Preston Pysh  11:39

Awesome. I love that.

Meb Faber  11:40

Fantastic. Let’s keep the show going. We prepared nine questions and I’m hoping we’ll get to all of them. We did the first one though, but the second one. So, on the podcast, our investment philosophy is deeply rooted in value investing. That being said, given the current market conditions with the highest valuations, we have discussed if our listeners should look more at hedge fund managers like Druckenmiller and Soros, rather than Warren Buffett. So, who do you expect to perform best in the next day, three to five years?

Well, if I knew I would certainly give them all my money. Let me know if you guys find out. But it’s challenging for investors. Most investors, if you talk to them, they have an investment methodology. So, you’ll talk to people to say, I’m a value guy, or I’m a trend guy, or I’m a dividend guy. I’m a Bitcoin guy who knows? But one of the challenges is taking a step back and say let the data speak for itself and what has historically worked and investing.

There’s a lot of approaches that work in investing: value works, trend following works, momentum works. And the biggest challenge why Warren Buffett has been so successful is not his system because the system is not that complicated. He invests in cheap stocks, high quality. But what’s beneficial is he sticks through his system.

And so an example we gave on the blog recently is we said if you just went and tracked what Buffett was doing through his public stock picks, updated at once a quarter. When those picks were public, he’s outperformed the S&P by something like 5% or 6%. a year since 2000. This would have been one of the top-performing mutual funds in the United States. It would have performed 98% of all stock mutual funds.

However, he’s underperformed the broad market and I think seven of the last nine years of that strategy. So, most investors, if that was a mutual fund or your money manager, they would have fired him after a year three or four or five. So, you see these long cycles where certain types of strategies outperform. So, this is a long-winded answer to your question but where we are in the US right now? You know, last year seven bull market, stock valuations are getting expensive. And the best quadrant to be in when you’re investing in the US is a cheap market that’s going up. And so, when I say trend, you could use a 200 day moving average or 10-month moving average, but just an exact quantum measure of is it going up or down? And the best quadrant is cheap and going up. And where we’ve been the past few years is expensive, but going up, and that’s not a bad place to be.

14:33

The problem is when that trend flips, which you’ve seen fourth quarter last year, where all of a sudden you go from cheap and going up to cheap and going down, or sorry, expensive in going up to expensive and going down, and expensive and going down is by far the worst place to be. It only happens about 10% of the time, but you want to move aside. I mean, it only looks we’re only three weeks into the year but it’s been a pretty dramatic start, where US stocks are expensive and going down.

And what’s working, you point out a lot of the quad investors, the managed futures type of funds are up around 6-7%. And we’ve said for a long time, as far as hedging US stocks, nothing is perfect. The best way to hedge is not to take risks in the first place. But US government bonds, and then managed futures historically been to the best. So, we love quant and macro guys, but we love them always. So, throughout every market cycle, we think they have a great, great place as a compliment to value strategies.

Preston Pysh  15:44

All right, fantastic answer. So, one of the ideas that you’re famous for, Meb, is providing a framework for imitating the best professional investors in the world. And you hit on that on the last answer a little bit. You’ve written this book called “The Ivy Portfolio.” For anybody else out there we have, we’ve gotten a lot of questions on our forum, a lot of people. And we get these questions just straight from email people saying, “Well, why don’t I just imitate the picks of Warren Buffett? Can I do that?” And the answer is Meb has written a book about this. And it’s called “The Ivy Portfolio.” And what I’m wanting to do is just provide the basic framework for this book and just tell our audience a little bit about this idea of mimicking and imitating the best investors in the world just by looking at their 10Q or just expound upon that idea.

Meb Faber  16:32

Well, the great news what a great lead-in because I just published my fifth book last week on this topic, it’s 200, and probably 60 pages deep on this called “Invest with the House.” But where this theory goes back to is back in college, I was a biotech engineering student, and was taking a security analysis class taught by a famous hedge fund manager. He manages probably 10 billion now and it was a security analysis class and each week, there would be a different hedge fund manager or a guest speaker.

And so, you would listen to these guys give talks. So, like Lee Ainslie of Maverick or a lot of these famous guys. And you would sit there and listen and say, “My God, they know so much more about these stocks than I ever will. They have far more resources, 20 analysts. They pay people to go spy on oil fields, they have people sitting in the parking lot of Walmart, counting shopping car all of these resources. So, why wouldn’t I just allocate to what they’re doing?”

And many people don’t know this. But you know, investors with over 100 million under management have to publish their holdings once a quarter, and it’s with a 45-day delay. So, the holdings as of the end of the year would come out on February 15th. There are some caveats to these type of filings such as it’s only the long picture off, the shorts don’t show up. The futures and derivatives don’t show up and so you want to be able to track the investors who have a long time horizon, who are stock pickers. You don’t want to track the high-frequency guys, the guys who are doing arbitrage, the guys who are doing macro, none of that works.

18:12

But Buffett’s a great example. So, I said, being a quant, I can never get comfortable with the possibility, say, does this strategy work or not? I have no idea because I can’t test it. And so, after a few years, I said, all right, I corralled a few interns. And we went and did this by hand. And when got downloaded all of the files online, this is all free. You can look it up on several websites that track these holdings, like WhaleWisdom. And I said, “I pulled together all these filings and found a non-bias stock database and said, let’s test these and historically how it worked.”

And so Buffett being the example we just mentioned, where we said what would it look like to track Buffett? And it turns out, it works great. And in fact, it works great for many of these managers and in some cases, performance is as good or better than the managers because you’re not paying the high fees. So, you’re not paying them the 2% management fee, the 20% performance fee. And so, what we illustrate in this new book and way back in the idea portfolio is you can cobble together a list of 5 or 10 of your favorite managers and use it in a couple of ways: one as a stock screen for an idea farm of new investments you may be interested in, potential stocks to buy so screen it down. Or you can simply outsource your entire portfolio to some of your favorite managers and let them do the work. You know, these are the Michael Jordans of Finance. And so, instead of allocating to what my broker says, or my next-door neighbor, I’m going to let Seth Klarman pick my portfolio, and I think it’s a great way to invest and we’ve been doing it for a long time.

Preston Pysh  19:52

That is awesome. So, just a quick follow up question to this idea of tracking these all-stars that are investing with just awesome returns, one of the things that we talk about on our show a lot, and my concern with sometimes telling people different picks, is that they will lack the conviction to stay with it if it starts moving against them, especially in the early part of taking that position. So, is that something that you talk about in this new book that you said, is just coming out “Investing with the House”? And if it’s not, I’m just really curious to hear your thoughts on this idea of conviction whenever you’re basically following somebody else’s move, and you might not fully understand why they’re taking that position.

Meb Faber  20:32

Well, look, investors are always their own worst enemy. And it’s not just retail, it’s institutional as well, where the biases we have, they’ll go out and chase performance. And you know, this happened over and over again. And all of the academic research shows that it costs investors anywhere from 1% to 4% a year by buying what’s done well and selling what’s done poorly.

So I’m eternally bearish on investors as a group. Never ever get it right regardless. So, I mean, buy and hold investing, whether it’s active. Regardless, the strategy commodities and emerging markets are a great example right now. No one wants those cheap countries we were talking about earlier. No one’s going to listen to this podcast and say, “You know what, I’m going to go buy Brazil and Russia and Eastern Europe and, Spain and Italy and all these throws in a little sprinkle and a little Peru and Egypt just to make it interesting.” Because it’s hard to do.

And so the same problems that face and it’s…  Look, I have all the biases. I’m overconfident. I’ll take too much risk if you give it to me, but that’s part of the reason I became a quant is to make these rules and say look, I know given these parameters, I’m going to make a lot of mistakes. And so, the same challenges apply, whether you’re picking stocks or buy and hold investor is that you know, can you put in rules in place and a great example is the Buffett example earlier. Could you still track this manager who’s underperformed seven of nine years? Despite that fact, he’s outperformed the S&P by %% or 6% a year and one of the best funds in the country.

You know, can you follow Seth Klarman after he had probably a down 30-20% year last year? And it’s hard. So, I don’t know if there are any easy answers to that question. But the biggest is to write down an investment plan. You know, some people call it a policy portfolio that accounts for any possible scenario and understands enough market history to say, look, I understand that, for example, my buy and hold portfolio will go down by 35% at some point, or my stock portfolio will decline in half. And this has happened to Buffett multiple times in his career. And if you can behave properly when things go poorly. My favorite quote is, “Investing is the only business when things go on sale, people run out of the store.” And you notice that I think that applies very broadly to any strategy not just to stock picking.

Preston Pysh  22:59

Yeah. A great answer. Meb, recently you wrote a blog post about the performance of various indexes. And we touched upon this prior to the interview, but what did you learn from studying international markets in 2015? And do you think there are any regions that investors should pay special attention to in 2016?

Meb Faber  23:19

Well, we’ve been saying for a long time that foreign markets are cheap, but that doesn’t mean they can’t get cheaper, We expect the cheapest bucket and we have ETFs that track this to have double-digit returns in the foreign stock markets. Whereas in the US, we expect low single-digit returns, but historically, and so we did a book called Global Asset Allocation that looked at 15 of the most famous guru portfolios.

So as recommended by David Swensen or Rob Arnott or Mohamed A. El-Erian, all these famous investors are managing the trillions. They’ve all recommended publicly at some point and asset allocation portfolio. So, they say you should put this much in gold, this much in stocks, this much in foreign bonds, real estate, commodities, whatever. And what you find is that it’s surprising, but they almost always recommend some in global stocks, some in fixed income and some real assets, such as reeds, commodities, and tips. There are vastly different allocations, however.

But the stunning takeaway from that book was that if you exclude the permanent portfolio, which is a little different because it has a high allocation to cash, all of the asset allocation portfolios in that book, were within one percentage point return of each other over 40 years. So, they all grouped in this little range of what’s called 5% real return so nominal around 10, historically, since 1972. Now they had vastly different returns in any given year.

24:54

So here’s the challenging part is that you went back to 1972 and said, “You know what? Crystal ball, I’m going to be able to predict the best asset allocation portfolio.” And that turns out it would have been the El-Erian portfolio, which is an endowment style. So, it’s heavy in growth and heavy in equities. And that’s not surprising, because that’s done well, the past four years, and said, “I’m going to layer on the average cost of a mutual fund today, which is 1.25%.” That would have taken the portfolio of the best asset allocation in our entire book and made it almost as bad as the worst.

And so what investors spend so much time thinking on, and this is the strategic asset allocation crowd is our stocks are expensive, should I’d be in bonds with the Fed raising rates? You know, what about commodities? And it turns out the actual allocation is not that important. What is important is the boring stuff, the basic blocking, and tackling of fees, commissions and taxes. And then on top of that, if you layer on the average via financial advisor, which is 1% in the US, so you’re up to 2.25% now. You take the best performing crystal ball allocation and turn it too far worse than the worst. And that’s a pretty profound takeaway from our studies is that a lot of the boring stuff has a massive impact.

And then we did one more study where we said we’re going to update the allocation once a decade with the best performing allocation of the past decade. So, what worked in the 70s, we will then use that allocation for the 80s, and then vice versa for the 90s. That would have cost you an additional one and a half percent a year by chasing performance. And thus lies the challenge. And the fun of our business is that people in the 70s, gold was incredible in the 70s and allocations… Most allocations did awful in the 70s. But what worked then and probably all the managers that would have been fired, would have done much better in the 80s, you know.

27:00

So the challenge right now, for example, the way we see the world is that what is dear is often the worst-performing asset class going forward and vice versa. So, commodities, emerging markets, they are universally hated right now. You go back to 2007, everyone’s talking about the bricks, everyone wants to commodities, these big institutions. Fast forward eight years and it’s the opposite.

So, I mean, again, going back to the idea of coming up with a strategic portfolio that does not have a home country bias. I say A) doesn’t matter, but B) one of my favorite portfolios that’s hard to be is very simple. I think we named it on the blog the Trinity portfolio because you put a third in global stocks, third in global bonds, and a third in trend following type of strategy. So, you could call it managed futures. You could call it any sort of global trend. That’s a nice portfolio because it performs well in most market environments. So, that’s a long-winded answer to your question. But we think there’s a lot of opportunity and foreign assets because the US has had a pretty, pretty strong run these past seven years.

Preston Pysh  28:17

So when we look at the international value investing strategy, we see that Japan right now is offering some good valuations, their PE ratio is very low, relative to a lot of other locations. But with that said, I don’t trust the Japanese currency at this point. I feel like we’re upon some interesting times in this coming year, especially as their QE seems like they’re not going to be continuing that anymore. I see that making their currency, extremely strong and very difficult for their equities.

So specifically with Japan, how do you see this playing out with their valuations being so low and they’ve got all these other currency issues happening? I’m just really curious to hear your opinion on this.

Meb Faber  29:02

Currencies are tough. There’s a good quote called currencies that aren’t difficult. They’re just confusing. And as Americans, we’ve benefited from having the reserve currency. And a lot of Americans don’t think a lot about currencies they think of them in terms of, “Hey, Argentine peso and Brazilian real went down big last year. That means vacation to South America is cheaper, or currency was expensive in Europe, and it’s more expensive to go skiing.” That’s it really, they don’t think in terms of investing.

But here’s the way we think about currencies. So, this is a broader question, then we’ll get to Japan. Real currency returns over time, meaning the net of inflation is fairly stable. The keyword being over time. You know, in any given year, currencies can go up, down 20-30%, as we’ve seen in the past few years. Particularly last year, the US dollar is very strong against several currencies. But over time, they’re fairly stable because they adjust for inflation.

So when thinking about hedging or not hedging equity markets, I’m agnostic. But I feel that you have to pick one or the other and stick with it. Either you hedge all your equity exposure or you don’t, or you stick with it because over time it’ll be awash.

Foreign government bonds in developed markets are a little different because that’s a low volatility asset class and currencies add volatility to an asset class that doesn’t historically happen. So, in that case, we think hedging makes a lot of sense. Furthermore, if you did say what about trading currencies themselves as an entire asset class? It turns out you can apply very simple factors that you apply say in stock investing, that work great and currencies too. So, such factors as value as a trend in momentum as carrying is probably the most famous one. And then you can create essentially, trading system on currencies as an asset class that correlates to very little. We’ve had a currency fund filed for a very long time. But I’ve never launched it because we didn’t think people were that interested. I think that’s changing. I think people were been more and more interested in currencies of the past few years.

31:09

Now getting on to Japan. You know, it’s interesting when you look back at the history of valuation of many of these markets, because if you look at the left side of the chart of cheap countries, and I mean, it almost gives you nausea to think about because it’s the worst geopolitical environment. Worst economies, Brazil’s probably in the worst recession, borderline depression they’ve ever been in. And you say, “WHat, my God, why would anyone want to invest in those?” And that’s part of the reason it works. And a lot of those country stock markets are simply cheap because they’ve declined a lot already.

So many of those markets, there’s something like 10 or 15 markets around the world now they’re down over 50%. A lot of those markets are GPE because the P has gone down so much, they’ve gone down 40, 60, 80% Greece’s case 95%. But the name has changed. If you go back to the late 90s, a lot of the Asian countries were the cheap bucket. Go back to the before that it was the Scandinavian countries who were in their banking crisis. In the early 80s, the US is one of the cheapest markets in the world.

So usually what happens is when markets are cheap, there’s a lot of reasons why you shouldn’t or would never invest there. Russia a great example, a year or two ago, when they were doing very poorly. I mean, they were shooting down commercial planes. They were invading countries oil going down. All these reasons not to invest in Russia. But as the story slowly fades away. You know, when things go from totally miserable to only slightly less miserable, that’s when you can have some of the big returns.

Japan is one of my favorite examples of valuation because people also talk about could you use relative or absolute valuation meaning should I just say the average overtime for all countries is around 16-17 and use that or should you compare them to their own value history? And I always say the former because bubbles and depressions have such lingering influence Japan had you said, I’m going to invest when it’s cheap relative to its own history, you would have bought the entire way down in the 90s and 2000s. And so, every year, it was cheaper to a historical cave of 50. But that’s just because it was a massive bubble.

 

So Japan finally got interesting a few years ago, but no one cared anymore. And then they had one of the biggest returns ever for their stock market. But of course, the currency got hammered as well. I think it’s interesting. It’s not hitting our filters as one of the cheapest in the world, though a lot of the countries are changing place very quickly, with the market volatility and China is another example that’s getting close to the cheap bucket but not quite there yet. So, we think it’s interesting but not quite hitting with super cheap yet for us.

Stig Brodersen  33:57

So, Meb, for the audience out there. And perhaps also for Preston, could you give us some stock tickers, if we want to look at say ETFs investing in these cheap countries?

Meb Faber  34:09

First of all, we have a fund that invests in the top quartile of the cheapest countries, it’s called Global value GDAL. That does it for you. An important point that I forgot and neglected to mention is that if you’re doing a deep value strategy, you only want to rebalance that once a year at the most. You could rebalance it every two years. But you need to give these countries and stocks time to work. If you rebalance it quarterly or monthly, you completely destroy the returns. So, you need to give it some breathing room. So, we run a fund based on it. It’s very concentrated. It’s my personal largest holding, but you could also do a lot of things. There are single-country funds that trade for almost every foreign developed and emerging country out there. A lot of the big-name ETF providers, and simply a value approach to global investing would probably work right. This is great anyway. So, there are several ways that to skin the cat, but at the very least, we tell people to put at least half into foreign stocks.

Preston Pysh  35:06

All right, Meb. So, the question I’ve got from a lot of our audience is wanting to hear your opinion on this. This is why I’m going to ask it. And they’re curious about the US equity market in the coming year. And they’re also curious about your opinion on what the Fed might do from this point forward. So, we’ve got the Fed that raised their quarter of a percent federal funds rate there and in the middle of December. I think that they’re not going to raise rates anymore into 2016 at all. I’m curious to hear your opinion on that. Or if you think that they might do it once or twice more. And I’m curious to hear your opinion on what you think’s going to happen with the US equity market, specifically.

Meb Faber  35:44

A two-part question. That’s easy. The first part of the Fed, I have no idea so we can go ahead and like Charlie Munger style, just say, I’ve got nothing on that. And then the second part: US equities if you go to Google on our blog. I’ve done an article last summer called “11 bearish charts, one bullish one” and an I detailed 11 different factors surrounding the US market, such as mergers and acquisitions nearing an all-time high, a percent of unprofitable IPO companies nearing all-time high valuations so such as Shiller and there’s another example, the median price to earnings of the stocks in the S&P 500 is at the highest it’s ever been since the 1960s.

The percent allocation of investors to equities is one of the highest it’s ever been, which historically says low single-digit returns. So, all these indicators say you should be bearish or have very low expectations for US stocks, however, I said, there’s one bullish and it’s actual… it’s like the queen of spades trump card that matters more than all of these combined and that was the trend. And so, I said at some point when the trend turns negative by 200 days, 10-month moving average whatever it may be, then there will be no reason to invest in US stocks.

And so that happened this fourth quarter where it flipped very quickly and went bearish then ran back up and then now you’re i… This is the S&P 500. It’s already turned bearish. And all the small-cap, mid-cap has been bearish for a long time on foreign stocks and commodities. So, going into the beginning of the year, we have an old white paper called “A quantitative approach to tactical asset allocation” I wrote back in 2006, and simple trend-following approach, but any of the trend following approaches would say you’re going to be mostly or 100% in cash. And so, I think the going forward caution is absolutely warranted in US markets. We’re much more positive on foreign but if the US enters a bear market which many foreign markets are already in, it’ll very likely drag down foreign as well. So, we urge caution in the US.

Stig Brodersen  38:06

Perfect. Last question, Meb, what investment book has had one of the biggest impacts on your way of thinking?

Meb Faber  38:13

Good question. So, I read a lot. I have a reading problem. So, there are many, many books that I’ve to ingest weekly. My favorite is called “Triumph of the Optimists.” And it is one of the most important things we think, for investors, to understand market history. So, to understand what has happened to be able to look back and say look, the US stock market has declined by 80%. Some markets have completely closed down like Russia and China. Or was the US the unique market of the past hundred 15 years?

And on top of that, you can go Google Credit Suisse puts out a yearly update called the global investment returns yearbook, and they’ve put out about 10 of these and they’re free. And so, you may end up on my blog because I’ve posted downloads of these every year. It’s one of my favorites. It’s like Christmas Eve waiting out for their public station because they tackle different concepts each year. They’ve tackled CAPE ratios. They’ve tackled what if you shorted of global markets on trailing GDP, and FX returns? What does the best? And they talk about dividends and momentum and trend. A wonderful education for free on all those updates. So, that’s probably my favorite book to take a look at and tackles currencies as well.

“Triumph of the Optimists” was written by a few British professors. You may want to rent it from the library because it’s, I think, $100 book, this beautiful coffee table book. It looks at, I think 20 marks stocks bonds bills back to 1900. And there are a few wonderful takeaways, one of which is that what I like to call the five to one rule, and this is roughly what stocks bonds and bills have returned for the past hundred and 15 years in global markets on average real returns. So, net of inflation, global stocks, around 5% of the US, I think, was six and a half one of the top markets in the world, maybe only one or two better, I think South Africa was the best. But there were countries like Austria that basically returned nothing over the entire period. And then bonds returned about a percent and a half. So, I’m rounding up to two because it’s easier to remember and then bills basically kept even with inflation around half percent, but I round up to one again to make it easy, so five to one, but it gives a lot of wonderful examples.

Preston Pysh  40:34

Thank you so much for coming on our show like this information you’re sharing with their audiences, just total abundance. We can’t thank you enough. This was just fantastic. And I know you’re going to have a lot of people from our audience coming over to your sites and wanting to read more about you after hearing this interview. So, if you could give them a handoff to your different sites and some of the things that you have out there so they can learn more about you and maybe some of your books, please share that with our audience right now if you could.

Meb Faber  40:58

Sure you guys can always find me at MebFaber.com. It’s my blog and has over 1500 articles. And if you’ve made it through this podcast and go to freebookMebFaber.com. I’ll even send you a copy of the free book. Promise to read it, though. And I post a lot of studies on Twitter as well at @MebFaber. And there’s a handful of white papers on the SSRN Network, and of course, any of the five books. So, plenty of reading to keep you busy.

Preston Pysh  41:32

All right. So, Meb, thank you so much for coming on the show. We just appreciate your time.

Meb Faber  41:36

Thank you. Pleasure.

Preston Pysh  41:38

All right, so that’s all we got for you guys this week. And if you guys go over to Meb’s website, I guarantee you, you’re going to learn a lot, all the stuff that he was talking about. We’re going to have that in our show notes. So, if you guys need or you’re not hearing it on the show, or you don’t have the opportunity to write it down because you’re driving in your car, just go to our show notes after you’re done on theinvestorspodcast.com and you guys can pull up all that information and all the links.

Also, please sign up on our email list. We try to read a book every other episode and we send out a free executive summary of all the books that we read. We don’t do any spam or marketing. So, go ahead and sign up on that and you can get those. And if you have a question you want to get played on our show. We haven’t played a question a little bit. But we’re getting ready to do our next episode. And we’re going to play a bunch of questions from our audience. You can get those questions played if you go to asktheinvestors.com and you record your questions there. And for anybody that gets their question played on our show, we’ll send you a free signed autographed copy of our book, the Warren Buffett Accounting Book. So, that’s all we have for you guys. And we’ll see you guys next week.

Outro  44:28

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