was anything but normal. I look back at this chart that's at the start of the book and it has this history of interest rates and it dates all the way back to 3,000 BC, but it seems that most of the reliable and accurate data is from around the past 300 years.

Starting point is 00:30:41 So I look at these periods where interest rates were at or close to 0%. And I only see three times on the chart. That was around the time of the Great Depression, the great financial crisis, and then during COVID. So historically, a normal interest rate, it seems to be anywhere between 3 and 6%. We saw a ton of fluctuations in the 1900s, especially, you know, at the oil crisis in the 70s and we jacked up interest rates. But the 1800s, for the most part, it was almost always in that 3 to 6 percent range. So I'd like to get your historical perspective on what might lie ahead in terms of interest rates,

Starting point is 00:31:18 given that they've risen over the past couple of years. And I'm also curious if we should be thinking about not only the nominal interest rate, but also consider the real rates as well after accounting for inflation. Yeah, I think first, just to address the second point, I think that real rates are all that typically matter. I mean, that's the most important rate to focus on for sure. Because to your point, you know, if you look at the 1980s, just looking at nominal rates and you see those high, you know, 18%.

Starting point is 00:31:47 You might think, wow, you can, you know, earn 18%. But in reality, the real rate was dramatically lower because of the inflation issues. And in terms of Edward Chancellor, he is definitely one of the goats of financial history. His book, Devil Take the High Most is a must read for anyone trying to learn more about financial history. And for a broader perspective, what's really interesting about financial history and investors' kind of reaction to interest rate levels is just how relative it is. Because in the 19th century in the UK, when the British government, most of the 19th century European financial crises can be summarized as the British government fighting a very expensive war,

Starting point is 00:32:29 loading up on debt and then trying to figure out how to get out of pain all of it once the conflict is over and they kind of realize how much debt they had accumulated during the conflict. And so there are a few times during the course of the 19th century where the British government dramatically lowered rates after these conflicts and in some cases just forced investors to accept the haircut. I think it was in the 1820s that the British government kind of just told investors that were holding 5% consoles, which were the equivalent of British long-term government bonds, that they would just have to accept the fact that now those bonds paid 3%. They were known as the Navy 5%, I think. And just that cut from 5% to 3% caused a lot of

Starting point is 00:33:18 outrage. And there was a famous quote that said, John Bull, which is the British equivalent of like Uncle Sam. John Bull can stand many things, but he cannot stand that. 2%, and that just kind of gave the, it was a good summary of kind of that feeling that investors felt, you know, over the last decade plus of you can't accept these just basically zero interest rates. And so they were forced further out on the risk curve. So I think what history shows is that one, to your point, zero interest rates is a very recent phenomenon in terms of broader economic and financial history. But that can give us kind of an insight into the likelihood that we'll see a return to zero interest rates anytime soon, which I think history shows is

Starting point is 00:34:02 unlikely just given how rare the instances have been that markets have endured a zero interest rate environment. And so I think that's the lesson going forward is investors who maybe have thought that now we've written out inflation, at least according to the Fed, that the war is won, essentially, that maybe we'll return to the previous kind of paradigm, which was that zero interest rate environment, but I don't think that that's likely to be the case, just given how much of an anomaly it is historically. Yeah, that's a very good point. And since we mentioned Edward Chancellor, he was actually on our podcast. That was episode 505. Stig had him on actually talking about the price of time. One of the issues with an easy money period that Chancellor talks so much about in

Starting point is 00:34:49 this book is really the capital misallocation that takes place as a result of that. It's really a misaligned incentive within the overall economy. So these zombie companies that are, you know, they're really just kept alive through cheap debt and projects are taken on in the overall economy that really wouldn't be rational in a period of normal interest rates. And then as a result, creative destruction isn't really happening in the economy. And this reminds me of the banking failures that happened in early 2023. And then the Fed put together this BTF program that was put in place that allowed banks to really cash in on bonds at their nominal value instead of their market price. And with that, it also reminds me of your piece talking about how stability breeds instability

Starting point is 00:35:36 and the feds providing the stability to the banks when they're running into some stability issues. I'm curious on your take if central bankers have ever been involved in planning the economy as they are today? Or central bankers today, you think, in a league in their own? I think it's a good question. It's also kind of a difficult question to answer because, you know, when we look back at history, we're always looking back and viewing it through the lens of modern standards and, you know, like what's happening today. And so it's easy to think that the action central bankers took in periods, you know,

Starting point is 00:36:12 like the 20th and 19th centuries, et cetera, are, you know, normal by today's standards, as in, you know, acting as a lender of last resort, for example. But in 1825 in the UK during the first kind of emerging markets crisis, when the Bank of England stepped in to act as a lender of last resort, that was a huge moment and a watershed moment in the development of markets and the role that central bankers play. Obviously, today we look back at that and not really bat an eye on that just because we've seen it now at countless times since then. But I'm sure at that point, they would have said that those central bankers are in a league of their own. And so I think it's hard to say kind of today's standards versus historical precedent, what's more kind of outlandish in terms of increased intervention by central bankers. But I do think that certainly today there does seem to be a heightened level of intervention, especially as I feel like conversations around the politicizing. of the Fed and calls for the Fed to take into account kind of more social issues into their

Starting point is 00:37:28 approach to setting interest rates, et cetera. Through reading history, I've not seen as much related to that. And so it will be interesting to see how the Fed navigates this post-COVID post-inflation world and what kind of the normal course of action now that we've left to zero interest rate environment is because for a long time, that was the whole deal was just the zero interest rates. And then COVID was an anomaly because that's such a freak occurrence. And now that inflation's on the way, it'll be interesting just to see what their level of intervention is going forward now that we're out of these kind of unique periods.

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Starting point is 00:41:58 rates to bring national debt levels to a more sustainable place. So essentially having inflation higher than interest rates to allow the debt to sort of inflate away in real terms. And then this also brought to mind another solution that could be brought about, and that's to restructure the debt. Are there examples in history that you've looked at where debt restructurings have occurred? Yeah, so in the U.S., it's not something that tends to get acknowledged, but in the first few years of our nation, we restructured our debt. I mean, that's what Hamilton was tasked with doing when he assumed office as the first secretary of the Treasury. When he came into his role in 89, 1789, there was a dire financial state.

Starting point is 00:42:50 At that point, you know, I'll take you back to U.S. history class from high school. But before we had the Constitution, we had the Articles of Confederation, which were designed to severely curtail the central government authority because, you know, obviously Americans were very fearful after having fought a war with a British monarch that any type of new government in the U.S. would fall kind of victim to a similar, heavily centralized and too powerful. governing authority. And so the Articles of Confederation essentially gave Congress no power. And so, for example, they did not have the authority to collect taxes, which is insane. And so that means that during those years, there was not a lot of revenue coming in. And so even after the Constitution was passed and the government we have today was put into place, there was a real problem because there was not a lot of revenue coming in, but there had been a massive accumulation of debt incurred during the Revolutionary War to fight the British. And I mean, we owed, I think, like, 80 million,

Starting point is 00:43:54 a lot of it to foreign governments. And when Hamilton took office, he had to write to the French government asking, you know, for a delay in payments because the U.S. was basically struggling to get on its feet. In fact, in the first year of his time in office, he had to write to Washington, President Washington saying that, you know, if we don't get, you know, the exact amount of but a certain amount of money into the Treasury's coffers in the next month, then we're not going to be able to pay Congressmen their salaries and there are going to be a lot of other departments and cabinet positions that won't be able to receive their funds because, you know, we're just so on the whole. And so what Hamilton's novel kind of idea was, and it was politically very challenging and a difficult thread to needle, was he had to essentially convince American debt holders to, to exchange their existing higher paying debt and US bonds that they owned for a package of new debt securities that he would issue, which would have a lower interest rate.

Starting point is 00:45:01 But his premise to these investors was the only alternative for continuing to pay out these higher interest rates would be to introduce new taxes or raise higher taxes, both of which we know would lead to probably armed rebellion. you could see in the case of the whiskey rebellion when there's a whiskey tax introduced. And so if you want to really avoid that, then the only way we can do so is if you accept the fact that, you know, instead of being paid 6% interest on these bonds, we're going to give you 4% interest going forward. And that was obviously a tough sell, especially when the nation was very divided and people

Starting point is 00:45:40 were still very wary of strong central government implementing new taxes or have to in too much control and, you know, changing their commitments to pay out what they had promised originally at 6%. And so that was very difficult. But in a matter of, I think, two years or so, he had successfully converted something like 98% of the outstanding debt into this package of new securities that were lower paying, lower interest bearing securities. And it saved tens of millions for the government. And so that was restructuring literally at the founding of our nation that was very successful. And one of the ways that he also was able to retire a lot of the debt, just kind of as an interesting side note, is by allowing investors to purchase

Starting point is 00:46:28 shares of the Bank of the United States, which was kind of like an early central bank-esque institution in the U.S. And the bank IPOed on July 4th in 1791, I believe, very patriotic IPO date. And he allowed investors that held U.S. government bonds to pay for shares of the Bank of the United States with these bonds. So it was kind of a win-win for the government because, you know, it injected capital into this new bank, but also it reduced the amount of debt outstanding that they would have to pay interest on by, you know, allowing someone to use, like, three government bonds to purchase one share of the bank of the United States stock. And so interesting and often under-referenced example of a restructuring in U.S. history because when there's talk of debt restructurings or defaults, etc., people tend to pull out the line that U.S. has never defaulted on its debt or in something like that. And the reality is that there have been these moments in U.S. history where we were in pretty dire

Starting point is 00:47:31 times and some novel solutions were needed. And obviously, we got through those ones and we'll get through this one that we're but it will be interesting to see kind of from a political perspective what's possible today versus what might have been possible in the past. I think every generation says that the country has never been more divided, but it does seem that it's just impossible to get anything major accomplished in Congress and in government today. And so it seems almost impossible to think that Hamilton could have implemented what he did

Starting point is 00:48:08 in the 1790s today, I don't think that people would accept a government figure telling them that they have to accept kind of lower rates and a restructuring of their debt. Jamie, I wanted to transition here to talk about the efficiency of markets. This is something you've studied extensively this year. One would think that markets would generally become more efficient over time. We always talk about how during the Ben Graham era, he was able to just sift through Moody's manuals and search for these cigar butts that, you know, are decent companies trading well below their underlying value. And these opportunities specifically seem to be much harder to come by

Starting point is 00:48:49 as, you know, they're pretty easy for a lot of investors to identify. But then another major factor I sort of think about in terms of market efficiency is the massive impact of passive flows on index funds. And you did a write-up that reference to Telegraph looking all the way back and, you know, investors first getting access to this quick information. So talk to us about the efficiency of markets and how that's changed over time. Yeah. So what prompted my recent interest in this again was a quote from Cliff Asniss in a recent Financial Times article.

Starting point is 00:49:24 But he said something along the lines of people that think technology is going to make asset pricing markets more efficient or the same ones who 20 years ago said that you know, social media would make us all like each other more, which I think is just a fantastic way to put it, because definitely social media does not make us like each other more and has increased the divisiveness in society. But also, I mean, it makes sense on its face throughout history that when you suddenly get these innovations and kind of communication and data that markets have become more efficient because people have more information. And while that's certainly true to a certain extent, there is definitely nowhere near kind of an elimination of mispricing

Starting point is 00:50:10 and inefficient markets because I remember when the telegraph cable first took over the world and people could get information in India to London, for example, in something like eight hours where it used to take much longer. Someone said that there would be no need for crises moving forward because now all the information would simply be known. And I just loved the kind of matter of factness with, I can remember his name is Arthur or something, but he was a person in high authority and he just put it so bluntly as if, you know, why would we have panics and crashes moving forward? Because now everybody will have access to information at the tips of their fingers, you know, at least in their day, that was considered tips of their fingers. And so how

Starting point is 00:50:55 could there be more panics and crashes? And obviously, if anything, the 19th century had more panics and crashes than any century. And so there is this just belief that technology will always make markets extremely efficient. But throughout history, you see the introduction of these technologies and the opposite occurs where, ironically, you know, when the telegraph and the ticker were introduced, there was a study done that showed how the states that as their ticker subscriptions increased within each state, people started gravitating towards companies listed in their state. And so basically a home country bias, but at the state level, if you can imagine it.

Starting point is 00:51:40 And people started just hurting into the same kind of like top 10 stocks within their state. And instead of the ticker and telegraph broadening the speculation across a broader set of stocks, people just continue to concentrate into the same names. And you see this throughout history in the 1600s when markets in London during the 1690s were kind of going through their first bubble. It's this IPO bubble in kind of the first technology mania. You saw a list of securities in one of the kind of market writeups, market commentaries that was published every two weeks by this guy, John Houghton.

Starting point is 00:52:22 He had a list of 20 securities that he monitored the prices of. And even though there were a couple hundred securities trading on the London Exchange, the vast majority of all trading volume on the exchange was concentrated into the same list of securities that he provided prices for in his market commentary every two weeks. And so while that's not necessarily technology by modern standards, it still just shows that even when investors are presented with a lot of different stocks to invest in, they tend to concentrate into the same ones that everybody else does. And so it's just this interesting phenomenon throughout history that technology does not necessarily change our approach to investing and, you know, cause us to expand our universe of stocks to select from.

Starting point is 00:53:06 And I think during COVID, we saw that same phenomenon with the Robin Hood tracker. I don't know if you remember that, but it showed just the level of trading on Robin Hood that was concentrated in the top 10 most popular stocks. And it was just crazy to see even in this modern age when literally you have unparalleled access to information at the tips of your fingers that still we kind of just heard into these same names as everyone else, even though you could be looking at a really exciting microcap stock or something. And I could be looking at, you know, Smith mid-Smit cap stock doing something exciting in, you know, the energy sector or something like that. But instead, people tend to just kind of hurt into the same U.S. large cap stocks. Yeah, it's another example of history showing us that when something new is introduced, the opposite effect of what most people anticipate can actually happen. And just because information is available doesn't necessarily mean that people are going

Starting point is 00:54:03 to be looking at and using the right information. I'm reminded of a John Bogle quote. He once said, The stock market is a giant distraction to the business of investing. And it's just so funny how a lot of investors focus on the wrong things. And I'm also reminded that I just have a hard time believing that markets will ever be 100% efficient, just really just due to the number of different players that are in the markets. And they all have their own different reason for being in the markets and their own different motives.

Starting point is 00:54:33 And just look at a stock like Apple, for example, you could probably come up with a thousand different reasons why someone's going to buy or sell shares of Apple. And just to list a few to show the listeners what I mean. You might have passive investors that just buy regardless of the price. they already been looking at the underlying the company's earnings or what the, you know, what new products are being released by Apple. You might have institutions that literally just put a certain percentage of their money into an asset class and that might include Apple. And you have day traders who have a time horizon of less than a day that are trading on

Starting point is 00:55:05 indicators and, you know, maybe you have some individual investors that, you know, they need to go out and buy a house or, you know, raise money for a down payment. So they're just selling their shares of Apple. And that's just a few different reasons of the, thousands of reasons that, you know, market participants are making decisions. Yeah, no, exactly. Very well put. Jamie, I had one more question for you before I give you the handoff. Since you're such an avid student of history and an avid reader, I'm keen to almost ask

Starting point is 00:55:35 what your favorite history book was from the year, but I'll just open it up and ask if you have any favorite books that you'd like to mention here for the audience. Yeah, this year has been very busy with moving. getting married, et cetera. And so I've done less reading than I would have liked in terms of books. But one that I'm really loving right now is called T in the Street. And it's all about the 120s and FDRs, pursuing New Deal legislation and regulation during the 1930s of Wall Street. And it really chronicles some of the key players, like Joe Kennedy, Roosevelt, and then the founding of the SEC. And just kind of it's interesting to,

Starting point is 00:56:17 see how investors at the time reacted to the introduction of a really diverse set of institutions that are going to be enacted or introduced and regulating very important parts of the American economy. So you have like the Public Utility Holding Company Act in 1935, which broke up the utility industry, which at that point was a massive, massive part of the American economy in stock market. And then also just the introduction of the SEC itself, you know, it's something we take for granted today, but it's fascinating to just think back to a period where so many pieces of legislation and regulation were introduced in such a short period. And after something as kind of catastrophic as the 29 crash in Great Depression, it's just such a crazy period where so

Starting point is 00:57:08 much happened and so much of our modern day markets were shaped during that period. And so it's just fascinating to see how investors navigated that turbulent period. And so I'd definitely recommend reading that. It's filled with really great anecdotes and just some wild stories of what occurred during the 1920s. But it's also fascinating to see how critics of FDR and of this regulation of Wall Street an American business was by just how insane the criticisms were, but also how similar they are to any type of new regulatory legislation that gets passed or proposed today, which it just

Starting point is 00:57:53 immediately goes to, you know, this is communism, this is un-American, et cetera, but even seeing it kind of puts in perspective how these same arguments are used now and 100 years ago. It kind of just makes you think a little bit about how, in 100,000. hundred years from now, you know, are some of these pieces of legislation and regulation that are being introduced today and being chastised as being an American or ridiculous oversteps from the government. Are those going to be looked on in a hundred years as ridiculous that people protested that? Because now we surely look back at the 1920s and think how crazy it is that, you know, companies really didn't have to uphold any standard in their prospectuses and that

Starting point is 00:58:34 the New York Stock Exchange could do a lot of shady dealing. where companies, like one thing I was reading about yesterday was a lot of smaller changes around the U.S. would trade unlisted stocks on the exchange, which gave companies that didn't have to go through any kind of approval process or listing kind of, yeah, listing approval process. The benefits of trading on an exchange and a lot of investors were wiped out by that. But still, when FDR called for in a standardized prospectuses and holding a directors and company management liable for the stuff that they printed and gave to investors

Starting point is 00:59:15 as information of the company, then that was still ridiculed at the time. But obviously, that's just crazy to think about not having those standards today. Yeah. Well, wonderful. I'll be sure to get that linked in the show notes for those that are interested. I know you're a bit strapped for time here, Jamie, but I want to make sure I give you a final handoff for those in the audience who would like to check out your blog Investor Amnesia, which I highly recommend. And any other resources you'd like to share. Yeah, if you go over to investoramnesia.com, you can sign up for my newsletter, which now goes out on Wednesdays and provides a kind of quick dose of financial history with some

Starting point is 00:59:56 interesting charts and stories and links to interesting historical sources, like the original documents that have been digitized online. So if you like that sort of thing, then you can go subscribe for free and you can you'll also receive any articles I post, etc. And on the website, you'll also find historical data library that I have built over the years as well as a broad interactive historical timeline and two online courses that you can check out, which have lectures from people like Niall Ferguson, Jim Chenev's Mark Andreessen, and other kind of industry legends where we sit down and chat financial history. So if this conversation has been your sort of thing, then definitely go subscribe and check out the website and follow me on Twitter, also at Investor Amnesia.

Starting point is 01:00:43 Great. Thanks so much, Jamie. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP595: Stock Market History & The AI Bubble w/ Jamie Catherwood

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