The Asset Allocator: Mebane Faber - All-Time Highs Are 'Nothing To Be Afraid Of' (Podcast Transcript)
Editors' Note: This is the transcript of Friday's SA for FAs podcast. We hope you enjoy it.
ETF manager, author and popular investment blogger Mebane Faber covers a wide range of asset-allocation issues from buy-and-hold to global value investing.
In this podcast (20:51), Faber’s sees asset allocation from the standpoint of market history, and insightfully addresses the difference between becoming rich and staying rich.
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Gil Weinreich: Welcome to the SA for FA's Asset Allocator Podcast, a series that addresses issues of current interest to financial advisors, including ETFs, asset allocation and the economy. I'm your host, Gil Weinreich of Seeking Alpha and today I am pleased to have as my very distinguished guest, Cambria Investment Management's Mebane Faber, an ETF manager, author, blogger, podcaster, and always a maverick in his unconventional views. We will be hearing some of those shortly.
But first, this word on behalf of our sponsor. Every day Invesco brings together ideas with technology, data with inspiration and investors with solutions. Let's invest in greater possibilities together. Find out more at Invesco.com/together, Invesco Distributors, Inc.
Our guest, Meb Faber of Cambria Investment Management manages a series of ETFs and is an indefatigable blogger and podcaster. But there's far more than just investment business and show business here. He also wrote one of the most downloaded research papers of all time on tactical asset allocation, and has been a constant iconoclast on numerous issues, some of which we will get to post-haste. So with no further ado, thank you, Meb for joining our show.
Mebane Faber: Hey, man. Great to be here.
GW: Pleasure. Med your fame as an investment thinker, as I can recall back in the day may have kicked off back when you pronounced buy and hold investing dead. Now seems like a good time to challenge you on that, given the incredible longevity of this bull market. Do you still feel that timing the market can be a beneficial form of risk management?
MF: So this is a deep question. And like many things I actually think buy and hold is just fine. We actually wrote a book on buy and hold as well and buy and hold has done a fantastic job over time, but the biggest challenge in buy and hold is not the allocation, it's not how much you put in stocks, it's not how much you put in bonds, or real estate or commodities, because I actually don't think that matters all that much.
The difficulty with buy and hold is the human side, the people side is the sticking to the whole part. And a lot of investors struggle with an investment approach that is often seen as doing nothing and sitting on your hands. And the biggest challenge with buy and hold is an environment like a 2008, as assets are declining, a lot of people the emotions creep in, and that's where the investment plan the problems start to happen. And you see the fractures and a lot of people listening this probably can reflect back, and whether you're professional and it's your clients or you are an individual or you are professionals, as you, a lot of people struggled and sold stocks, couldn't take it anymore in 2008 or 2009 when stocks were down 50%, and many never to get back again.
We've had conversations in the 10 years post, where people said, I never I never got back in the market, what do I do? And so buy and hold is fine, but it's hard from a behavioral standpoint. And other ideas like trend following, which we talked about in the paper can be a potential solution to that. But they're also hard. It's also not easy to follow the strategies as well. So the whole key is, of course, trying to find something that keeps us all compliant and works for each and every one of us.
GW: You recently expressed a quite provocative idea that is highly relevant to today on the question as to whether it is worthwhile to buy at an all-time high. Is it?
MF: So as you look back at the history of markets, you know, one of the biggest challenges you can either be totally agnostic as to valuations or anything else and say, look, I'm going to own stocks no matter what, which is what most people say you should do. I mean, John Vogel despite writing articles, over 30 years ago, outlining a formula for expectations on the stock market, and actually, before he passed, by the way, he said that, you know, he expected the US stock market to do about 4% going forward, which is quite a departure from the historical 9.5%, we like to say 10 just to round up, so 10, quite a bit lower. And so valuations matter.
But I think what you're referring to is this question of, there's only two states of the market, and you're either at an all-time high, or you're in what's called a drawdown. And the drawdown is simply the distance you are from that all-time high. And US stocks regularly go down 10%, 30% 50% and on the super rare occasion, back in the Great Depression, it went down over 80%. And these big holes is what you really want to avoid because it takes a lot to get out of and it's a lot worse, the further down you go. So if you go down 10% you only need 12%, you go down 20% you need 25%, you go down 50%, you need 100% to get to back even. If you go down 75%, it takes 300% to get back to even. So avoiding those big holes.
But the problem is that's a natural part of markets. Most markets spend about two-thirds or 70% of their time in some form of a drawdown. So all-time highs are actually kind of rare. And while most people are scared of them, my friend, Jerry Parker had a great phrase where he said people are hopeful of losses but afraid of profits. Meaning as people make money on their investments, and there's a lot of behavioral research to support this, they often sell too soon. And so all-time highs sound scary, and sometimes they are. Sometimes they do correlate with high valuations and sometimes they don't, but our research has shown that in general and across markets, it's actually a great time to be investing when you are at all-time highs, it's not really that much of a trading strategy as it is just demonstrating that it's nothing to be afraid of.
So right now, you have somewhat of a conflicting environment, which is yes, U.S. stocks are on the expensive side, but they're in an uptrend and hitting all-time highs. So it's somewhat of a balanced scenario and the biggest summary is it's nothing to be afraid of.
GW: Let's talk about valuation. Many investors believe in a sort of American exceptionalism, when it comes to their investments that U.S. stocks are innately better than the rest, even at today's high valuations. What do you say about that?
MF: Recent Nobel laureate Professor Robert Shiller wrote in the 90s, about applying Ben Graham's ideas, which was looking at the price to earnings ratio of an investment over a longer period five to seven years. In this case, Shiller said, let's do 10. And let's apply it to the entire stock market. And so he came up with what he called the Shiller PE ratio or CAPE ratio, and it has a way of having a very long term focus. But you can also, because it's inflation adjusted, you can try to compare 1920s to the 1990s, to the 2010s, et cetera.
And what he found over time was that the stock market traded at a value of around 16 or 17. But it had been as low as five. And it been as high as 45 in the late 90s, internet bubble, which was my favorite bubble, a lot of fun back then. And in general, high valuations preceded low future returns over the next 10 years and vice versa. You have low valuations, the next 10 years returns tended to be great. And so it more than anything, it's meant to be a yardstick which you can gauge and have expectations. And so as you wind down the New Year, or wind down the end of this year, and the end of this decade, and 2020 is looming, you know, for most American investors, they can cheers, glass of champagne, wine, beer, tea, coffee, whatever you whatever you're choosing with at midnight and say, man, it's been an awesome decade. And pat yourself on the back. Problem is, is that - that's pretty rare.
It's pretty rare for the U.S. as an example to be the standout, and it has been, by far the best-performing - one of the best-performing markets of the past century. I think tiny South Africa did better, but most countries did worse. But that's also because the U.S. went from 15% of the market cap of the world to well over half. And so you have this scenario where the U.S. has had monster returns. Back in the early 2000s, 2008, 2009 financial crisis, most markets in the world were trading at low teen price to earnings ratios, so much cheaper. And the big difference is the U.S. has gone all the way up to PE ratio of around 30 right now. And so that's not terrible. It's not as high as the 90s. It's not a bubble. It's not crazy, but it does mean future returns are likely - it's going to be a headwind of valuations. And most people that live in the U.S., they put 80% of their money in U.S. stocks when it should only be 50 as a starting point, and so that's a huge active bet and congrats.
That's been an awesome active bet for the past decade; but realize that's a very active bet. And they say no Meb, U.S. stocks are exceptional. They're better than the rest of the world. To which we say, well, then if that was the case, they should have a historical valuation premium versus the rest of the world. And it turns out, they don't, the valuation premium of U.S. versus the rest of the world is zero. But right now, foreign developed is around 24, and emerging is around 15. And if you look at the cheapest bucket, this is what our largest fund does, you know, invest in the 12 cheapest countries around the world, that gets you to a PE ratio down around 12. So much, much, much lower. And historically, foreign developed and emerging, they kind of zig and zag. Sometimes the U.S. is more expensive, sometimes it's cheaper.
We had a recent article that said this is the biggest valuation spread we've seen in 40 years. But 40 years ago, the U.S. was the cheap one, and the rest of the world was more expensive, in particular, Japan, which was the largest stock market in the world at that time in the 1980s, hit a PE ratio of almost 100. And so it's a - as we wind down the decade, it's easy to get caught up in the U.S. being the star performer and it's going to extrapolate forever in the future. And it might, but the odds if you're a gambling man, if you're a better, would be to have some prudence and look beyond our shores as well.
GW: So where should investors want to put their money nowadays?
MF: So the starting point, you know, we always tell people if you're looking at stocks is the global market portfolio, and of that market cap weighted, the U.S. is only half. Now, the U.S. as percentage of world GDP is only about a quarter percentage of population everything else is even lower. And so the starting point we tell people is half U.S. and then the majority in foreign developed and then emerging as well. Now if you are value conscious, then you should have tilts even more towards foreign developed and particularly emerging. Emerging is really cheap.
But you could also say look, describing markets in terms of U.S. foreign developed and emerging is a bit arbitrary. I want to be a pure valuation guy. And if that was the case, then you should be geography agnostic. In which case, most countries spend most of the time being somewhat around fair value. So and that's sort of 14 to 25 range of valuations. And that's where most countries are, which is good news compared to the U.S., which is one of the most expensive in the world. But there's some countries that are downright cheap. Russia is one of the cheapest countries in the world, stock markets also up I think, 30% this year. Greece is up 50%, one of the cheapest markets. It's a smattering of Europe and emerging Europe. So Czech Republic, you still got some of the pigs [ph] in there, Spain and Italy, still are struggling. You have countries that have made it in there. And by the way, the PE ratio, the biggest movement of that ratio is the P, not the E.
So a lot of these countries in the buckets simply are down 40%, 60%, 80%. And one of the reasons that the value works is a lot of people don't want to own those countries. Imagine getting off this podcast and saying, oh, I got to go buy Turkey, and Russia and Greece and all these countries, it's hard.
And on the flip side, that the countries that are high PEs are hitting new highs. So it's somewhat of a conflicting concept, value and all-time highs what we talked about earlier, but the times where you really need to be mindful of the valuation, I believe, is when things go crazy. And so the times when the PE ratios are hitting 40 or 60, or 90, true bubbles. And so we saw that, by the way, not too long ago, in the mid-2000s. Everyone was clamoring for emerging markets. Emerging Markets dominated, 2000 to 2008. India and China were trading in PE ratios in 40, 50,60, true bubble territory. Everyone wanted the BRICs. But fast forward 10 years, nobody wants them. And so a lot of those countries are quite a bit cheaper and sort of rinse repeat.
So I think depending on how weird and different you're willing to be, you should certainly start by tilting away towards certain countries. The UK, by the way, is one. I'd say the Brexit mess has created a lot of uncertainty there. Their stock market's gotten to be quite cheap. And then if you want to get really weird, you can invest in the cheapest countries in the world. But certainly, geography or developing status emerging would be the big pick there.
GW: Meb, you wrote a book analyzing the many approaches to asset allocation and came to the surprising conclusion that better than even the very best method is simply keeping fees low; yet many of those invested in cheap investment products still performed badly because of their own unforced errors. How do you reconcile these ideas?
MF: I think we talked a lot about, there's a great graph from Bill Gates every year, he puts out about talking about malaria, and he says what animals are people scared of killing them. And it's sharks and wolves and lions. Sharks are fair. I live at the beach, lifeguard says he sees sharks all the time here, great whites. So that's okay. But they don't kill hardly any people here. But what kills the most people? It's mosquitoes, it's other humans, it's dogs, the things you wouldn't be afraid of. And then of course the next five are like snails and worms and everything else. In my kind of argument here is that relates to fees. And so most people what do they spend all their time thinking about, and talking about, the sexy fun stuff?
What we've been talking about and it's interesting asset allocation and how much I should put in stocks, whether I should tilt towards foreign, is the Fed going to raise interest rates? What about gold? Are real estate prices too high? How do they do in the current environment? What's the yield curve, all that stuff? And that's what 99% of time CNBC talks about. But what has way more outsized impact is the cost to implement those portfolios. And so in the U.S. the average mutual fund fee is 1.25%. On top of that many use advisors, which we love, but they charge another percent. Hopefully they're doing a lot of other value-added activities outside of the investment part. And that's a 2.25% fee.
And we live in a world in 2019, where you can invest in a global portfolio of assets for essentially zero, 0.05% and willing to pay 1.25% or 2.25% at this point is totally voluntary. Now are there active approaches? Are there approaches that are worth that fee? Absolutely. But it just goes to show that there's a bar from which you have to do better than. The base case asset allocation for dummies is zero. And the problem with a lot of these fees is people, the smartest thing Wall Street's ever done is have this fee that's a per year fee that people don't see get it get skimmed out of their account, but I guarantee you if you were to ask someone, hey, would you go deliver $10,000 $20,000 $50,000 to your broker each year in cash, rather than it just coming out of your account. No one would do that.
And so this ends up becoming a much bigger determinant, the book we were talking about Global Asset Allocation, which by the way listeners you can download for free on our website, walks you through this concept where it says we look - take a look at most of the best asset allocation portfolios recommended by the top gurus that manage in the trillions. We're talking, people the manage the Yale Endowment, PIMCO, et cetera, et cetera, Warren Buffett. And we examined all of them and came to the conclusion they all did fine.
But even more important than that asset allocation was how much you decided to implement them with fees. And most of the rest of the world's worse. So the U.S. is actually a pretty strong outperformer as far as the fee structure. You go to Canada or Japan or some places and it's really atrocious. So…
GW: And yet you have your own family of ETFs that charge money. What would you say about that?
MF: We manage a dozen funds. We have one of the lowest cost, world allocation funds in the world. Most of our funds are 40% cheaper than the index average. So we like our funds, and - but they charge more than zero. So we obviously think they offer some value-add.
GW: We have time for just one more question. Meb, you have written persuasively that the way people become rich isn't necessarily the way they stay rich. And your solution is one I've frequently advocated myself, namely, maintaining cash in a high proportion. Can you elaborate on that?
MF: We often tell people that come and talk to us, that are wealthy, that have built up a lot of money. We say, look, you've won the game. So at this point, how you want to protect your assets may be different than how you wanted to grow them in whatever manner you may have grown them, whether it's been a business owner, whether it's been saving for 50 years, et cetera. And the challenge for a lot of people is that you naturally assume that young people should be very risk tolerant and older people should be risk averse. And in general, that's a reasonable framework.
But at the same time, we know plenty of 80-year-olds that say, look, I'm happy with my situation. I'm not investing for myself. I'm investing for - I want to give it away to charity, or I want to pass along to future generations. So I'm comfortable with all stock portfolio. And I know plenty of 20-year-olds, their portfolio goes down 10% they lose their mind. So it's a hard generalization to make. But in general, a lot of people think once you've gotten to be self-sustained, and you have a lot of money the safest possible option is cash, or bonds. And that's true on a nominal basis.
So if you put your money in bonds, right now, let's round up, say you get 2%. Congrats, but remember, inflation is probably also around 2%. And there's been times in the past in the US and lots of other countries where inflation is actually higher than bond yields and what we call financial repression. And then it's happened a few times the last 10 years. And so often if you're in this all cash safe portfolio a lot of people, I say what's been the biggest drawdown or loss of 10 years safe U.S. government bonds historically, and most people assume it's under 10%.
And the answer is actually about half. It's actually a little over half. Same thing for cash. So a lot of people don't realize that the safest portfolio is you actually have to invest some of it. It could be a third, it could be half. But it's actually safer historically, to invest. When I say invest, I mean, a balanced portfolio of stocks, bonds and real assets, which is my favorite portfolio because it's 2,000 years old, back citing the Talmud, which talked about a similar investing strategy 2,000 years ago, and it's like one of the hardest portfolios to be today, still very simple. And so you actually have to invest a little bit of that because one of the biggest risks of long term sustainability is inflation. And so being able to protect that portfolio and we've lived in a world, particularly in the U.S. when inflation hasn't been a concern, but other countries it certainly has been and it has been in the US historically.
So trying to come up with an allocation that certainly does well in any market environment is important. And then even once you've won the game, I think, to be sensible about all the risks, but also all-in cash can be actually quite a bit risky investment as well.
GW: Provocative ideas on asset allocation. Go to his website, mebfaber.com and download his book for free. Meb, thank you so much for joining us.
MF: It was a blast, Gil. Thanks next time we'll have to - we'll do it again for longer.
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