#3 – Bob Elliott: Portfolio Construction, Outlook

27:36And markets obviously move in advance of the outlook. And so you can justify selling low. I mean, you're supposed to buy low, sell high. You can easily justify buying high and selling low. And it happens over and over again. And I think the cycles are long enough where people, the lessons are lost and people are kind of doomed to repeat the same mistakes over and over. And that's why no one has a negative reaction, a quick shift to try to preserve capital. If their investment portfolio is down five or 10 percent, right? Like, you know, we sort of all accept that that's part of the normal volatility if you're trying to generate any returns, five, 10, even 15 percent.

28:22People are pretty good about, you know, navigating through those. It's when you move outside that range that people start to respond by preserving capital and rationally respond. I remember a very vivid memory in March of 2009 when, if you remember, the S &P 500 bottomed at 666, having a rational conversation, totally rational, evidence-based conversation where I said, well, look, the outlook for stocks at that time could be earnings at 60 and PEs at 10. Like that would have been a totally plausible outcome at the time. This is not random people on CMBC. This is one of the biggest, most sophisticated institutional managers in the world.

29:06That was a reasonable outcome that could have penciled out the S &P 500 in March 2009 at 600. And so think about that. That is the mindset that you have. And that would mark the bottom, right? And we had 15 years of incredible equity market performance since then. That is the type of mindset that exists. And so you have to recognize that. You have to say, hey, look, how am I going to respond to that? And much more often, you're better off targeting a lower return over time with less volatility because it's a plan you can stick to than targeting a higher return with more volatility on a plan you can't stick to because you will fail at actually experiencing those higher returns.

29:54Paper doesn't translate to practice if you can't stay on the ride. It's one of the reasons in alpha strategies why systemization is so valuable, because part of the challenge is getting edge. But the other big part of the challenge is actually playing your hand as you need to play it in order to maximize that edge. And so one of the great things about systemization is that it creates discipline to actually operate in the way that you expect to operate. And so that means you're getting the most out of your most out of your edge. Right. Whereas if you're trading in a very discretionary way, like, you know, I mean, there's all sorts of studies and things like about a judge before and after lunch.

30:39Like you are that judge. Like your trading is worse before lunch than it is after lunch. Just recognize that if you're trading discretionarily. And the question is, do you want your edge to be based upon your skill or do you want it to be based upon whether you just ate or not? That's not a good – that's not – I know which one of those two I prefer. So let's go back to framework. I know we've talked about this before, but you think of the world as there's beta and there's alpha. So there are returns that are risk premium that you collect by holding risky assets. So this is kind of buy and hold.

31:17You have a positive expected return. And then there are trades that you can make. And in a moment, we'll get into your market views. But maybe just quickly summarize that distinction between the source of returns and then how you think about balancing those two in a well-diversified portfolio. When it comes down to it, you can generate returns from three different sources. There's cash, the cash rate, essentially the central banks. Is that what that is? You get it for free and with no risk in T-bills and stuff like that. There's beta, as you say, passive investing. And over time, you'd expect assets to outperform cash.

31:57And the reason why that is is that the sort of fundamental construct of markets is that you forego the riskless cash return to hand your money to someone, whether it's to lend or to invest. And you would expect a higher return as a result than holding cash. And it's a reason why if you look back through time, very, very rarely over meaningful periods of time does cash outperform assets. In fact, over any one-year timeframe or any 12-month timeframe, it's like 70-30 that assets outperform cash. And so the choice to overweight cash is actually an alpha choice. And you have to be darn good at that timing in order to actually have conviction that you should overweight cash, since so often assets outperform cash.

32:52And then the last choice, as you say, is making bets in markets. And when you think about a portfolio, you want to think about each one of those different pieces in a different way. First of all, you want to think about your overall risk tolerance. I mean, we talked about we talked about, you know, can you absorb 75 or 50 percent drawdowns in your portfolio or say, for instance, you're getting close to retirement and you really want a lot of conviction about exactly, you know, how much capital you have for retirement. And so that sort of gives you the sense of what's the choice between cash and assets, right?

33:26The amount of risk that you're willing to take in order to generate in order to generate returns in excess of cash. So that's different for every individual. And you just want to think about that thoughtfully and proactively to target your return. And then when you think about assets, the real question is how much do you want to put in passive investing versus active investing? And there's an important tradeoff there, which is passive investing generally has lower expected returns, particularly relative to the risk that you're taking. but it's more consistent, right? More reliable. You would expect assets to outperform cash over time.

34:05Whereas alpha, you have the opportunity probably to get a better return relative to the risk that you're taking, but the reliability is lower. And so how do you balance these things? I mean, the frank reality is there's no obvious way to do it because you have to take into consideration a variety of different things, including how reliable you think one is versus the other, how much skill you think managers have. I think if you look at big institutional managers, they're allocating something like 80 percent of their capital to beta in one form or another, whether it's liquid or illiquid, and about 20 percent of their capital to alpha strategies.

34:39And I think that basically is about right in the sense of, you know, in general, beta strategies are going to give you pretty good consistent returns. So you really want to rely on that. But alpha can help protect portfolios, particularly in difficult times. And so you want to put something on it, but you don't want to go overweight it. So something like 80-20 makes sense, which is the answer to every... It's either 80-20 or 50-50. Those are the answers to all of life's weighting questions. Yeah, that sounds about right. And then I guess it's also alpha is a zero-sum game. It's a negative-sum game if you add fees.

35:19In a lot of cases, maybe the managers can generate alpha, they can outperform, but they take that in fees and the investors don't get as much as they might otherwise. So I think you have to weigh that as well. And passive investing is heading to zero in terms of cost. Right. And fees. The biggest issue for an investor is fees. And the reason why that is, is alpha is uncertain. Fees are certain, right? Whatever the fee is, you know what that management fee? Certain. That pass-through, let me tell you, it's certain and it's big, right? Those fees are certain. Whether you can generate alpha is uncertain.

36:03And so given that, I think one of the things, I mean, one of the things that's core to what I'm trying to do right now is to bring these strategies, these alpha strategies, which are uncertain, but bring down the fees. Because if you can bring down the fees, you at least know that you're getting – that's a certain benefit to the investor, whereas the alphas are very uncertain. And so absolutely, there's a big difference between your net of fees returns and the gross of fees returns, which the managers see. And I'd also add very important is there's also a big difference between what your outcome is before taxes and after taxes.

36:41And all too often, people don't think carefully about how, in particular, alpha strategies are disadvantaged from a tax perspective. And so that adds even more difficulty to adding alpha to your portfolio unless it's in a tax-efficient wrapper like an ETF. Yeah, and we'll get into this in a second. But basically, if you're trying to generate alpha, you're actively trading. And that, by definition, is going to be less tax-efficient than something that's passive. Right. Just by definition, you're going to have more turnover, more short-term capital gains, which are, at least in the U.S. context, are less attractive from a tax perspective.

37:25So a couple of points you made is the 52-48, I think, is critical. There's – in recognizing that, you want to be well-diversified and you want to emphasize diversification in your portfolio so you don't take a massive hit at any point in time. Yet when we, so all that sounds very logical. You know, obviously as a scientist, it makes perfect sense. As somebody who doesn't have a science background, I think conceptually makes sense. You know, the kind of the oldest rule in investing is don't put all your eggs in one basket. And what you're describing is basically how to do that in practice. And then thinking of the world in alpha and beta terms and different streams of returns and how to put all that together.

38:03So that's like an engineering exercise. So all that sounds very logical. And I think when I talk about that with people, they say, yeah, that makes perfect sense. Logically, it makes sense to be well-diversified. Yet, when we look at how most people invest, their portfolios are basically invested in the stock market. All their eggs are in the stock market basket. When you turn on CNBC, they're talking about the stock market. When you read the papers, they're talking about the stock market. Everybody's focused on the stock market. And you ask somebody, how's the market doing? They're not talking about any market besides the stock market.

38:33So why do you think there's a disconnect between what logic would suggest as being diversified? And then when you look at actual portfolios, even a 60-40 portfolio, almost all the risk is in the stock market. So why do you think that's the case? A big part of it is that people's eyes are drawn to the more volatile thing. And so I think it's not surprising that the assets that get the most capital into them are the highest volatility assets that are sort of commonly available because those are also viewed as the highest returning assets. And I think that really is one of the fundamental fallacies of how people think about investing is they think about investing in assets as they come rather than as economic exposures.

39:27And obviously, you folks have done a lot of work on this particular topic. But there's no – again, going back to that paper that said you'd be 100 percent invested in stocks over time. They say a big reason why that is is because stocks are higher returning than bonds. And the answer is like, why? Why would stocks be higher returning than bonds? Like if you just hold long duration stocks like, you know, or long duration bonds, you can have bonds that have, you know, excess returns that are equivalent to stocks. They can have excess returns that are higher than stocks at a certain volatility. You can leverage them, right?

40:02You can buy futures. There's all sorts of different ways that you can unpackage these assets and think about them in – based upon their economic risks independent of what your return or volatility target is for these assets. And so I think it is a bit of a fallacy. Like I bet if you asked the man on the street, they wouldn't – you mentioned leverage. You have to start to mention leverage to investors. Oh, I want nothing to do with leverage, right? And the answer is like your stocks are levered two and a half times. Like what are you talking? about, right? Like you've got tons of leverage in your portfolio.

40:37And it's just, it's hard for people to understand and break down those pieces and then put them back together. And so I think that's why folks are just drawn to the highest volatility, normal asset class. I think that's an example. I think if, you know, I don't know, if Bitcoin had a volatility that looked like 5 % a year rather than 500 % a year, I don't think anyone would talk about it, right? Because, because it just wouldn't be volatile enough to attract people's attention. It could be a good investment. It just wouldn't attract nearly the interest. Yeah, and I guess there's also a draw towards investing in companies, which makes sense.

41:17You think about investing, it's investing in companies. These are great companies. I want to own these. And X is a great company. Y is a great company. The index is a basket of great companies. How can you lose if you just buy and hold great companies? That's right. And I think that unfortunately, that desire or that view, for instance, that you have to have even productive capacity of assets in order and yield outcomes of assets in order to generate returns, I think, closes the door to assets that could be highly beneficial to a portfolio like gold that have attractive risk return and correlation profiles.

42:00that are different from what, you know, stocks and bonds provide. And so I hear you. I think that that's right, is that there's sort of a tangibility of a company. And like, you know, Nike produces the shoes that I'm wearing today. What does the U.S. government bond produce? It's kind of hard to get your head around. Yeah. And I'm curious, why do you think there's just so much, and maybe you disagree, but Why do you think there's so much misunderstanding about how the economy works, how markets work? You know, we're in a world where information is readily available. There's probably too much information.

42:37There's probably a lot of noise. But why do you think we're in a place where, you know, the average investor doesn't have a good grasp of these concepts? If financial Twitter is any indication, there's certainly plenty of noise out there. So much noise. Very valuable to you get a lot out of it. But there's a lot of noise you have to filter through things. I think at its core, I think there's a real education gap that exists in understanding economics. And also, I think there's a huge education gap in personal finance. Like we're – I mean, as an example, like we're teaching young kids about farm animals instead of how they should invest their paycheck.

43:23Like that is – and 100 percent of people will have to figure out how to manage their paycheck and 1 percent of the employment in the US is in the farming industry. And so like that is a fundamental gap that exists in our educational system. And so I think the macroeconomy is hard. To be clear, lots of things are hard. Writing a good essay is hard. Understanding physics is hard. There's lots of different things that are hard. But we don't spend time societally in prioritizing a deep, rich understanding of macroeconomics when it is a thing that affects everyone's lives every single day, which is kind of incredible in a way that they you live your life and you make your personal, you know, your personal decisions when the mortgage rate goes down.

44:15Any person in the market who's thinking about buying a house, which is two-thirds of the people in the US own houses, it affects all of those people. And yet we don't talk about it. And so I think that's a real gap. And I think it's particularly a gap that is harmful for those people who don't have access to this information. I think increasingly it's becoming more available and understandable in various channels. but there's still not a good canonical way in which we educate people in the way that we do biology, chemistry, physics, math. It doesn't make sense. Yeah. I mean, that's one of the reasons I'm doing this podcast is when I look at the other information out there, I feel like there's just a lot of misinformation.

45:01It's almost like you would have been better off not hearing that because it could lead you down the wrong path. And I'm just trying to share some insights that hopefully are helpful to investors. Yeah, it's just such a fascinating field. You know, if you think about, you know, the average person, they have to work really hard to earn money. And then they take that money and they put it in some investment, you know, to save for retirement or, you know, down the road. And, you know, all that hard work could be wasted on investing inefficiently, which when I look at kind of the average person, their portfolio is really out of balance.

45:35It's basically, you know, one bet. And it's just, it's kind of overly risky. And it doesn't have to be that way. I totally agree. And it's how they allocate how you allocate your savings. And then also all the different steps, all the ways in which you can allocate savings, like all the planning aspects, which are so credit, I mean, so, so critical to getting the best outcome that you can. And a place where, you know, if you ask that average person on the street, Like what do you do? What's the most efficient way to save your money? It is not obvious. We don't have these conversations with the everyday person about how best to save, how best to structure it, how best to create a great portfolio.

46:20All of those things, there's a huge gap in terms of the education. It's the role – I mean the great thing is there's also tons of advisors out there who really understand this stuff well and are out there trying to educate their clients and put them in the best position. So I think there's a great force for good that's out there to do this in a better way. But there's still a huge gap between what the man on the street understands and what is actually available to them and how to best implement a portfolio. So talking about availability, why don't you spend a few minutes talking about what you're doing at Unlimited and kind of democratizing these return streams, trying to make them low fee, and also maybe spend a minute talking about why you selected the ETF structure.

47:14At Bridgewater, I worked with some of the biggest, most sophisticated clients and pools capital in the world. And what you see – I mean we talked about it a little earlier. What you see is they put about – let's call it 20 percent of their capital in hedge fund style strategies, the most sophisticated ones. And when you compare that to the everyday investor, they basically don't have access to those strategies at all because typically you have to be a wealthy individual. You have to have certain levels of assets to even have the ability to invest in them. and then you have to have access to the funds to actually invest in them.

47:53And a lot of the funds aren't very good. And one of the challenges for advisors who look at these platforms and things like that is, first of all, how do you evaluate all these different funds? But also the negative selection bias, which is a big deal, which is the person – the fund that's taking your$100 ,000 check is probably not the best fund to be in. and certainly not the best fund to be in when it's tax structured in an LP structure and you're paying rack rate on fees plus platform fees and stuff like that. You're talking about a very bad structure. So the biggest, most sophisticated institutions in the world, they invest in these strategies.

48:34They have a 20 percent allocation. The everyday investor basically has no access to these strategies. The other thing in working with these sophisticated investors you see is that when they invest in these strategies, they invest in a diverse portfolio of them because any one of these strategies, any one of these managers, they might be good, they might be bad at any particular point in time. But when you put them all together, they actually generate a pretty good return. And so these institutional investors are actually creating indexes, essentially creating index products that might invest in 60, 70 of these different managers, which is essentially like buying an index, right?

49:11Whereas – With a lot more paperwork. With a lot more paperwork. Whereas the individual investor – if you're an advisor, you're directing folks to like one or two funds, right? There's not – you're not investing in 70 funds. So they invest in hedge funds. They index those hedge funds. And then the last thing, which is a very important thing, is those institutional managers beat the funds down in fees. And so the idea of paying$2.20, if you're a big sovereign wealth fund, you don't pay$2.20, right? You pay a lot less than$2.20. And so what they've done is they basically created a low-cost index fund of these alpha strategies.

49:50Now, how interesting is that? When you look at what's out in the market, you basically don't – there's nothing that looks like that low-cost index fund and certainly nothing that's available for the everyday investor. And so that was the basic idea is we said, look, I bet we could take our experience as – having built the proprietary strategies and all these different hedge fund styles, I bet we could take that understanding, build technology that allows us to replicate what those managers are doing. Not perfectly, of course, but in a way that's pretty good. And because we can use technology instead of investing in the PMs, we can basically do it at a much lower fee structure and also in a way that's much more liquid than typical LP positions and much more tax efficient.

50:33And the outcome for the investor is the investor cares about net of fees, net of taxes. that structure at a quarter of the fees and half the taxes is much more compelling than typical LP positions. And because it's diversified, it should create a more consistent return stream, manager diversified as well as strategy diversified. So that's really at the core of what we're trying to do is use those principles, those principles that big institutional investors bring to the table in terms of how they manage their money and bring that to the everyday investor. Yeah, that makes a lot of sense. And that ETF structure has kind of – it's almost like a tax loophole in some ways.

51:14I mean almost like a tax – it's a tax loophole. Like I think it's one of the things – no reason to beat around the bush. There's a structure. It's been set up so that for the investor, it looks like a stock. It has all the properties of an individual stock in terms of its tax structuring, which means typically if you buy it and hold it for more than a year, It's taxed at your capital gains rate rather than your ordinary income rate. That's a great tax loophole to have. ETFs are also advantaged relative to mutual funds in that they have the ability to wash the capital gains in the securities underneath.

51:54And so therefore, you don't get – I mean in the vast, vast, vast majority of ETFs, there are not capital gains distributions. Even for products that have moderate turnover, there are not capital gains – typically not capital gains distributions that you see in other funds. And so what that means is you pay the taxes when you want to pay the taxes, not when the manager has redemptions or when the manager rebalances. That's all very advantageous. And so it's just – and not to mention the fact that it's transparent and it's liquid and it's a 40-act product that's SEC registered and at arm's length and has independent custodians and an independent board, which for hedge funds, like how many times are you looking at hedge funds and you're saying, well, I mean what's the probability of fraud?

52:47I'm not saying that there's lots of fraud. But that is a thing you have to worry about. Well, if the security in an ETF, if the securities are held by an independent institution, I don't touch the money. Right. I can't touch the money. It's an independent trust that holds the money. Not me. It's an independent trust that, you know, that is highly regulated by the SEC. That's a very advantageous from a consumer standpoint in terms of the risk of fraud or abuse that comes from a manager. Yeah, I've always felt if you could take your total portfolio, whatever, however way you invest, and put the whole thing inside of a single ETF, you'd be in great shape because you're basically putting that tax-efficient wrapper around.

53:29This is obviously for taxable investors. You can put that tax-efficient wrapper around the total portfolio. Obviously, that's very complicated, not easy to do. So short of that, you can try to put an ETF wrapper around those return streams. That makes sense. Most people think about ETFs as low-cost index funds because that's That's basically how they started. But the tax efficiency is actually the best with moderate turnover portfolios because you don't have to take the capital gains in and out. All right. You can put those all into a single wrapper and only take – only basically take the taxes, only pay the taxes at the point of sale.

54:06And so actually the ETF structure is more tax efficient, better for actively managed strategies than it is even for passively managed strategies, which is pretty neat. I mean, that's why I got, you know, I've always been in the LP structure with institutions which are all different gain. I looked at the ETF and I said, well, if you look at all these different pieces, it's actually far and away the best structure for the vast majority of investors. Which is also probably why it'll be around for a long time, because it's for the average investor. It's not for, you know, the ultra wealthy. That's right.

54:43Yeah. I mean, it's been, just think about it. actively managed ETFs. Last year, they got about 25 percent of the incremental flows. They might get as much as 50 percent of the incremental flows here in 2024. That really speaks to the fact that but even if that even with that, you know, actively managed ETFs only represent something like five percent of the overall ETF and mutual fund actively managed market. So there's there's a long way to go here in the evolution of actively managed ETFs. And I think people are finally starting to recognize the real advantages of the structure provides, particularly for those actively managed products.

55:19So why don't we transition to market and investment outlook? You're very active in sharing your views, your alpha views of what you think the future holds. You know, we're talking about the kind of the 52-48 conversation. conversation. I'm curious about what are some of your big themes that you're contemplating that you'd like to share with us? Well, the first thing I'd say is, remember, 5248, so the probability that anything that I say at this point is right is about that, right? So just, you know, that's, I love having that conversation about humility, and then it's like, what are your views?

55:58Well, you know, don't have too much confidence in any view that I have, but I'll give you what my views are. So take them or leave them. You know, I think most of us in our professional lives have basically experienced two, maybe three cycles, which were relatively acute experiences. So 2020, obviously, I mean, I don't know, it was that cycle was like three weeks from top to bottom, back to reflation in 2008, which was the course of six months, and then the 2000 cycle, the equity bubble pop. And those cycles are not normal cycles. Normal macro cycles are very boring, very slow moving. This doesn't get any clicks on Twitter when I'm like, the normal macroeconomic cycle is like watching paint dry.

56:47Stop listening to any of us. This is going very slowly. And I think that's very important to recognize if you go back to cycles, like old time cycles, like in the 60s and the 50s and stuff like that. And so if you think about where we are in that cycle. We're late cycle, unemployment rates at secular lows. There was a tightening. Inflation was elevated. There was tightening. That tightening is very, very, very slowly slowing the economy, but it's very slow moving. And what we've actually seen instead is that people's expectations of what's going on have whipped around that very, very slow moving moderation in the economy.

57:26And that whipping around has created a lot of opportunities. If you think about it, what have we done in the last year? We went at the beginning of last year, we were going to have a recession immediately. Then we went to hire for longer. Then we went to a banking crisis. Then we went to an AI boom. Then we went to hire for longer. Then we had recessionary dynamics. I mean, we've been through like every macroeconomic state in the course of 12 months. And the reality of the economy is just so much more boring than that, right? I should have started. What's been going on with the unemployment rates?

58:03Basically, it's been the same for 18 months, right? Like you want to understand what's going on with the economy. It's that there you go, nothing. Nothing has happened. Nothing has happened. And inflation spiked and it kind of gradually kind of went back down. And then inflation spiked and came down. And there were obviously issues related to the COVID dynamics and the supply chain, things like that. But those things happen and they're sort of one off, up and down. But the basic underlying fundamentals of the economy are very boring, late cycle, tight labor markets, elevated wage growth, inflationary pressures, tightening and response, moderation or slowing of the economy.

58:38And that's basically where we're at. And then sort of more tactically, so that's sort of the foundational space of the economy is sort of secularly tight and growth is about a potential. And then on the margin, what we've had over the course of the last 10 weeks or something like that is one of the biggest easing experiences, short-term easing experiences that we've seen in history, which stocks that are up 20 percent or more bond yields have come down 120 basis points, a huge easing that's basically been ejected in the economy. And what you'd expect – and that sort of level of easing is typical of recessionary environments but not very typical of late cycle environments.

59:19The reason why that happened was a variety of things related to Fed policy, Treasury policy and inflation coming down. But what it created was an effective easing in a late cycle environment and actually what we're starting to see is a reacceleration of the economy. And that's a bit of a dangerous point because when you get a reacceleration of the economy at a late cycle moment with elevated wage inflation, the risk of inflationary pressures reemerging are present, particularly after a period where we had such idiosyncratic but nonetheless meaningful inflationary pressures that existed coming out of COVID.

59:54And so that's kind of where we're at, which is we're likely – that's where we're at macroeconomically, likely to have continued pretty good, fine, good growth and very low unemployment and tight labor markets. But the thing that's very interesting is that the asset markets are pricing in wildly different outcomes. Stocks are above highs. They're pricing in pretty good conditions. Bonds and in particular short rates are pricing a lot of cuts. Now, typically, you wouldn't see an environment where you have the economy, unemployment at secular lows, inflation risks elevated, and growth pretty good, and stocks at all new highs and 160 basis points of cuts priced in.

1:00:37Those two things are totally inconsistent with each other. And I think that's basically where we stand in the economy is we're – in many ways, it looks like we're back to things that look a little bit like where we were at the beginning of 2023 where people are coming into the year with big expectations of weak economic conditions that are really unlikely to be realized, which is likely to put pressure on the bond market and particularly the short rate market and the pricing of all of those Fed cuts that are currently priced in. Yeah. So in some ways, bond market pricing and stock market pricing don't really match.

1:01:14It's hard. It seems like one of those is probably wrong. And that happens, right? Different pools of investors, different market views, different flows, different things like that can often create different pricing in markets. And so that's – if you think about this, the question is where do you have edge? It's about looking at what's the macroeconomic conditions. How are they likely to proceed into the future relative to what's priced in? And right now, we have a pretty good economy, pretty tight conditions, pretty good asset prices, and bonds are pricing in a terrible outcome. Right now, if you look at the short rates, December 24 short rates are pricing in a roughly 30 % chance of a lower than 3 % rate in December 2024.

1:02:05I mean, that's a pretty bad – that would be a pretty bad outcome. 250, 300 basis points of easing in the course of a year would be quite a bad macroeconomic outcome. But that's priced in at a 30 percent probability. That seems unlikely. It doesn't mean it's impossible, but it seems like that probability is too elevated relative to the set of macro conditions that we're seeing today. I wanted to go back and clarify one point. The 52-48. And then also macroeconomic conditions are slow moving. So when you talk about your forward-looking expectations, I assume the odds of getting that right is more than 52%.

1:02:46And the 52 % is more related to trading around those views. Is that accurate? Yeah, that's right. So the thing about trading, which makes it fun and challenging, is that to get the bets right, you have to be different from what's priced into the market. And so – And correct. And you have to be right. That's a good one. You have to be right and different from what's priced in. And so that's one of the challenges. That's why it's so hard to make money in markets because there's many times when everyone says, well, the economy is likely to deteriorate or the economy is likely to do well. And yes, you're right.

1:03:31You can have much more – much higher probability understanding of those things than comparing those outcomes relative to what's priced in and betting on the markets, which – where you have to be not just right about what's likely to transpire with the macro economy but right relative to what's priced in. And when I look at what we've experienced the last, you know, 5, 10, even in my career, 25 years, and relative to what people have thought was going to happen, it seems like there's been constant surprise after surprise after surprise. Yet when you talk to somebody who's a seasoned investor and they've been investing for 30 years or 40 years, they can look back and say, you know, I've seen it all.

1:04:12And they feel confident that they have a pretty good sense of what the future may hold. Yet more likely than not, they're going to be surprised. I'm curious when you kind of zoom out and you look at, let's say, the last four or five decades, you had the inflationary 70s, the disinflationary 80s and 90s, the last decade of the 2000s when growth was the weakest since the Great Depression. And you had this boom since 2009, as you referenced earlier, and obviously COVID in the middle of all that. How do you, just in terms of what you feel the next five to 10 years looks like just from an economic standpoint, do you feel like it's going to resemble one of those cycles that we've seen?

1:04:50Or do you feel like they're just very different dynamics now and it's maybe probably another surprise down the road? Any one cycle always is some mishmash of a bunch of different experiences in history. And I'll say, while I was not around in the 50s and 60s, particularly the late 60s. I think that's probably the right feel in terms of what's going on. And I think the reason why I say that is I think there's a lot of elements that are similar. Taking COVID aside as a sort of one-off shock that has existed in the economy, which was unusual in its own right, the sort of foundations of the macroeconomy are very similar to the 50s and 60s periods and those cycles where you've had where during those times you had actually relatively significant healing of balance sheets right after a debt problem.

1:05:47You had particularly as you get into the 60s, you have sort of creeping in inflationary pressures. You have relatively significant deficit spending in you had periods of rising conflict, geopolitical conflict there in the late 60s and early 70s, obviously, which extended into the full 70s. And so you sort of see, and you see the Federal Reserve response during that period being a bit behind the curve, so letting conditions run a bit hot relative to monetary policy. And I think a lot of the conditions today look like that. Now, that doesn't mean you should trade based on, you know, line up two charts from 1965 to 1975 and say we're in 1968.

1:06:31It's not that simple. But a lot of the dynamics are very similar to that. And I think it's notable how surprised people have been in the environment. You know, that cycle, that period, the late 60s kind of dynamics and early 70s is something that's sort of fallen out of the consciousness of the professional traders that have existed, right? They've sort of aged out of having had that lived experience. And so it's not surprising to me that this macroeconomic dynamic feels very surprising given essentially no one has lived through a dynamic like that. And I think that combines with the fact that the high levels of information availability have created the circumstance where there's just constantly a flow of information where everyone is trying to catch the incremental turn, right?

1:07:24The incremental data that is the incremental turn. I don't know how many people are listening to this go on Twitter or whatever, but how many single charts, single line charts of this data point or that data point that has called – now we were going to a recession. Because this particular data point, I mean, it's like every day, dozens and dozens of charts in my feed look like that. And I think that that is creating this extreme whipping of expectations around a macroeconomic cycle that basically no one has seen who's traded in their professional lives. And that's creating a set of dynamics that are very interesting.

1:08:00I think it creates a lot of opportunities, particularly to fade extreme market pricing relative to that overall dynamic. But I think that's the feel that I have in terms of what we're experiencing today. Yeah, it's really interesting. I remember when 08, 09 happened. And it's probably closest to the Great Depression. And I remember very clearly in 06, 07, there was talk of, could the Great Depression ever happen again? The answer was, no way, because we've learned from that. And we got very close to it happening again. And it's almost the same time frame where that escaped the memory of most investors at the time.

1:08:36That's exactly right. And so, you know, it's why you have to really look outside of your lived experience. When you're thinking about investing, you really have to be outside your lived experience. And I think one of the challenges is, you know, people too often rely on their lived experience rather than, you know, opening the scope to all the different plausible experiences. It was a big thing, you know, that helped navigate through the 08, 09 period that, you know, having studied in incredible depth the depression and the dynamics there, that was critically important. And I think a lot of people were challenged by in that particular cycle, the difference between sort of a recession, which is what they knew, and a depressionary dynamic that they didn't know.

1:09:24And I think today we sort of see the same thing where a lot of folks have never lived through this compilation of different cross-cutting forces that are going to drive the macro economy over the next five or ten years. And so going back to those old-time cycles like the 50s and the 60s and the early 70s, not to say that it will be literally the same, but the dynamics are very familiar. I think it's very, very relevant to what's going on today. Yeah. One notion that you alluded to earlier is the deficits. You know, I think, you know, the way governments are supposed to work is when you're in a boom, you have a surplus.

1:10:00So you save for a rainy day and then you are in a recession and now you run a deficit to kind of combat the, you know, reduced spending during those periods. But in the US, we basically, you know, we oscillate between a little deficit during good times and a massive deficit during bad times. And the worst of times, the bigger the deficit. And obviously, you have ballooning, you know, government debts that accumulates over time. I'm curious how you, you know, how does this end? You know, it seems like you're kind of abusing the privilege of being the world's reserve currency. And this is one of those other things that's slow moving until you hit a tipping point.

1:10:37I'm curious how you think about that whole dynamic. There's a lot of governments in the developed world have high levels of debt. And when you have high levels of debt, there's basically, you know, you have to, you basically have to grow out of them in some way, shape, or form, and you either grow out of them with higher inflation, and essentially inflate away those debts, or through higher productivity. And so when you think about that process, the first step is transitioning from an elevated deficit environment to a more constrained deficit environment, so less borrowing. And that's a painful transition.

1:11:20And I think we may see that sort of transition happen in a way that is counter-cyclical, in a way that could be challenging. When eventually we get to a downturn environment, we're probably not going to accept deficits at 15, 20 percent of GDP, it's not going to happen. And so if you have constrained deficits at a time of economic vulnerability, you could have a more significant downturn than maybe folks expect. But that's in the distance. But first, you have to think about the stages, which is first you've got to constrain the incremental borrowing. Then what happens is you've got to figure out how you get your way.

1:12:02How do you pay down that old borrowing? And there's basically, as I said, the three ways. You inflate, you have higher productivity. The other option is you can just print money in the way that Japan has. And so my guess is we'll see some combination of those. The optimal way of doing it to pay down those debts is through higher productivity. May happen, may not. Wouldn't necessarily bet on it. More likely, we're going to see more inflation and more money printing than maybe people expect in order to retire that debt or at least move it out of the hands of the private sector. And so that's really the story.

1:12:37The good thing, I think, for the dollar as a reserve currency is that there's lots of debt problems everywhere. This isn't a U.S. specific thing. And so basically everyone's going to go through some form of that. And given the fact that the U.S. has the deepest, most liquid capital markets, we may be ugly relative to things like gold, but we sure aren't necessarily, you know, we sure look pretty good relative to a lot of the other options that are out there. Yeah, that makes sense. Bob, you've been very generous with your time. I'm going to end with one big question, which is, you know, in all your years of studying markets and your experience, what's the one big unique insight that you'd like to share with us and maybe many have not heard before?

1:13:23It may seem incredibly obvious, but it's so often forgotten, which is when you're thinking about markets, you have to start with what's priced in. That is because everything that you do in terms of your investments and also whether or not you can generate alpha comes down to how you see the world in the future relative to what's priced in. And I always like it at the beginning of the year. It's a good time to just take a minute, take stock. What is actually priced into these markets? While it many times is the easiest thing to do because it can be relatively well-known and measured, it's the thing that gets forgotten.

1:14:04And so particularly in this environment where we have these expectations whipping around relative to the reality, having a firm foundation there starting with what's priced in and then going to what's likely to happen is going to be very advantageous for investors. That's great. Bob, I appreciate it. It was great chatting with you. I love the insight that you shared. So thank you for being here. Yeah, thanks so much for having me. It was great. Thanks for listening. We hope you enjoyed this episode. Please visit our website at insightfulinvestor.org to access past shows and learn more about our podcast.

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