20 January 2018

As the stock market continues to make new highs day after day, we look at recent comments by Billionaires Ray Dalio and Bill Gross to try and understand what’s happening and what might happen moving forward.

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  • Why Ray Dalio suggests the Market is transitioning into a tightening phase in 2018.
  • Why Dalio thinks the stock market might have more upside.
  • Why the Bond market is a risky place to be in 2018.
  • Bond King Bill Gross’s thoughts on the Bond market in 2018.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Preston Pysh  0:02  

Hey, how’s everyone doing out there? On today’s show, we discuss some interesting comments that billionaires Ray Dalio, Bill Gross, and even Warren Buffett had said at the start of 2018. Although we’ve seen one of the biggest bull markets that has lasted nine years, some of their comments suggest there could be even more to come. 

Now, whether you agree with that or not, I think some of their points are interesting and important for people to think about xo that’s why we’re going to play a couple of clips and discuss what we heard on the show today. 

Additionally, Stig was visiting family in Denmark. So I asked my longtime friend Brian Rutherford to join me in the conversation today. Brian is a graduate of West Point and MIT. He’s previously worked as an economics instructor at West Point. 

Alright, so I hope you guys enjoy the show.

Intro  0:51  

You are listening to The Investor’s Podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.

Preston Pysh  1:12  

All right, Brian, awesome to have you back on the show. I don’t know how long ago was your last visit. I think it was 2015 that you and I had a chat about what were the seven biggest mistakes that investors make? Was that what the episode was?

Brian Rutherford  1:24  

That’s right. I can’t believe two and a half years ago. We chatted. I can’t remember what episode number that was, but we had a nice chat. I’m pretty sure there was a glass of wine somewhere in there. I think it was a popular episode. We talked about investor mistakes for young investors. 

Preston Pysh  1:41  

Hey, so back when you and I because we had a lot of conversations that summer back in 2015. We haven’t talked too much since. The market, however, has changed. In my opinion, the market has changed a lot since 2015. I know back then the thing that you and I were talking about on a daily basis was, “Hey, I don’t know the Fed can actually raise rates. They kept saying they’re gonna raise rates, they’re gonna raise rates and then they just kept delaying it.” 

Then eventually I think it was that fall that they raised rates for the first time at a quarter of a percent. We were all positioned for just doom and gloom to hit because the Fed had been acting so weird they’d been done. They’ve been doing so much quantitative easing, and then they finally raised rates. That Christmas, the market had a pretty big pullback compared to anything else we’ve seen since 2008.

Then, it came back up and then had another punishing fall of like 10% or 15%. I can’t remember what it was. Then that’s when Draghi and everyone came out and they said that they do QE until the cows come home and the thing just went nuts. 

That’s where I think I was very suspect when that started happening. I was still kind of sitting on the sidelines, like there’s no way this is going to hold up. But it did and it just kept going and going and it’s been a pretty interesting scenario ever since.

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Brian Rutherford  3:05  

So much uncertainty in the market and we saw in a couple of different ways it laid in 2015. Then again, when Trump was elected, I think that we talked that night during the presidential election about uncertainty in the market, pricing things in and it was really unexpected. 

So, we saw futures go way down and then if you remember, the next day, the market was already up, because there was some anticipation of what deregulation might mean and whatnot. We’ve seen just people work in concert since then and I think it just goes counter to what we thought was going to happen when we were chatting over a year ago,and even a couple of years ago as well. 

Preston Pysh  3:46  

I think that the central banks, particularly [those] over in Europe and Japan, and the amount that they’ve been printing with their quantitative easing, has been the main catalyst for the global markets that just kept on running. What I think, and I’m going to play a clip here from Ray Dalio that was recently recorded here. 

I think that Ray’s take has changed substantially because I know back in 2015, he was somebody I was following very closely, and he was coming out and saying things like, “I think the Fed can only raise rates one time before maybe we start to see a correction here because we have zero inflation and they’re paying too close attention to the short term cycle and not enough attention to the long term cycle.” That’s what he was spouting back in 2015. 

Let me play a clip from Ray Dalio here and this just so people understand the timeline. This was recorded on October 26 of 2017. So just a couple months ago, he made this comment, and this is what he said. 

Bloomberg Interviewer  4:52  

You are predicting a bear market. It seems like every Friday all the doom and gloom comes out of higher interest rates, lower stock prices. Can Ray Dalio predict negative 18% of the equity market? 

Ray Dalio  5:00  

No. We’ve been long equity markets and without getting too much into our positions… Anyway, I’m saying no, the answer to your question. I mean, eventually, it comes along but we’re in a different environment now. From 2008 until 2017, we were in a certain type of environment and that environment, it was one in which there was the pushing of interest rates down to the point of creating negative interest rates, and with the positive carry, plot by doing quantitative easing, to push money into the system. 

2017 is the transition and ending of all of that all around the world. We are entering a new era in which there is going to be and there is the raising of interest rates and the reducing of quantitative easing. That action that they took in that produced significantly bad real interest rates. 

I mean, today 10 year on real interest rates are about a half a percent next to nothing. The breakeven inflation rate for 10 years is about 1.8%. So those numbers are very low because of, let’s call it, repression, in order to get the economy to do that.

We are now in a transition, a whole different environment. That’s the equivalent of then during the late stage of the cycles and that’s when there’s a tightening. Tightenings become progressively more concerning because as you move along, there are more and more difficult to get perfect. 

So, as we’re progressing, we’re entering a period of greater risk and the nature of the market. So when you look at the bond market right now, there is risk in the bond market. There’s looks to me as a significant amount of risk in the bond market.

Preston Pysh  6:43  

So he ends up getting cut off there at that point in the interview and just so people know, that source where we are pulling this from is on YouTube, the Bloomberg interview that Ray was on. We’re going to have a link to that in our show notes. 

If people want to hear the whole interview and also to give credit to Bloomberg for this piece of media. It’s in our show notes. We’re providing a link there. So if you guys want to watch the whole thing, we highly encourage you to do that. 

Brian, so whenever I’m listening to this, what I find interesting is kind of Ray’s change in position from you go 2015, where he was saying, “I think the Fed can only raise the federal funds rate one time, before things start getting squirrely.” 

Now he kind of seems to be like looking at the market very differently. I have no problem with… How can I have any kind of problem with anybody changing their mind? I think it’s very important for people to continue to update and change their mind. 

However, it seems to me like Ray is looking at this a little bit differently than he was two years before. I think that he’s more comfortable leaving his positions on as the Fed is unwinding their balance sheets slowly. Some people would say they’re not unloading it slowly. I think it’s just getting started, but he clearly signaled that the Fed is now tightening, and they’re tightening, much different than the tightening they’ve seen in the past. 

Brian Rutherford  8:08  

You’re exactly right. So they’re tightening but I think the other part of that interview is he’s talking about doing it in concert with other other national banks, other nationalities, right? So we’re not doing something by ourselves where we are going to turn ourselves into, let’s just say, the United States is a less good investment than other places. So it’s happening in concert. It’s not just happening in the United States. It’s happening with the rest of the central banks as well. 

I think that that’s what we could not have predicted in 2015, when he said, “Hey, maybe one time we’re going to be able to do this, but then there’s going to be this race to the bottom and who’s going to make their interest rates, the lowest, fastest. We actually saw a lot of work together.” That’s, I think, what we could not have predicted and what any of his models probably would not have shown is that all the central banks working together.

Preston Pysh  9:03  

Yeah, that’s the thing. I think that was really surprising. 

Now, what I find is something that I cannot understand at all, we were just talking to Richard Duncan last week about this. Here’s the US tightening and tightening in a major way when you compare it to any other country out there, but yet the dollar is weakening. I can’t for the life of me make any sense of that. It doesn’t make any sense whatsoever. 

However, this trend, what I do notice is that the dollar started weakening as soon as the Fed started unloading their balance sheet. As soon as they started making changes, they started instead of being a buyer in the bond market at any price to being a seller in the bond market, and now that selling is accelerating each month as we go forward. It’s appearing like that’s weakening the dollar and it’s also causing inflation.

Brian Rutherford  10:01  

My thought on this is just the telegraphing by Yellen of what we’re going to be doing. I think that’s another thing that is different than what I have watched in the market for the last 15 to 18 years is when there was a Fed announcement 10 years ago, let’s say on whether rates were going to go up or down or stay the same, that really moved the market. 

Well, now, that’s not the case because they telegraphed exactly what they’re going to do. We parse the minutes in the Fed statement so much that we know exactly what’s going to happen.

So I think those things get priced in the market that the shocks… I think we’ve largely reduced the shocks of the Fed announcement and whatnot so that investors can get a handle on where they’re going. 

They’re certainly not scrambling to change a position after the announcement comes out. So it’s interesting, it’s no one thing I believe  that moves these markets and that moves inflation. It really is about short term versus long term expectations and Dalio talks about that quite a bit. So I wonder what you think about that in terms of telegraphing? 

Preston Pysh  11:11  

Well, back in 2015, the Fed was signaling that they are going to raise the federal funds rate. Signaling and then they wouldn’t do it, then they would do it. What’s interesting now is they’ve published this timetable of offloading their balance sheet and I think the real story here is the balance sheet, unwinding the balance sheet, not necessarily the federal funds rate. 

I think that’s important, but I don’t see that moving at the pace that’s going to be nearly as significant as the unwinding of the balance sheet or what people are calling quantitative tightening. 

When I talk to various people, every one of them seem to just buy the schedule. What I mean by buy is like they buy into the idea that they’re just going to stick to the schedule, and I find that I guess surprising because of how they’ve acted for the last three or four years when what they said wasn’t necessarily what they did. 

However, listening to Ray in that discussion there, he seems to buy it 100% that they’re just going to kind of stick to that schedule, and other people that I’ve talked to kind of buy into the idea that they’re just going to stick to the schedule until maybe things start to fall apart.

Brian Rutherford  12:18  

Exactly right.

Preston Pysh  12:19  

When one does that happen you know? 

Brian Rutherford  12:21  

Yes. So the schedule works great until the schedule doesn’t work, until there’s a shock in the system at that unloading or the selling of more bonds would create another like a worst movement in the wrong direction. 

Then, “Hey, we’re gonna throw out the playbook. We’re gonna throw what we did,” because you’re right back in 2015, they say, “Hey, we’re going to raise rates.” Then, the stock market took a tumble then and then, even though the Fed is not supposed to look at the equity market by itself, you got to believe that they did.

Preston Pysh  12:57  

So there’s more to kind of Ray’s thoughts on this. So what I want to do is I want to play another clip. This one was recorded in December of 2017, just last month. This was with ET Now, the company that he had this interview with. So here, I’m going to go ahead and play this one.

Ray Dalio  13:17  

It’s not overvalued, in that all of these assets today are not expensive in relation to each other, or in relationship to cash. So equities are not expensive in relationship to cash rates or bond interest rates. There’s lots of liquidity. In other words, they put out a lot of money, there’s $15 trillion worth of purchases, and the world has quite a lot of liquidity and it all has to compete to go into something.

So, equities are not expensive, even though they’re multiple are high, any more than the multiples of bonds or the low cash interest rates, which they compete. In relationship, they’re not high. That’s where we are. 

The key when we go forward is what happens to liquidity through Central Bank policy because if they pull it back for one, they pull it back for them all. Then those expected returns start to change. You have to understand that when asset prices go up, a lot of that price rise is having a present value effect. 

In other words, it’s the equivalent of pulling future returns to the present because as interest rates go down, and those present values go up. It means that the future returns are going to be lower and that’ll have a big effect or on producing this squeeze that I’m talking about. 

So yes, the multiples are high, but it doesn’t mean that it’s risky if the asset, if the interest rates don’t rise faster than discounted, and that if liquidity is there, because the liquidity has got to go into investments.

Preston Pysh  15:13  

I found that to be a pretty interesting discussion and really, I think the really interesting part about it is the amount of buying that he said $15 trillion of quantitative easing buying that occurred, not just in the US, but globally. So he’s saying, “Hey, all these central banks, they bought a bunch of bonds, and they put all this cash out in the economy, all this liquidity, and that liquidity has to go somewhere, and it’s just chasing yield.”

What he’s really saying here is they start to tighten, and this is another interesting thing that he said in there: if one tightens, they’ve all got to tighten. I found that really interesting that he said it that way because the US seems to be the only one that’s unwinding their balance sheet right now. They’re the only ones that are selling those positions. 

You look over in Europe and Japan, they’re still in buy mode, but I think that what the concern moving forward… Maybe this is a case for why the market can continue to run more is because until you see European and Japan start to stop their quantitative easing efforts and then start to pull in their interest rates, and start to do what the US is doing. So all that money and all that fiat in those locations is going to be chasing yield and  is that the reason why Ray is kind of saying that? 

I think this is also important if you read… This wasn’t in any of the interviews but something that Ray had recently published on LinkedIn and one of his articles he said, “The Fed is tightening and they’re they’re not doing what they’ve been doing for the last, call it eight years, and we think that the punch bowl was is isn’t going to be spiked much longer. So we’re still dancing at the party, but we’re dancing closer to the exits,” is the way he kind of described it.

Although you might hear that little clip that we just played and think, “Oh my god, Ray Dalio is a huge bull in the market. He’s saying it’s not overpriced.” I think that if you read some of the other stuff and you listen to some of the other interviews, I think what Ray is really saying is if you’re invested in the market, maybe you just continue to hold your position. 

You might want to tighten your stops a little bit tighter than normal, and just be prepared for you could still make money with this thing running higher because everyone’s trying to chase the only yield that exists. That’s 3% in the US stock market. 

So I’m curious, Brian, with all that said, sorry I went too long. What are your thoughts?

Brian Rutherford  17:45  

Hey, Preston, great point as I was preparing for this tonight, this is one of the notes that I took about Dalio’s point about equities and in relation to other investments. The way I saw it was like a tide, right? He’s like, this is a high tide moment. So if we were to look at the piece of the equity market in a vacuum, we’d say, “Oh, they’re historically high.” 

But if you see it in context with the high liquidity environment, then maybe they’re not really that high. I bet he’s got a way to factor in into his algorithm, to factor in the liquidity environment and probably gives a more real look at what the P/Es are, say in a different type of liquidity environment. 

So your point about chasing yield and maybe this is really prescient of the Fed to tighten right now and nobody else is. That could see… that could drive in future investment in the United States. Yeah, I definitely could see where the United States would be the place to be.

I actually think about something else. It’s not just monetary policy, but really the regulatory environment that we have seen over the last year. At least there’s a belief that we are deregulating our businesses. We’ve already seen a lowering of the tax rate down to 21%. So I think that we’re well positioned actually to see that investment come to US companies. 

Now, as Buffett said, and I’m sure you’ll play this here in a little bit… It’s hard to understand exactly what the competitive environment is going to be with the change in the tax laws, but none of these things are happening in a vacuum, right? These all happened together. So I think you just see enough signs or enough arrows pointing in one direction that I do think that you could see more move up in the stock market because of this.

Preston Pysh  19:50  

Yeah and then the question becomes how much more? When you look at the amount of buying and I mean, it looks and feels like it’s going parabolic right now, which is usually a sign to really put your guard up and be worried.

Brian Rutherford  20:07  

*inaudible* I think the market just this last week was up 500 points. Percentage wise, that’s a smaller percentage. I mean, you’re right, we have just seen the up and up and up, and that usually as a signal of the reversal. But who knows?

Preston Pysh  20:25  

I think the thing that has to be said is, this is not normal. What we’re experiencing in this last cycle is so different than anything we’ve experienced in the 30 years before this. Most of it just becomes… because it’s so heavily manipulated, the markets are… for anybody to think that the markets, especially in the bond markets, that what we’re seeing is just free and open, they’re just totally kidding themselves, right? I mean, is that just me being a pessimist or do you see it the same way? I’m curious if you see it the same way.

Brian Rutherford  21:00  

I think you’re 100% right, Preston. I think you are 100%. Right. I think we’re seeing a lot of free money entering the market. That is what’s what’s holding prices up. However, I still believe that there will be some event that is not… the unpredictable event will be the thing that will cause this to turn, but I think it will cause people to look inside and say, “Hey, we’ve had a huge run here. This doesn’t make sense, and then there might be a storming for the exits.” But that is usually preceded by that paraboli moving up, which we were just talking about and you just mentioned. 

Preston Pysh  21:41  

I read something really interesting. This probably just a couple weeks ago and the new Fed Chairman who’s replacing Yellen here. He gave some type of testimony back in 2012, about the effects of quantitative easing, how he had concerns about quantitative easing and the terminology that he used for his concern is that quantitative easing was “short volatility.”

So if quantitative easing equals short volatility, what does quantitative tightening mean? Just doing the inverse of that means that’d be long volatility, meaning things are going to become quite chaotic if you start doing quantitative tightening. 

Now, I don’t think that we are far enough along this quantitative tightening. I mean, we’ve only been doing it for a couple months, at very low selling points that the Fed is doing. But as we ratchet this up six months later, we might see some of the craziest amount of volatility if his statement and how he was testifying before Congress back in 2012, is a true statement that… *inaudible* combined to the volatility, mostly just because they’re buying in such huge numbers. They’re buying and selling. I guess I should say selling now. They’re selling at such huge numbers. 

So I think that right now, things couldn’t look any rosier. Could they? I mean, it started 2018. It’s just everyday the stock market goes up. Now, the bond markets have been a disaster. From the equity standpoint, this thing has been one heck of a ride. 

I want to tell you something that I’ve done personally with my own portfolio. My big mistake is I haven’t left enough on this thing, because this thing has just run like crazy. However, one of the changes that I’ve made here at the start of 2018 is I’ve moved a lot of my equity position into an ETF that is very low volatility relative to everything else. I’ve moved out of a lot of my individual stock picks because they’re so volatile in the price action. 

So my thinking on this, and I’m curious to hear your thoughts, that’s why I’m bringing this up, Brian, is I’m thinking let’s get into something that has very low volatility. So I don’t get spooked in the price action, and if I do see something that steps outside of that price action that’s within its standard volatility, like I’m in the Russell 3000, I have a large position in the Russell 3000. 

The volatility in that thing’s like 8%, so I know if I see some type of 15% volatility out of that thing, there’s probably something that’s not normal happening, because when you look at how that thing’s performed over the last eight years, it has rarely stepped outside of that volatility range. Yet, it’s had tremendous returns. It’s gone right there with the S&P, but it has very low volatility. 

So I’m curious, do you think that that’s a smart approach? And I’m curious if you have other ideas on how to maybe handle this thing moving forward? 

One last thing, this is really important, and I’m setting my stop on the position very tight, because I’d rather just get stopped out of it, and not risk the chaos that could potentially come with all this. So I’m sorry, go ahead, Brian.

Brian Rutherford  24:59  

That’s a great lead into using stop or stop loss orders, right? Where you can bracket your position or make sure that your downside is limited. I think this is what we’ve been talking about for a couple of years now is, “Hey, we don’t know how much further this thing’s going to run. But it seems like the upside is smaller than the downside risks.” 

So to put those stops in and I think it was described to me when I was a very young investor is hitting a bunch of singles, will get you where you want to be, and just always going for the home run will lead to despair.

Now, when you talk about going to low volatility, I think that that’s pretty smart in this environment, because I think that what we’re gonna see over the next 12 to 24 months or even longer, we’re just in uncharted territory. So we can’t look back and say, “Hey, well, the last time we unwound a QE position, this is what it looked like,” because we’ve never done that before. 

Everything is uncharted territory. So when Powell says, “Hey, you know, quantitative tightening is going to equal volatility,” that’s a pretty safe bet because we’ve never done this before. We know that central banks generally when we try to hit targets, when they try to hit targets, they overshoot, or undershoot theT. then they don’t get it quite right., and that’s why we have recessions.

Preston Pysh  26:22  

This is such a strange credit cycle. I think that you’re seeing a record number of hedge funds closing in the past three years, because this thing has just faked so many people. I think the duration of how long this credit cycle has run is just fooling everybody. I mean, you got guys like Ray saying that the equity market isn’t expensive, and that’s crazy, you know, but I mean, it all comes back to interest rates.

Brian Rutherford  26:57  

I  think, you know, two years ago, he wouldn’t have said that, right? I’d like to know just what’s fascinating about his book, and it’s a must read, is that it’s really principles of life and really talks about what happened in 1982 when he bet wrong. 

Then, it made him look at underlying assumptions and taking information that was contravening to what his position was and really downplaying that. So I think that what he’s better at now is, and this is probably something just as you just age, you may get better at this, is looking at the world through different eyes. 

Preston Pysh  27:33  

In the audio that we listened to when Ray was talking there, he made the comment that the bond market was not a good place to be. I think you’d have a hard time arguing that point. I think anybody would have a hard time arguing that point. 

So what I did is I pulled up a recent audio clip from Bill Gross, who’s the Bond King is what people call him. He’s a billionaire investor that primarily focuses in the bond market. This recording came from January 11, and this is him talking about the bond market in 2018. So let’s play this.

Bill Gross  28:09  

This March, the bear is starting to wake up, growling a little bit, but not significantly. It means in fundamental terms that 10 Year Treasuries, which are now at 2.55, probably over the year will go to 2.75 or 2.80, for a number of fundamental reasons and that… Yes, that’s a bear market, but it doesn’t really significantly affect total return in a negative way for bond investors. It leaves them, in my opinion, flat for the year of 2018. I think 10 yYears have broken a number of technical barriers in the last few days and in the last week or so. 

Some of the fundamentals are working against them. For instance, the nominal US GDP is probably inching closer to 5% and 4%. Typically, ever since the era of financial repression in beginning in 2009, you know, the spread between nominal GDP and 10-year Treasuries has been about 140 basis points. So if we got to 5% nominal GDP, which I think is possible in the next few quarters, then a 360. A 10-year is possible. I don’t see it going away, but 3% is possible. 

Preston Pysh  29:25  

I find that comment really interesting. So first off, he’s saying that even though we’re in a bear market with the 10 Year Treasury specifically, folks are going to basically break even because of the interest that they’re going to receive on that versus the price change. 

However, if the price jumps up over 3%, which he said he thinks is possible, but not likely, that might cause trouble for the equity market because it starts moving too fast. We were talking with Bill Miller a year ago and Bill really said, “It really depends on the speed at which you see the bond market change.” That was a really profound point that he made to me that I didn’t necessarily think about before that interview. He brings up a great point. 

It’s interesting to hear Bill Gross say something really similar right there. So Brian, I’m kind of curious, what do you think about Bill’s thoughts here on the bond market and kind of how that impacts the stock market?

Brian Rutherford  30:26  

When I heard him say that as well, as I was preparing tonight, I thought that was fascinating. I didn’t know that the 10-year tends to lag the nominal GDP by about 140 basis points. So he thinks that the nominal GDP could approach 5%, meaning that the 10 Year T-bill could go to 3.6, which is… I mean, that’s almost a 50% move up from where it is right now. I absolutely, if that happens, then I do think we’re going to see a spillover into the equity market. 

Again, the key is how fast and again, this is in an era of quantitative tightening and something we haven’t seen before. Is the Fed going to stop selling their bonds? What is their reaction going to be? What does their playbook look like? There’s nothing to fall back

Preston Pysh  31:21  

In the past when we’ve seen the market get super saturated, and we saw the equities kind of do their big reversal, that’s when we looked at the bond yield curve. It’s always been flat or inverted. I think that this time around, it’s going to be interesting because I don’t necessarily know that we’re going to see that and I don’t think we’re going to see it because the Fed is now unwinding their balance sheet. While in the past they were never doing that. They were always just adjusting the federal funds rate. 

What you typically see in the past as you’d see the short tail of the short end of the bond yield curve come up. But you’d also see the long tail kind of come down and meet the short end, the federal funds rate kind of in the middle. We saw this in all the previous credit cycles. I think this time, if you’re expecting to see that, again, I think maybe we’re kidding ourselves, because not only is the federal funds rate going to be going up, but I think that you’re going to see the mid term bonds kind of go up with it. I think it’s still in question whether we’ll see the long end of the 30-year bonds kind of increase in yield and have a sell off as well. 

I think that the reason why the Fed might be reluctant to sell the long duration bonds, which were done through the Operation Twist. When was that? 2013? I don’t necessarily see them unwinding the long duration wants because that’s going to really play around with housing and the real estate market because they start adjusting that they start selling those long term bonds off. 

I think you get yourself in a world of hurt with what’s going to happen in the real estate market, because you’re going to see the value of homes and all sorts of real estate really go down, if you start to see the long end of the tail start to sell off. 

So that’s where I think this really all gets interesting is what duration is the Fed selling off on their balance sheet? How much of the long tail do they actually own? And how much are they willing to sell? I would be willing to bet that they’re not going to sell off too much of it. I think that you’re going to see the 30-year kind of stay fixed. 

I think you’re going to see the 10-year kind of bump up because I think they’re going to be selling that duration and shorter. Then, I think you’re going to see the federal funds rate maybe go up by a percent, assuming nothing bad happens in the market. If something bad starts playing out in the market, then all that goes out the window and it’s going to go down. Would you agree with that as far as how you’re seeing it?

Brian Rutherford  33:56  

100% and back to your comment about If something weird happens in the market, I think that we are ripe for that. I mean, just look at the last 12 months. A 25% move up in the market is really a huge move. I’ve read articles on both sides of this, it’s 2018. Will 2018 be another 2017? You know, man that looks like the consensus is no, but I guess if you were to ask in 2016, what 2017 would look like, move up like this. 

So how much of how much is the new tax plan is already factored into prices in the market? I think that they’re already pretty well factored in, but we’ll see how things go. Again, it’s all about expectations of the future. So I’m very interested to see what earnings are [in] the next quarter or two.

Preston Pysh  34:49  

I agree with you. I mean, how many more times can we price in the tax cuts?

Brian Rutherford  34:55  

Right. It’s interesting as to what we were pricing into the market. It looked, we heard, as low as maybe 15%, and then it looked like, okay, it’s definitely going to be 20%. Then, at the 11th hour it became 21%. 

I remember a few years ago at business school and in my tax class talking about and listening to different CEOs discuss what it should be because even at 15%, there are tax havens that are lower than that. So it’s a kind of a race to the bottom.

What I think that the question was posed to John Chambers, then the President or CEO of Cisco, “Well, what would it need to be for you  to onshore your profits?” He wouldn’t commit to a number. I thought that was really interesting, not committing to a number because who knows? You want to say yes at 20? Well, there’s always something lower than 20. An aside about tax policy, but you’re right, I think it’s been priced in time and again, then we’ll see what happens.

Preston Pysh  35:59  

When I think through… Let’s say we go through a scenario here, okay? So six months from now, the Fed, they’ve done all their quantitative tightening the market continues to run, it goes crazy. But then six months later into the summer, we start to see the equity market really struggle. Let’s say we see a 15% or 20% downturn in the stock market. 

At that point, I think the Fed takes their timeline, and they’re selling their balance sheet, unwinding their quantitative tightening schedule. I think they throw it right out the window and they say, “Hey, we’re going to pause all of this right now, and we’re going to leave the federal funds rate fixed at where it’s at until further notice.” 

I think that’s how they would respond to something like that. I think that you’d see a similar response. I mean, heck, who knows? Is Europe still gonna be doing QE and isn’t Japan still gonna be doing QE? I don’t know. I guess maybe they would.

So how does the market then respond from there? Do they do kind of the routine that they did back in 2015 to 2016 where they basically come out and say, “We will print, and we will keep this thing afloat at all costs.” Do they do that again? That’s what I asked myself whenever I think through this. Then, I guess the question after that is, “Will it have the same impact that we saw two years ago, whenever they said that, where they were able to reflate this in a major way?”

Brian Rutherford  37:31  

Yeah, I think that that’s a great point. Then getting back to the psychology of the market, we all have these recency bias. So the things that happen most recent is the thing that is first and foremost in your head. So I think that they might go back to what worked last time and let’s try that again. 

But what worked last time and when a certain set of conditions may not be the conditions that we see at that point in time. So again, we know over time that central banks tend to either overshoot their targets or undershoot them, but rarely, if ever, have they got it right on. So you’re right. 

Or there may be some other unprecedented thing that you and I’ll be sitting talking over a beer about like, “Wow, can you believe that the Fed is doing this? Or what is the newest name of the newest program that they have, that we’ve never seen before in an unprecedented time, as they’ll say, and taking extraordinary measures and then what will the impact be?”

Preston Pysh  38:33  

So the last thing I want to talk about was really kind of the unemployment rate. When we talk about central banks, and we talk about what their what their major role is, and I think if you go in there and you read their mission statement, it’s really kind of to create stability, and make sure that the unemployment rate is within a reasonable level and that they don’t have excess inflation. 

So when we look at the unemployment rate today at the start of 2018, we’re sitting at 4%, and when you look back since 1990, so you’re almost going back 30 years. The only other time we’ve seen unemployment this low is back at 2000. The peak of the 2000 bubble was when unemployment was this low. No other time in the last 30 years, probably even 40 years, have we seen unemployment this low.

For me, that’s concerning as an equity investor. That’s very concerning. How much further would the Fed be willing to push that rate or I think the Fed gets themselves into a tricky situation where they are saying that we need to have loose monetary policy in the event that the market would start to show signs of trouble. 

I think they have a hard time justifying their stance that, “Oh, well. We’ll just go back to QE or we’ll just throw the whole thing out the window and just keep monetary policy loose.” I think that that gets hard for them to justify that, when assuming unemployment would stay low as where it’s at. I’m kind of curious to hear your thoughts on some of that stuff, Brian.

Brian Rutherford  40:16  

Yeah, sure. So we were talking two or three years ago, we would be talking about the shadow unemployment, right? So as the unemployment rate went down, we would we would say, “Hey, economists really believe that the unemployment rate is maybe double whatever figure is actually reported, because of people who are underemployed, the person who doesn’t qualify for unemployment because they’ve got 20 hours a week of work, but they really want to work 40 so they don’t show up in that statistic.”

There’s still probably some of that. People who are not working as much as they’d like to and then the thing that I think that the Fed points to, whether they do it overtly or really with their policies, their point again, and they’re making a nod to this is wage growth. 

So if in all other instances of really low unemployment, you’ve seen then wage growth, and that makes sense, right? When the market for labor, the market for people tightens and as a basic supply and demand, that when the demand for labor goes up and the supply is relatively fixed, that you must see the price of labor or wages go up. We really haven’t seen that. 

I mean, maybe we’ll start to see it. You know, Walmart just said that they’re going to and they are the single largest employer in the United States behind the Postal Service, actually. So the total for the largest private employer is going to raise their minimum wage to $11 an hour, and they’re really a leader in the labor market. 

We might see other companies do the same sort of thing. So, we’ll see if that has an effect on wages. If it does, then we would expect them for inflation to go up. People making more money, and there’s more money in the market. All these bonuses that were announced right after the tax cut… assignment law.  

I think that that’s the thing that the Fed is going to watch really closely. You’re right, I think we’re at full employment, but they’re going to watch really close to the inflation number over the next 12 months, and should that start to creep up, I think they’re going to be increasing the Fed funds rate. 

However, in concert with all the other things we’ve talked about for the last hour or show, none of these things happen in a vacuum. So you pull one lever and it has multiple effects or some trickle down effects. That’s the thing that they’re going to keep an eye on.

Preston Pysh  42:43  

The reason I pay close attention to the unemployment rate really was triggered by billionaire Jeff Gundlach who’s also a huge bond guy. He uses this as one of his big criterias for understanding where he’s at in the credit cycle. Ever since he said that I’ve always paid very close attention to this, whenever I look at it… You kind of look at how the unemployment rate has moved historically, at the top of credit cycles… 

You get a good six months to a year where you see a really flat, where the unemployment rate goes flat, and it actually kind of starts going back up before you’re pronounced inside of a recession. So I’m paying close attention to this and whenever I look at it, the trend is that this thing is still going down. The way that it looks, it looks like it’s just going to push straight through. The rate that it’s at right now, we’re not seeing any type of plateau on this. We’re not seeing it coming back up. We’re definitely not seeing it come back up. 

So it’s interesting because the longer that I think the Fed allows their quantitative tightening to just be not very significant and as it slowly trickles in and gets stronger and stronger, it seems like the unemployment rate might even set some records here for 40 to 50 years of performance. 

However, I liked your point there, Brian, about although we were seeing really low unemployment numbers, the wages are just stagnant. I think that that’s why you’re seeing although the whole country’s employed, I think that you’re seeing dissatisfaction. You’re seeing the whole political landscape mature the way that it is because you’re seeing this major divide where the middle class is just getting obliterated, but I don’t even want to go down that path.

Brian Rutherford  44:37  

Well, that’s one of Dalio’s main points as you know– to talk about the modeling to different economies, and you want to talk about a shock to the market is something like the class warfare that… You’re right, it is a discussion for another day, but definitely when you see the market doing what it’s doing, yet wage growth is completely stagnant, as the market has done so well over the last eight or nine years… Something’s got to give, right?

Preston Pysh  45:06  

Hey, so, Brian has a really cool thing that he did. Typically, at the end of the show, we’ll give the guests a chance to give a hand off to their Twitter feed or whatever, but Brian has a small business. This is the coolest thing ever. This is a really neat story. He created a small business around selling wine because him and his brother absolutely love drinking wine.  

So they went out to Napa Valley, and they started their own wine company around… It really just started with you and your brother just buying a barrel because you’d liked certain wines out there so much and then you guys would bottle it yourself. Then you had so many friends like me who would come over to your house and rave about your wine. Then you were just like, “I just need to start a business around this.”  

Brian if you don’t mind. I don’t know if you mind telling the story or not, but if you don’t mind telling the story, tell the audience about it and give them the five minute version of this business that you started because this is so cool.

Brian Rutherford  46:10  

Well, my brother and I were really interested in the wine market. I got interested back when the wine market tanked with every other market back in 2008 to 2009. I started buying high end wines that were for pennies on the dollar. So I got an opportunity at a younger age to drink some nice stuff.  

Then, as we visited Napa Valley more often, and actually, my brother lives in San Francisco right now. You know, we figured out that even high end wineries always had a few extra barrels in their cellars, right? 

So even wines that would normally sell for $150 or more, we realized that because of supply and demand, that the demand for that wine, year over year, really didn’t change that much, but that the supply might change as you have really good vintages which produced more wine. 

Those wineries had an option then to bulk out their wine, so basically, sell it by the barrel. Then, there’s well established markets. If you had 50 extra barrels where you could go a broker might buy it and it would show up somewhere else… But there’s not a great market if you had two to four extra barrels. 

My brother and I had this business where we would go into high end wineries and taste that wine, make sure that we’re not getting you know the stuff that they just didn’t want to bottle themselves because it was not any good, so we taste it and then make a deal on the spot. 

We’d send it to our bottler or label cork capsule the whole deal. Then, we sell it through our own website, where we provide high end wines to our customers, which really started as our just close family and friends for literally pennies on the dollar. 

We take all those savings that we find and we just don’t sau where we get it from. That’s our only stipulation. I can’t tell you the winery that it came from, but the deals we’ve done over the last 18 months really range the gamut of I think the most expensive retail. From that winery was 155 bucks a bottle, and we sell that for about 70% off of that. 

So, again, bringing good wine to our family and friends. It is a little side business that we do and it’s opened up so many doors. I think, Preston, you and I’ve had many great conversations over a glass of wine. It’s a fun story. Again, we try to let people who would never buy a $100 bottle of wine, you can have that same experience for a whole lot less.  

Preston Pysh  48:42  

So for the audience, so I was very… I guess suspect is probably the right word of a bottle of wine that cost more than $100. I thought that for the most part that my impression of that was the whole Robert Cialdini Psychology because it’s an expensive price. That’s what you’re really paying for is because you feel like you’re getting higher quality. 

Brian though he taught me something. I didn’t know this. We sat down and he said, “This is a $20 bottle of wine. This is $150 bottle one. Taste the difference.” I tasted it and I said, “Wow. I know I probably sound really cliche, but I felt like I could taste the difference.” Then, he explained to me why there was a difference and I didn’t know this.

Brian, correct me if I’m wrong because I want to tell this story the way that you told me. So he told me he said when they press the the grapes in the wine, if it’s a cheap bottle of wine, they’re not cleaning the the grape off of the vine or the leaves nearly as much as they are for a very expensive bottle of wine, where they’re very particular that they only get the grape whenever they press it. 

So what happens is you get kind of like a tang or like a sour kind of taste in the cheaper… like a red wine it tastes more sour, where if you taste something that’s $150 a bottle or higher, that it’s been much cleaner and you don’t get that sour like tangy taste in the wine. Did I remember correctly because you told me this like years ago?

Brian Rutherford  50:19  

You’re exactly right, Preston. So the process by which they make some of that more expensive wine is it’s much more hands on. They’re looking at literally each individual berry as it’s going down to be pressed and they’ll take out twigs and leaves and everything else. Still, even with all that, there’s still a lot of marketing dollars and there’s a lot of cachet in a $150 bottle.

So that’s that’s exactly where you know where we come in and say, “Hey look, you can have that experience without paying for all that marketing. So you can buy that $150 bottle for much, much less and actually get what you’re paying for. We put it all in the bottle. We think that the product should really stand on its own.” 

But you’re right, I tell everybody get a bottle of our *inaudible*, our 2014 Diamond Mountain *inaudible*, which is kind of our flagship right now. Drink that next to whatever it is that you drink on your random Tuesday night, and if you don’t taste a difference, then I’ll buy that bottle back from you. So I’m confident that everybody needs to have that experience.

Preston Pysh  51:23  

All right, awesome story, Brian. You didn’t even say the name of the company. What is the name of the company in case people want to check it out?

Brian Rutherford  51:30  

Yeah, you’re right. It’s *Claudine Wines.

Preston Pysh  51:33  

If you guys are listening to this, just go to our show notes. I’ll have a link in there to take you to Brian’s company. 

All right. That’s all we had for you guys and we will see you again next week.

Outro  51:43  

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