Episode #346: William Bernstein, Efficient Frontier, “We Are Creatures That Seek Compelling Narratives”
Guest: William (Bill) Bernstein. Bill is a financial theorist, a neurologist, and a financial adviser to high net worth individuals. Known for his website on asset allocation and portfolio theory, Efficient Frontier, Bill is also a co-principal in the money management firm Efficient Frontier Advisors. He has also authored several best-selling books on finance and history, and is often quoted in the national financial media.
Date Recorded: 8/4/2021 | Run-Time: 56:22
Summary: In today’s episode, we start by covering Dr. Bernstein’s recent book, Extraordinary Popular Delusions and The Madness of Crowds. He explains why we’re susceptible to manias and walks us through situations that have seen extreme speculation. Then we turn to discuss today’s market. We cover Robinhood, meme stocks, lofty valuations, and crypto. We even get into what narratives Dr. Bernstein sees today, whether it’s with star fund managers or the idea that the Fed will save the market.
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Links from the Episode:
- 1:22 – Intro
- 2:04 – Welcome back to our guest, Dr. Bill Bernstein
- 2:34 – The inspiration that led to Bill’s new book; The Delusions of Crowds: Why People Go Mad in Groups,
- 5:34 – Reasons for groupthink
- 9:19 – What is so attractive about end time narratives? Left Behind
- 12:15 – Unpacking contributing factors that have led to us being so polarized
- 16:20 – Why it’s important to understand religious appeal in relation to the tribalism of today
- 18:05 – Bill’s thoughts on the financial world and current mass delusions
- 22:19 – The dangers of investing with an all in or all out mentality
- 26:11 – Reminiscent investor styles of the 90s appearing today
- 28:06 – Are today’s projected returns unrealistic?
- 29:57 – Other asset classes and sectors that excite and worry Bill
- 33:23 – Things Bill is mulling over and thinking about
- 35:45 – Using philosophy to combat bad ideas about the market
- 38:22 – What Bill believes that most people don’t
- 41:50 – The Man Who Solved the Market
- 42:50 – One of the biggest delusions in the book that stuck out most for him
- 45:54 – What Bill plans on writing about next
- 47:22 – Episode #318: Perth Tolle, Life + Liberty Indexes
- 48:30 – Ways we can get more young people into thoughtful investing
- 49:46 – The difficulty of mass acceptance of objectively good ideas
- 52:40 – Learn more: EfficientFrontier.com
Transcript of Episode 346:
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Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: What’s up, everybody? Another amazing episode. Our returning guest is the neurologist, author, and co-founder of Efficient Frontier Advisors. In today’s show, we start by covering our guest’s most recent book, The Delusions Of Crowds. He explains why we’re susceptible to manias and walks through situations that have seen extreme speculation. We turn to discuss today’s market. We cover Robinhood, meme stocks, lofty valuations, and, of course, crypto. We even get into what narratives he sees today, whether it’s with Star Fund managers or the idea that the Fed will save the market. Please enjoy this episode with Efficient Frontier Advisors, Bill Bernstein.
Meb: Bill, Welcome back to the show.
Bill: Glad to be here.
Meb: It’s been almost four years, which I can’t believe since we last had you on to chat and pretty smooth sailing, a little pandemic in between, and did you just find yourself in Portland, said I got nothing else to do, write a book. I got it here in my hands. The Delusions Of Crowds, a nice thick one. What number is this for you? Number 10?
Bill: It’s fun how you count them. It’s my eighth full-length book, four financial books. And this is my fourth book of history.
Meb: So what was the inspiration? Were you just bored during the pandemic? You had an itch you wanted to scratch?
Bill: Well, it’s sort of a 20-year timeline or actually a 25 year or even more timeline. Probably one of the most important books I’ve ever read was the progenitor of this book, Charles Mackay’s “Extraordinary Popular Delusions and the Madness of Crowds”, which I suspect a number of the audience have read. And it’s a book about financial and religious and social and sartorial and cultural manias, but the most famous part of it are the first three chapters on financial mania, starting with the tulip mania. He was the one who gave the English language that word. And I read the book, I’m guessing, around 1993 or so. I thought it was interesting. I thought it was irrelevant.
The financial markets at the time were relatively well-behaved or as well-behaved as they normally get. And I sort of filed it away and thought to myself, “Gosh, it must be interesting to whip at a time like that.” But I thought I’m never going to see this happen in my lifetime. And lo and behold, several years later, the late ’90s come along, and I see all of the phenomena that Mackay described laid out in front of my amazed eyes.
And as it did for a lot of people, it saved my bacon. I had seen the movie, I recently read the script. And I knew how it ended. And it turned out that it wasn’t a unique or a new experience. This book has been in print more or less continuously since 1841. And investors have been reading this book ever since then. And as long ago as more than a century ago, Bernard Baruch read the book, and he said, “Oh my God.” And it saved his bacon in 1907 and, again, of course in 1929.
And because of that, he wrote the foreword to the 1932 edition of the book. So that was number one. And then the second thing that occurred was about five years ago when, like everybody else who read the news, I was absolutely gob smacked by the ability of the Islamic State to attract people from around the world to fight and die in what had to be and what still is hell on earth. And the Islamic State attracted people from prosperous Western societies.
And in reading further about it, I realized they were deploying an end-times narrative, which is very similar to the end-times narrative that’s believed by a lot of fundamentalist Christians today. And it’s been believed for the past 500 or 600 years, it was well described by Mackay as well. So I realized that the time had come to write an update about the subjects covered by Mackay and basically to write an homage to Mackay’s book, to which I owed so much.
Meb: Yeah, it’s such a classic book. I mean, I remember reading it, and like so many people, I feel like it’s easy to read it and say, “Gosh, look how silly, look how crazy these people are. I would never get caught up in something like this.” You know? And then the more behavioral research I’ve read over the last 20 years is like, “Oh, I have that. I totally do that. I also do this. I’m overconfident.” Yadda, yadda, like all the way down. But as we look back some of these, like, not just individual delusions, but mass delusions, kind of walk us through some of the concepts there about how, particularly when people were in groups, how we get kind of caught up in some of these ideas and they’ll let you pick the starting point or which one or what? How has it happened?
Bill: Well, the most important research that I wanted to write about to tie together all of these subjects really wasn’t so much the class of Kahneman and Tversky work, which is very important. But that really operates at the individual level. What I’m describing in the book and what Mackay described was more of a social phenomenon, which Kahneman and Tversky didn’t concentrate quite so much on. But there are some other researchers that did.
And the basic concept of the book is that we are people with stone-age minds living in a space-age world, or as I think, Jimmy Buffett famously put it, “We’re caveman in blue jeans.”
And first and foremost, we evolved 10,000 years ago, when there were certain behaviors that got selected for, the primary one most important one for my story, and for Mackay’s story is that we are the ape that imitates, and that’s a very useful characteristic.
If you think about it, the human species settled the New World, the Western Hemisphere over about roughly a 10,000 year period after crossing over from the Bering Straits. And within several thousand years, human beings have established themselves not just in the Arctic wastes, but also on Great Plains, and then Central America and South America. And along the way, they have learned how to build kayaks, hunt bison on the Great Plains, construct … blowguns in the Amazon. Those are all extremely difficult things to do. You and I couldn’t come close to doing any of them without observing someone else over a period of many years and learn how to do it ourselves over the course of our childhood and later development and sometimes well into adulthood. So this ability to imitate in the state of nature is extremely useful and gets selected for. Unfortunately, in the financial world, as we both know, imitation is death.
If you’re doing what everyone else is doing, you are going to have your head handed to you.
So that’s the first thing.
The second thing is that we are the ape that tells stories and listens to stories.
And it turns out that a narrative will always, no matter how flawed and no matter how non-analogous to the situation at hand, will always and data.
And so time and again, investors get snookered by stories. And, of course, people get snookered by religious stories, as well, particularly pertaining to the end of the world. And finally, we’re the apes of six steps and reaching proceeding status is pretty obvious. It’s a way of bringing forth of applying our DNA. The more status you have, the more your DNA will get forwarded into the next generation. And so that plays into both the religious and the financial narratives as well. There’s nothing more pleasing than the idea you’re going to get effortlessly rich or that you’re going to be saved and everybody else is going to hell.
Meb: As I was reading the book, I was trying to think about this. And I don’t know the answer. So I’d love to hear you opine on it. What’s so attractive about this sort of end-of-times narrative? What about that kind of sucks people in? You’ve seen it throughout history. It’s not just like it’s one episode. It’s lots of episodes where people get drawn up in this concept of there being like a finale only they know about. Is there something that I’m missing or there’s something that you think really attracts people to that idea?
Bill: Well, again, it goes back to our evolutionary past. We have been selected to attend more to bad results than good results. It’s a way of avoiding fatal risk. And so you see it almost every day when you drive along the highway. If it’s a car that stopped on the side of the road, you’re not going to pay much attention to it. But if it’s a crumpled mess, it’s going to slow down traffic. And if there are red lights and sirens, it will stop traffic. And there’s a psychological paradigm. It’s given a name, which is the bad is stronger than good. It’s something that psychologists are very aware of. So that’s the first thing. And the second thing is what I already mentioned about narratives.
We are creatures that seek compelling narratives.
Well, what more compelling worried, negative narrative than the end of the world? And one of the things I did in the book is I traced the evolution of the end-times narrative over the past 500 years. And what is fascinating about the current narrative, which is called premillennial dispensationalist, which is believed by probably most evangelical Christians. It starts out as this very dry, tall theological doctrine in the hands of a couple of Anglo-Irish academics more than 100 years ago. And it’s really dull. It’s really not something that anyone would want to listen to or read.
And what happens over the ensuing several decades after the birth of the narrative, is it gets crafted by entrepreneurs, by evangelical entrepreneurs and literary entrepreneurs into this really, really world narrative that just sells books and sells copies and puts famines and diseases in queues. And the classic examples of this are, of course, the “Left Behind” series and Hal Lindsey’s books started with the Late Great Planet Earth. And these are books and movies that no secular Americans are aware of, but have sold like hotcakes. Hal Lindsey’s books sold probably more than 100 million copies. The “Left Behind” series has made probably billions of dollars in revenues.
And if you want to understand the cultural divide in the United States, the political divide in the United States, you can almost do it just by talking about how Lindsey in the “Left Behind” series of the LaHaye and Jenkins series. To one side are the people who have heard of it and love it and believe in it and probably 90% of those are Trump voters. And then you have got the people who’ve never heard of it. And probably 70% of those are Democrats.
Meb: We’ll get to financial topics in a minute. But you talk a lot in the book about sort of the current political, cultural polarization. And I think it’s particularly timely now as so many people think about everything social media and amplification that you can have that may not have been there 100 years ago. We had newspapers and telegrams, but not necessarily to the extent you could reach millions or billions of people pretty easily. You want to unpack a little bit about this topic, why things are polarized and then kind of what has led to that or what the important factors are, if that makes sense?
Bill: Well, that’s another psychological and social psychology subject that I cover I’d say in some detail in the book, which is that human beings are tribal, groupish creatures. We identify with other people with similar beliefs. And we become very tribal in our beliefs. You can see that happening on both the left and on the right in the United States. And human beings have this tendency to do that. And, again, it has evolutionary roots. In our evolutionary past, adjacent tribes were constantly at war with one another, there was constant competition, and the ability to cohere as a group and to behave generously and selflessly towards people in your in-group and to be absolutely homicidal to people in the out-group gave your tribe a competitive advantage. So those were the tribes that tended to survive.
Now, one of the things I didn’t get in the book because I didn’t read about it until after the book was published is there are very good anthropological data that suggests that if your group has not only a unitary God, but a punishing God, an all-seeing punishing God, that gives your group a competitive advantage because that keeps the free-riding down within your group so everybody cooperates. If you have kind of a namby-pamby God who will send you to heaven, but not send you to hell, that puts your group at a disadvantage if the neighboring tribe’s God believes in hell because they will cohere more than your group will help. That’s the basic reason why we behave this way. And it’s basically hardwired into our behavior, into our genetics.
Meb: Is it sort of the same framework applied to a different topic? Are there common threads that are exactly the same or is it a slightly different animal?
Bill: They are almost identical with some very small differences. Again, we are the ape that imitates. So we obviously imitate the religious and theological and political beliefs of the people around us. But we also imitate the financial behavior of the people around us. As Charles Kindleberger most famously said, “There’s nothing so detrimental to your well-being as to see a neighbor get rich.” And that’s exactly what happens in financial bubbles. Getting coined the word FOMO, that came 40 years later, but that’s exactly what he is describing. So there’s that. And then there’s our proclivity to accept glib doubters. So the Internet changes everything. These large tech companies that have monopolies are going to take over the world, their first-mover advantage.
That’s another narrative that we’re seeing now. And, of course, religious narratives fall into the same category. The other thing that I didn’t really talk about… There is sort of a fourth characteristic human beings have which we are, like I touched on, which is that we’re the ape that likes to morally condemn others. And that’s the one thing that really doesn’t figure in the financial media as much as religious manias do. But even so, we see it with financial manias, the people who don’t understand the new paradigm, our old fogies who just don’t get it. The five words that you’re most likely to hear, almost with a scribble in your face sometimes, when you express skepticism are, “You just don’t get it.” And so there is an element of moral condemnation as well. If you don’t understand the new paradigm, you’re done.
Meb: Before we finally jump over to financial, I feel like some people may be surprised or not the decision to include some of the religious manias and why you devoted time to it much like Mackay did. Why do you think that’s important?
Bill: I did it for three reasons. Number one is because the psychological mechanisms that operate in both arenas are nearly identical, not quite the same, but they’re very, very similar. The second reason I did it was because I wanted to get people in my tribe who are Democrat-voting, secular people an understanding of what’s going on the other side of the political and cultural divide. Because before I started working on the book, I really had no idea, and now I understand what’s going on a lot better.
And I wanted to make sure that other people understood that. I might also say that I probably should have put a trigger warning into this interview about 10 or 15 minutes ago because I imagine 25% of your listener, by this point, are either boiling mad or have already turned off the podcast. If you’re not, if you’re an evangelical Christian, you probably shouldn’t read my book. And then the third reason why I put those two together was simply as a homage to Mackay. That’s what Mackay’s book was about. Sixty, seventy per cent of Mackay’s book was about either financial or religious manias. So I just wanted to be true to his book.
Meb: Yeah, I love the book. I thought it was great, so much that… Listeners, you can’t see it because it’s on YouTube, but I wore my namesake, my brother gave this to me at Christmas, my namesake favorite college shirt today from Animal House, the older people know it with the very famous Emo-favorite quote, “Knowledge is good.” So you’ll have to check out Dr. Bernstein’s book to dive into some of these. Let’s talk about the financial world. We have time this nearly perfectly, doctor, because this is August 4th. Robinhood just went public and, who knows, somewhere between a share price of $20 and $200 probably by the time this gets published.
I feel safe saying it’ll be within those bounds. But who knows? And it’s definitely interesting times and there’s a world is awash in narratives. I could probably reel off the top 10. You and I could ping pong back and forth, on and on and on. Some of which may be true, some of which may not so much be true. What’s the world look like from your perch in Portland today? Is there any sort of mass delusion sweeping up the world as you see it or things look, business as usual?
Bill: Well, when I try to ascertain if we’re in a bubble, I think of several things. First thing I think of is that they’re very rare. I’ve seen maybe two or three big ones in my lifetime. And as you can see from my visit, my lifetime has been fairly long. And I try to identify four characteristics. Let me back up from them. I don’t think you can model bubbles. I think that there have been some brilliant financial economists who’ve tried to model them most recently, William Goetzmann of Yale University. They did a brilliant job and came to the conclusion that, no, there’s no price patterns that you can build. And Eugene Fama would certainly agree with that.
And I wrote a pungent quote from the book saying that the word basically drives him nuts. But this goes all the way back to the time of Isaac Newton when he supposedly said, although it’s certainly an apocryphal quote, that he could calculate the motions of the heavenly bodies but not the madness of men. So if Newton and Fama can’t and Goetzmann can’t model bubbles, certainly it’s not a good idea for any of us to try and mathematically model them.
I take more of an empirical and sociological approach, which is I fall back on the famous quote of Potter Stewart that said that he couldn’t define pornography, but he knew it when he saw it. And you can make that same observation about bubbles. And there are basically four characteristics of a bubble. First and foremost, it’s when a given investment becomes topic A. So, typically, right now, you can’t get into a Lyft or Uber car without talking to your driver about his crypto account.
So that brings in crypto. The second feature of a bubble is when people trade perfectly good jobs in order to trade that particular asset. Again, we’re seeing that with crypto. The third thing you see is what I just talked about, which is when you see people meeting skepticism with … And I can remember very clearly, back in the late ’90s, expressing skepticism, having just read Mackay about the Internet bubble. And I got responses ranging from, “You’re an idiot.” to insults to my parentage.
And we saw that most recently, with a well-known tech entrepreneur, I think, who is no longer with us who said that, if Bitcoin didn’t hit $500,000, he would perform an act on national TV that require great spinal flexibility. And so that’s the third thing. And then finally, when you start seeing extreme projections or predictions, that’s also the sign of a bubble. So we’re seeing all four of those things with Bitcoin. $1,500,000 Bitcoin certainly qualifies on that last criteria. Are we seeing it in the overall stock market?
No, I don’t think so. But what worries me about the stock market is it is being driven now by ridiculously low interest rates. Now, these interest rates maybe with us for the next 10 or 20 years or forever, for all I know. But what worries me is that the risk-free real rate is now somewhere between -1.5% and -2%. Typically, historically, a generous estimate of the equity risk premium on top of that is 4.5% or 5%. So that means that the best you can expect in stocks over the very long haul is about 3%. To me, that’s somewhat frightening. And it’s very concerning for anybody who’s trying to save and invest for retirement over the long haul.
Meb: Yeah, there are a couple of great things in there. And I was flipping through the book as you’re talking, I’m sorry, because I’m a big highlighter and marker-upper to books. I was laughing as you were talking about this because I just travelled to a couple of weddings, I had a pandemic wedding, meaning they’d already gotten married, they just had the actual ceremony, which kind of is better than a normal wedding. It’s like none of the pomp and circumstance just the party.
But every single topic, every single conversation involved real estate too, because real estate for most people, that’s their biggest sort of investment often. And I’m at that sort of age demographic where a lot of people will have kids who are moving, and every single topic was about real estate going crazy or going up. I live in Los Angeles. And that’s certainly the case where we are. And I’m sure with Portland, you guys have been seeing a ton of those damn Californians and others moving into the neighborhood.
And stocks this year have kind of been isolated. It seems like a lot of the conversations too, some of the meme stocks. And I’m sure Robinhood, going bananas along with AMC and GameStop, and everything else is going to probably reignite that. But the topic of bubble, I think, is challenging for a lot of people because it’s the… There’s a great F. Scott Fitzgerald quote you had, you said, “The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.”
And so kind of thinking as you think about markets or even saying if there’s a market that’s getting to be expensive or a bubble, it then becomes the kind of what do you do about it? Is it you actually try to implement part of your investing plan, or is it just, on the flip side, where you’re altering the expectations and the personal finance where you’re saving more, etc, in… I think the intersection becomes the hard part for a lot of people because they want to think in binary terms. Is it a bubble? I got to get out? I got to short it all or nothing? Or is it a screaming buy? I got to get in? I can’t help myself. And I feel like that’s the most dangerous place to be is when you feel like you got to be all in or all out.
Bill: What I like to say is that investing is an operation that basically distributes assets to people who have a strategy and can execute it from those who either don’t or can’t. And one of the things that I’ve learned over decades of investing is that the most important thing to be able to do is not pick the right allocation of the right stocks and bonds. It’s simply to be able to have the discipline to stick with your policy, to stick with your overall strategy. And I don’t see the world now as being radically different than it was 10 years ago or 30 years ago. The equity risk premium is still about probably 3% or 4%. And so that means that your overall balance between stocks and bonds shouldn’t really change.
The only time in my life, in my investing lifetime, that really wasn’t true, was back in the late ’90s. When stocks were pretty ridiculously priced, the dividend yield of the S&P 500 was not much more than 1% dividend, real dividend growth generously might have been 2% so that gave you a 3% real return, which is pretty much what you got from the top of the market until today.
On the other hand, you could buy at one point in the late ’90s, a long tips of 4%, which is essentially on the long-term, a riskless asset in real terms. So that was the one time in my life when that equity, the obvious equity risk premium, was obviously much lower than it should have been. And that should have been the time when we should have had a lower equity allocation. That’s certainly not true now. Right now, it really still looks like the equity risk premium is 3% or 4%. The real risk-free rate sucks.
Meb: Yeah, technical term there. I love saying that. One of the big narratives that does certainly remind me of the ’90s, I was in university at the time, but as the return of the superhero star manager, and I love citing Bogle’s old work on this, where he looked at the top 20 funds per decade going back, I think, to the ’70s, the big outperformers. And then the next decade, of course, everyone knows the takeaway is they underperformed. And I did my own variant of the studies, I was looking at Morningstar’s nominations for Mutual Fund Manager of the Decade and when we did it in 2010, how many outperformed in the following decade. It was zero.
They all underperformed, and I think the average was something like 7% a year. And so this is like my white whale struggle is trying to get investors to not chase the hot idea and strategy. And I’m not sure what to do about it. I felt like part of the star manager concept was going away after the bubble burst in 2000 and then hedge funds have struggled for a decade largely. There’s still a handful out there. But most people say I only give a manager two to three years. And that’s not just retail, that’s institutional. What are your thoughts on that? Does it remind you a little rhyming of the ’90s on people getting all hot and bothered about their superheroes?
Bill: Well, investors are always looking for the financial sale clause. If I’ve quoted … I have to quote his now more-famous cousin who said that what you always want to be doing is praising by name, but criticizing by category. So I’m not going to bring up the obvious name that I think we’re both thinking of right now.
Investors are always looking for the financial Santa Claus, and they frequently find someone who looks very much like Santa Claus. But in the fullness of time, it turns out that the person we’re really looking at was Homer Simpson, not Santa Claus.
Meb: We use the Homer graphic in some of our presentations when we were talking about the low expected returns of 60/40. And he’s at the bar with Moe and its Moe saying, “Just take your medicine, will you?” Saying basically, like, look, if you’re going to do U.S. stocks and bonds, the expectations becomes the big issue where if you look at all the studies, they always say, pension funds, depending if they’re private or public or S&P, historically around that 8%. They’ve come down a little bit, some to 7%, in the average financial plan, that gets around 6-ish, but the individuals are always at 10%. But they’ve been creeping up over the last five years. Schroeder’s last year had individuals at 15% expected returns, and The Texas this year had them at 17% real in the United States.
So let’s call it 20%, the highest in the world, obviously, because the U.S. has been booming. And that really becomes the hard part. The expectation as someone who’s been in the medical field, you know, like, there’s nothing more damaging than having expectations not meet reality. It doesn’t matter if you’re in a relationship or your financial world, it can be traumatizing, and can’t even recover from it. What do you say to people when you hear these sort of expectations? Do you just shake your head and say, “Go read my eight books and get back to me in a month or two”? What’s your response?
Bill: Oh, I change the subject. And if I’m … they say, “How about those blazers?” It’s not a productive conversation. It never really goes anywhere. I mean, this is where you have to fall back on individual… your psyche, your basic … social psychology, which is the availability heuristic, or that’s the new name for what we used to call recency. So if the stock market has been getting creamed over the past three or four years, people think that expected returns are going to be low in the future and vice versa, which is what we’re looking at right now.
Meb: You alluded to this earlier. And I think you have a good example where you say, like, the crazy part is, it’s not just… Like, the professionals love to look down on the individuals, but they get swept up on it all the time. You mentioned, Newton, obviously a pretty smart person, and others like Druckenmiller obviously talks about it in the late ’90s and others kind of getting caught up and wrong-footed. We’ve seen a lot of people get upside down on markets the last couple of years. I think short-sellers are almost totally extinct from the looks of it. If they weren’t extinct before this year, they’re probably extinct now. What else are you thinking about these days? Any other areas that got you worried as you look around the world, or particularly excited when it comes to asset classes and booms and busts and opportunity sets or ideas?
Bill: I wish I could say that there were asset classes that I was excited about. I mean, I was certainly excited back in the late ’90s when I wrote my first finance book to see that the US stocks, large-cap US stocks were greatly overvalued, that there was almost every other asset class you want to look at was actually pretty reasonable. I mean, rates back in the day were yielding 8%, 9%. That’s certainly not the case now.
Am I worried about anything in the financial markets? I mean, if I put on my science fiction hat, I worry that North Koreans with their absolutely deep bench of Packers, what they train people to do in North Korea are going to MPL Coinbase. That would be fun. That would be interesting to see. I worry about something. It’s more ordinary. I worry about the fact that 25% of office space is vacant and probably will remain vacant for a very long time. And they’re going to be some real estate companies that are going to be in very big trouble as their leases roll off over the next two or three or four or five years
If a bunch of real estate companies go belly up, it’s not going to be that big of a deal. But you worry they’re going to take a couple of banks with them. I’d like to circle back because this pops into my head to something that we were talking about, which is 60/40, take your medicine. One of the evergreens of financial media and of big bank market strategists is that 60/40 is dead. I mean, look at ever since the Amsterdam Stock Exchange opened in 1602, there’s been publicly traded debt and has been publicly traded equity. That’s the only two ways really that you can fund any venture.
And 60/40 has been dying for the past 40 or 50 years. It’s done pretty well, right up until today. And I just don’t see that 60/40 having a prudent portfolio of inexpensively accumulated, well-diversified stocks and bonds is ever going to do very bad by anybody. I mean, you have hyperinflation and may wind up like … bonds. But stocks after all are a claim on real assets. Okay. On the other hand, if we have a banking crisis, we wouldn’t be very glad about the very high-quality debt you have. And it’s sort of a much simpler version of Perry Brown, late investing.
Meb: I’m just happy you mentioned that about Amsterdam, because I rarely contribute when we go to trivia night at our local Irish pub here in Los Angeles, because it’s a bunch of Jeopardy winners, but I was finally able to when they asked where was the world’s first stock exchange, I can finally get a question right. Sadly, everyone else somehow knew it. But I was happy to get that one. Yeah, and also, you start to get into topics on the 60/40 where it’s creamed, like, most of the endowments or basically anything in the past decade. And I find that partially hilarious because our worlds spend so much time and fees and effort into just trying to beat that.
And it’s like the old “Wall Street Journal”, monkeys throwing darts experiment. I’m going to try to bring that back, hopefully, this year at some point. We were going to try and do it last year, it felt a little tone-deaf to be launching an idea on that. But, yeah, people have been talking about it for a while. The challenge, you know, I think is also to that everyone thinks conceptually in the market-cap-weighted, this is what stocks are and going back to 2000, I think, is a great example. You had totally different outperformance of strategies such as REITs at the time, small-cap-value dividend strategies did great 2000 and 2003. Nobody wanted them in the ’90s. Very easy to just talk about the S&P 500 only, but also there exists thousand and thousands of companies out there, many of which are not necessarily trading it. Price-to-sales ratios are 20 or 50 or infinite, depending on some of the big dudes. What’s got you scratching your head?
Bill: No, it’s just the big question, the $64-trillion question, which is how does this entire regime of financial repression with negative real rates pan out? Are we really… The narrative now seems to have shifted that we are… This is a permanent regime with low rates of capital return, particularly on the death side. Are we there forever? Now, I happen to think that that is a long, secular trend that operates over many centuries. But it’s also very noisy trend. And 2,000, 2,500 years ago, it was relatively easy if you were willing to go out and do it, to start lending money to get credits.
And if they you defaulted, you could enslave them, so you had pretty good collateral, and you could get 20% on your loan money. Unfortunately, you had to live in a very poor society and dangerous society to get that. Now, we live in a very safe and prosperous society, and we’re looking at sub-zero real returns on safe assets. How long does that last for? Is that a permanent state of affairs? Or does it revert back to something like we’ve seen over the past, say 20 or 30 years? And that to me is the big question. I don’t know the answer to that. I don’t try to answer questions that are imponderable though.
Meb: Yeah, for me, that’s like happy hour discussion. Like, I love to talk about it. It usually makes no impact on the actual investment methodologies we employ. It did make me think, though, as we talk about narratives, in, look, we both know, bear markets are normal. They happen all the time, not all the time. But they’re a regular feature, not a bug of markets everywhere. And certainly, we’ve seen them a lot more in other places than the U.S. over the past decade in many foreign markets in many other asset classes. And one of the dominant narratives, it feels like, and I hear this from professionals, too, to some degree is basically the Fed is going to save us. Like, this narrative that no matter what happens, stocks can’t go down because there’s a backstop.
And there’s been many times, look, you and I were around for the idealization of Alan Greenspan. People were talking the other day to me about Paul on Twitter. And as this is he’s not even one-tenth the superstar the Greenspan was at the time, it seems like to me there’s a lot more attention and coverage now. But my goodness, he was the maestro. And this belief system that that has an impact, it seems to me it’s pretty widespread. I mean, almost universal, even when I talk to professionals that somehow next bear market, they’re going to start buying a bunch of stocks and similar asset classes. I don’t know that it has any impact, again, like, it’s more just have a happy hour discussion, but it seems like one of the delusions that I hear on a daily basis at this point.
Bill: Yeah, I mean, it’s a narrative. You and I can both put our heads together and come up with a half dozen ways to think that narrative all falls apart. For starters, small investors and institutional investors may become so spooked that the Fed buying stocks may not have the desired effect. In fact, it may have the opposite effect. What can you practically do about it? And the answer is, I think, you can just be philosophical. And you can say that we’re all sitting on much larger portfolios right now than we deserve to have because of low rates. I mean, think about the counterfactual world in which you’re looking at 4% T-Bills.
I can tell you that the S&P 500, isn’t it 4,400 at 4% T-Bills? So you have a choice between a great big portfolio with a crappy yield, or you can have a much smaller portfolio with a better yield. All right, which would you rather have? And the answer to that is it depends upon who you are. If you were me, I’d rather have the great big portfolio with the crappy yield. On the other hand, if you’re a much younger person like you, you’d rather have the opposite, because you’d rather be purchasing stocks much more cheaply as you accumulate assets.
Meb: One of my favorite threads that I think is useful for listeners in particular, and you and I probably have more of these than most, but I’d say, for the investment professionals out there and this view implies individuals to, I said, “What belief do you hold that the vast majority of your peers,” so let’s call it two-thirds, three-quarters, “do not share?” So meaning if you and I went to a local CFA, CFP, institutional investors sort of meet up and they say, “Doctor, what do you believe that most people here don’t?” Is there anything that comes to mind that you think is something that you kind of are out in the wilderness about? I think I ended up with about 20 of them, but is there anything that you have in mind?
Bill: Well, that last belief that I told you about, I think it’s something that most of my peers in the local CFA society probably wouldn’t accept, but one difference of opinion I know I have with them because I was part of a panel where I expressed this opinion and I got pushback. This was at the end of 2018. If you remember, the end of 2018 was pretty volatile period, just before Christmas, as I recall, and someone asked me what I thought was the cause of the exceptional volatility that we were having. And I said, “This isn’t exceptional volatility. Watching the market go down by 4% in a day is not at all unusual.
Seeing a market decline of 20% is not unusual, seeing a VIX of 38 is not unusual. It happens all the time.” And I think that’s the one difference I think I have other professionals is I think that they’re much more in the moment than I am. I mean, I don’t spend most of my time managing money. I spend most of my time reading and writing. But if you’re in the moment, and you’re constantly managing money, and you’re constantly dealing with clients who are calling you at 3:00 a.m. in the morning during the bad states of the world. That, I think, affects your psychology in an adverse way.
Meb: Yeah, in this thread, I had one that was broadly on a similar topic where I was talking about a reasonable timeframe to evaluate a manager strategy. And so many people try to extrapolate from, my God, it’s not even years now, it’s down to quarters, and months. I said, 10 to 20 years. And often a lot of the takeaways, if it’s a asset class, in particular, is that the more it goes down, the more interesting it is, as a longer-term hold. And assuming you’re talking about something like an entire stock market and not something like a tiny industry or sector that may end up going the way the dodo bird, I don’t know
Bill: Yeah, the answer to that, I think, and sorry to interrupt, is that, basically, the average typical fund manager, if they are skilled, and there are a few skill fund managers, but they’ve only got a 1% or 2% margin. The answer to that is that it takes hundreds of years to figure that out. Now, there are people who are so skilled and whose models are so good that it becomes very quickly apparent that they’re skilled. Renaissance Technologies comes most easily to mind.
But guess what happens to Renaissance Technologies? Okay, as it becomes more obvious that they were very, very highly skilled, they first stopped taking money. And then the next thing they did was they kicked out all of their outside investors and just gave all their money back and said, “Sorry, we’re privatizing all this. We’re taking all this and we’re managing it for ourselves.” And there was a guy who worked for them. His name … We go speak with them, and part of the settlement was and the thing that made him happy was to be able to just keep his money at Renaissance. That’s all they had to do to keep them happy.
Meb: And the funny thing about Renaissance too, and this is such a great example, on the recent book by Zukerman. I can’t remember the name of it. It was a great profile, but most of the other funds at Renaissance besides Medallion have been totally average. Some of them have launched and shut down. It’s really that one fund that’s done really well and the rest, despite all the brainpower… And it’s also such a phenomenal book because it talks about even Simons, who’s had arguably the best track record ever, and being kind of quantish, still went through periods of doubt well into the end of his career, where he was still wanting to tinker with the models or having very real emotions about the models aren’t working or being broken. And you would think that someone who’s been there done that for decades would be this steely-eyed, totally Zen master. And it’s not the case. Anyway, great book.
Bill: It was great. I believe it was titled “The Man Who Solved the Market.”
Meb: Listeners, listeners go check out the book. It’s a fun one. On the same topic, you and I obviously, are big fans of Vanguard. They had a paper come out a few years ago, and I was trying to explain to people… We actually wrote an email to our shareholders. We have 12 funds. So something is always pretty much doing well and something is almost always doing terrible. And we tried to write a letter about one of our funds that I love the methodology but has been doing terrible. And the subject line was, “Totally not crushing it.” And was explaining how bad it’s been. And, of course, zero people were interested. They’re only interested in one that’s done amazing.
But Vanguard had a study looking at funds, and I no longer think this term has the meaning it did 20 years ago, active versus passive, but they examine just to clear the active space from 2000 to 2014 and show that of the funds that even survived usually over 10 years, you have about half the funds go poof, disappear, is 94% underperformed in at least five years and over half underperformed in at least seven years. And you can extrapolate this, of course, with asset classes too. It’s pretty normal for them to outperform and underperform. And less than 10% of the funds survived, outperformed and never experienced three years of underperformance. But that two to three years is always what people are looking at. As you look back on the book, do you have a favorite delusion or story? Is there one that sticks out where you just kind of rub your eyes and say, “Oh, my God, this one is just like beyond words.” Either interesting or crazy?
Bill: Yeah, the one delusion that I thought was just the most remarkable narrative in the book had to do with the end result of the dispensationalist narrative, this end-of-the-world narrative, which of course, was something that David Koresh believed in. And Koresh wasn’t entirely to blame for what happened at Waco at the end of April of 1993. It’s really more of the federal law enforcement really didn’t understand the religious point of view that he was coming from. They thought he was a con man. And he probably wasn’t a con man. He was very sincere person who also enjoys fertile benefits of being a religious leader.
And what stunned me was not just how close Koresh beliefs were to kind of dispensationalist beliefs but the end part, the timeline of the narrative is that one of the eyewitnesses of the events of Waco in April of 1993, this Inferno that killed dozens of people, was a guy by the name of Timothy McVeigh, who was handing out gun rights literature. And he vowed revenge, which he got in Oklahoma City, on the two-year anniversary of the Waco raid. And so that was a connection that I really, really wasn’t aware of and was sort of the most outlandish story in the book. It was the sort of thing you wouldn’t believe if someone wrote it as a novel.
Meb: Listeners, you have to go check out the book. I’m not going to give away all the good stories in there. But it’s a fun read. A lot of headshaking, a lot of note-taking in there. What’s your pen going to be focused on next? Have you already started? Because you know, the publication schedules. This means you had been done a while ago with most of this. Have you already started putting pen to paper on something else? You got your brain focused on anything?
Bill: Well, I’m always thinking about what I can be writing about next. Almost 20 years ago, I wrote a book called “The Birth of Planning” which was about a great growth inflection in the Western world that occurred followed by the rest of the world in the early part of the 19th century. What was behind the industrial revolution? What has this wealth done to us? It was a modestly successful book. And there has been a lot of very interesting research on that subject that has followed in the past 20 years and some other things that I’ve become interested in relating to that. So I may do a follow on to that book.
I suppose I can give some of it away if it actually does get written, which is that one of the reasons why I became interested in that question was my observation 40 years ago that the best performing stock markets in the world were in English-speaking countries. And they also had the most successful economies, which was a major reason for the successful stock markets. And I realized that had to do with the English common law. It wasn’t even language. It was the English common law. And I never really understood where English common law came from and how it evolved out of English culture. And I now have a much better idea of that. And so that in itself, I think is worth writing about.
Meb: That’s really interesting. You know, we spend a lot of time thinking about foreign markets. And that’s certainly come to the forefront over the past few weeks with the gyrations in China. We had a long fun podcast with Perth Tolle. Listeners, we’ll put in the show note links, if you didn’t see it who goes and ranks emerging markets by consensus of a lot of these freedom scores, saying that certain markets historically looking at kind of a way to invest based on the various rankings of the sort of governments, and I’m always fascinated by the macro factors. Usually, these don’t play any sort of input on our side, but thinking of things like demographics, thinking of things like sort of legal structures as well as evolution of economic sort of frameworks, endlessly fascinating. So I’m excited to see that.
I was going to say we did a poll…we said, like, there’s about six categories that I said, “If you want to teach someone to learn to invest, give me your top books in each category.” And when we got to asset allocation and then history of markets, I think you had more entries than just about anyone. Your other namesake, the late Peter Bernstein had a handful too, but Perth Tolle was the top of list of history of markets. So I’m excited to see anything else you put in there. That was one of the more fun reads on the list. How do we get more young people interested in investing? I don’t want to say because this sounds a little righteous, the right way. But what’s the way we could go about getting this future generation away from the casinos and into a thoughtful approach like either policy ideas at the government level or private initiatives? Any good ideas there?
Bill: I think it’s a Promethean task, I think it’s impossible. I think that we have to back up even further and look at our entire system of retirement. The idea of expecting the average person who’s turning us over in the ICU or flipping our burgers or teaching our kids in elementary school and teaching them somehow to save and invest competently for retirement is about the same as trying to teach the average person to fly their airliner to Chicago. I think we need a completely different system that basically is based on social security, but it’s greatly expanded and enables people to retire in safety with a reasonable annuitized stream of income. What I’m saying is that I don’t think that our current retirement system needs a nudge. I think it needs time and like…
Meb: This is a topic that I almost universally I talk to people and they’re in support of it. And I always wonder with our government, you know, the inner workings and the cogs of why very common sense ideas don’t get put into practice. And people always result either conspiracy theories or conflicts of interest. A good example would be the tax code. Why is it so complicated? Everyone says, “Well, it’s just the lobbyists at Intuit.” I’m like, “That’s one company.” You’re telling me that all of the systems and structures are built upon the interests of one company? That can’t possibly be right. And so thinking about this sort of concept of the universal retirement or we’d said copying something like in Australia where it’s an automated pension savings type of idea, but no matter what, it’s better than what we have now. And it seems so odd that there’s so much resistance and, like, I don’t want to run for public office. But why do you think it’s so hard to take ideas that probably have universal acceptance or near that seem like such common sense? Why is it so hard to get that push through?
Bill: Yeah, I mean, I think it’s politics and ideology. It helps to look around at the rest of the world and ask how other countries are doing it. And it’s patently obvious that the other social democracies in the world are doing it much better than we are. You don’t see the almost universal debt peonage that we see college graduates among Americans. You don’t see that very often abroad. Their healthcare systems, better outcomes at a lower cost than ours too. Every libertarian I know, they all seem to have the same cousin how to had to wait six weeks for a shoulder surgery or six months for a shoulder surgery. But on the other hand, if you’re an American diabetic, you are three times more likely to have your foot amputated than you are in England or in Sweden.
They’re obviously doing something right that we’re not and the solution is not to make the system more free-market-oriented. We have the most free-market-oriented healthcare system in the world. It’s probably to make it more like Sweden’s or Britain’s or Germany’s. Germans, by the way, don’t have a national healthcare system. They just have nationally mandated health insurance, but the health insurance is actually privately run. They don’t have to have socialized healthcare running healthcare systems, you just have to have an intelligent system mandates and insurance company regulation.
Meb: Warren and Charlie talk a lot about this. And we actually like this quote so much we put on one of our books, where Monger was saying, “I believe in the discipline of mastering the best that other people have figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.” And so to me, if you go talk to the people, if you look at like the Australian Retirement System, everyone loves it.
Every single person I’ve ever spoken to loves it. Or you talk to people in some of the countries you mentioned that have extremely high-quality life that love their system. It’s odd that you can’t just say, “Well, let’s just go… We don’t have to just copy it. But let’s take some of the best of what’s around and try to implement it.” It doesn’t seem like it should be that hard. But again, politics. Dr. Bernstein, I’ve had an awesome time talking with you today. We could go on for hours. Listeners, check out the new book, “The Delusions Of Crowds: Why People Go Mad in Groups.” People who want to follow up with what else you’re up to writings, where’s the best place to go?
Bill: Oh, boy, I’m going to sound like a real Luddite. I don’t do social media. I just don’t see the purchase in it. I guess when I have a new book out, I do put it up on my website, which is the mausoleum, efficientfrontier.com. I post there about once every year or two. So look at my website, look at efficientfrontier.com about once a year if you want to follow me.
Meb: Awesome. Bill, Dr. Bernstein. Thanks so much for taking the time today.
Bill: My pleasure. Let’s do it again some time.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.