Wall Street's Evolution and What It Means for Investors With Josh Brown (EP.173)

0:28We all need to make smart decisions with our money. sitting down with Josh Brown, CEO of Ritholtz Wealth Management, and one of the most influential voices in the world of financial commentary. Part of what makes Josh so uniquely positioned to comment on markets, the economy, and even the business of financial advice is because of where he sits professionally. He is a massive blogger, a CNBC TV market commentator, an RIA founder and CEO, a former retail stockbroker, and he has even been tapped in the entertainment industry. It's this unique combination of experiences and expertise that I think puts him in a position to make connections that really others just can't.

1:12And he is so great about sharing those insights with the world. The other thing that I feel like I have to point out is that Josh has been a trailblazer for people like me in the transition of financial education from traditional media to blogs and social media. Truly, he is one of the reasons that people like me have a platform. And honestly, he's a big part of the reason, whether it's directly or indirectly, that you would even consider getting financial education from a podcast or a blog post or a YouTube video. Now, if you haven't read Josh's work before, then I highly recommend checking out his new book, You weren't supposed to see that.

1:52And in this conversation, we touch on many of the topics covered throughout the book, including this impact of blogs on how markets are covered, how Wall Street has adapted to major shifts in investing trends, the evolving role of financial advice, and how financial advisors can be a unique ally to do-it-yourself or self-directed investors. And if you happen to be a fan of Showtime series Billions, then do stay tuned until the end where Josh shares his experience being a technical advisor for the show, as well as making cameo appearances as a version of himself. As always, you can find resources and links to all the things that we mentioned throughout the episode at thelongterminvestor.com.

2:38And without further ado, here is my conversation with Josh Brown. Josh Brown, welcome to The Long-Term Investor. Thank you so much for having me, Peter. It's a pleasure. I am just so excited to have you, as I mentioned in the introduction, because you're so uniquely positioned to comment on markets, the economy, the business of financial advice, just because of where you sit professionally. But one thing I didn't mention in the introduction that I have to mention now is that you also paved the way for people like me to have a voice and have a platform to educate, to help others. So truly, thank you from the bottom of my heart.

3:16I just want to make sure that you know how important of an impact you've had on my life and on others. Truly a legend for those listening and who don't know Josh, but truly, Josh, thank you so much. Well, I really appreciate hearing that. And it's kind of cool because I feel the same way about a lot of people who came before me that I had learned from and been inspired by. So hopefully this continues and there will be a generation of market commentators, financial planning podcasters who say the same thing to you someday. Boy, wouldn't that be an honor? And I remember starting in the blog world just being like, I want to do what Barry Ritholtz is doing.

3:55I want to do what Josh Brown is doing. And trying to describe that to some of my partners was difficult. But there really has been a huge shift where what you and I do now is pretty normal. Can you just start by sharing your own story, describing to the audience how the world shifted from traditional media to the blogs, the podcast, social media, et cetera? Well, I think there was a moment during the financial crisis where it became obvious that the mainstream media had missed the story, or they had reporters who were doing good articles, but weren't really getting to the heart of what was happening.

4:32And part of the reason for that was that the reporters were talking to traditional sources, people that came from Goldman Sachs, Merrill Lynch, Bank of America, JPMorgan Chase, and they were media-trained people who were not telling the whole story because they couldn't, or sources that they had previously relied on from the government, and just people that didn't really want to tell the full thing of what was happening because it would make their institution or corporation look bad. So there was a hunger for non-traditional sources of information in the financial markets. And there were a small group of people who had been independently and really for no monetary compensation whatsoever, just people who had taken it upon themselves to be writing financial blogs about the markets, the economy, the crash, the mortgage problem, the housing problem.

5:32And those people became rock stars. And there were, I don't know, 10 or 15 of them. One of them was Bill McBride at Calculated Risk, who effectively predicted the crisis using data. Then there was Barry Ritholtz, who predicted the crisis using a combination of data and anecdotes and curse words. And there were several others. But Barry, very uniquely, had been writing about the stock market and behavioral finance and knew a little something about real estate because his mom was a realtor. Barry had this one very unique insight. So I'm from Long Island. We talk with our hands. So Barry basically said, here's a chart of housing prices.

6:17And it goes from the lower left to the upper right. Almost like perfectly diagonal. just up and up and up and up during the 2000s decade. Here's a chart of average incomes, and it's a flat line straight across the bottom. So Barry's big insight is this is very simple. Either everyone in the country is about to get a 200 % raise, or the price of houses is completely unsustainable and is about to crash. And of course, it's the latter thing that happened. and he saw it coming. He documented it meticulously. I don't mean one article. I mean, he wrote about this five times a day for three years and then it happened.

7:00So Barry is effectively at the vanguard of this new crop of market commentators who were not coming from a traditional gatekeeper. They weren't sent by a publicist to go on the air working for one of the larger firms. And that's really the beginning, I think, of the financial blogosphere. And then, of course, I am working on Wall Street during that crisis, and I'm trying to be able to figure out what's happening. And I'm reading people like Barry. So Barry kind of becomes my idol. And I say, when I grow up, I'm going to start a blog. So of course, I started one five minutes later. And I got to meet Barry as a result of both of us being part of this movement of independent people kind of calling it like we saw it.

7:50And once we met, it became obvious that there were a lot of complementary skills and we could work together. Well, and so the traditional media landscape changed and you guys were sort of at the forefront, at least in the finance corner of the world, because this is true of really any sort of commentary, whether it's sports or fashion or entertainment, everyone can have a blog. It's almost costless at this point. But if that was maybe the big change in my career of how people consume information, the other change that you talk a lot about in your book is just where Wall Street profits went. So over time, the bull market of the 20 teens, I feel like I've heard you and others and myself say like, oh, it's the most hated bull market ever because no one on Wall Street was making any money.

8:38Big theme throughout the book. Can you talk a little bit about just the enormous gains of passively managed ETFs, how traditional money management firms and the brokerages and the investment banks who are cating to them sort of didn't profit from a huge, huge bull run? Yeah. Index funds and passive investing effectively went from 5 % to 50 % of the market. And what that meant was an enormous amount of outflows from actively managed mutual funds. We're talking about trillions of dollars moving away from high-fee, actively managed funds and strategies over to index funds, which effectively Wall Street makes no money on.

9:18If you pull out BlackRock and State Street, there's nothing there for anyone. Maybe there's some revenue on the trading side to be a counterparty with the authorized participants who are buying and selling stocks to create or redeem the baskets that are the ETFs holdings, but that's not a high margin glamorous business. The really glamorous business on Wall Street in terms of asset management was being the person who runs a$50 billion actively managed large cap mutual fund. And those effectively began a long, slow march toward extinction. It's not that they're not good at their jobs. It's that their jobs are impossible.

9:58No one can literally year in, year out beat the S &P 500. The S &P 500 is the ultimate momentum machine. The best companies become the largest weightings. And if you don't own the top 10 stocks in at least a market neutral weighting, you are destined to lose. How likely is it that somebody can pick the top 10 stocks every year? So it's almost an exercise in futility. Investors ultimately figured this out. We probably played some role in that with all the blog posts and the commentary. So Wall Street finds itself in a position where there's a massive bull market happening, but the industry itself is not cashing in in the way that it had historically during previous bull markets.

10:47So there's still M &A. There's still syndicate business, IPOs. It's not that no one's making any money, but it is sort of joyless. And you look at these firms that historically, they would have been hiring 20, 30, 40 ,000 people in a bull market. We actually had some unbelievable years for the S &P 500 where you saw the largest firms on Wall Street laying people off. Pretty unheard of. So it was kind of like a joyless, sexless, anticlimactic thing for professional Wall Street people to watch the market continue to hit record highs while their bonuses didn't. And it was kind of an interesting moment in time.

11:29Yeah, there won't be any movies made of the great bull market of the 20 teens. Obviously, there's the big short and that sort of stuff. But you don't have these Wolf of Wall Streets or Wall Street to look back and glamorize some of the parties of Wall Street. Yeah. But Peter, meanwhile, the S &P 500 compounded at 14%. So people did win. It was just they were regular people. Yes, regular people won. And that's because financial advisors weren't getting paid to shovel these high cost products into their accounts. I think there's been a big shift in the business model. And I'd love to hear your thoughts on my theory.

12:04I feel like private equity, private credit, private real estate, not inherently bad. But to me, like this is the new asset management. This is how Wall Street is going to make up lost profits, because those are active managements. They're super concentrated, actively managed funds with very high fees. Maybe that's the next place that allows people to go into that sexy finance career. And if you rewrote this book 10 years from now, that might be the focal point. I could not agree with you more. And I'm going to tell you, Wall Street, how can I say this politically, delicately? It's okay. Go for it.

12:39Wall Street will sell you whatever you will buy. Wall Street doesn't sit and say, what's in the best interest of investors. Wall Street says, what will investors pay money for? That's it. And there's nothing wrong with that. This is no different than record companies. They're not like, what's the best music? They're like, what's the music that is most likely to become commercially viable so we can sell a lot of concert tickets and albums and streams and merchandise? So Wall Street doesn't sit in a room and say, how do we get people to pay more for actively managed mutual fund. They don't care.

13:16They're, okay, fine. People won't pay for that. What will they pay for? What is unique enough that Vanguard can't replicate it for free? And the answer is private equity, alternatives. All right. We can't get 1 % anymore for a large cap growth fund. The jig is up. Everyone knows the SPIVA scorecard. Everyone knows there's no persistence of returns. Everyone knows that a manager who is 20th percentile performance is as likely to be bottom 20th percentile five years later as they are to be top. Everybody understands this point. Morgan Housel and Ben Carlson made sure that everybody would, okay, fine.

13:59So they won't pay 1 % for that. What will they pay 1 % for? That's it. And then once they figure it out, oh, people are really into this alts thing. You got high valuation stocks. You got bonds yielding almost nothing. We could tell a story where those two asset classes should not be the only thing you should own. You should have this third thing that will be non-correlated, LOL, will be less volatile, super LOL. But we could get people to pay 1 % for this. So that's what they're doing. And it's fine. There'll be winners. There'll be losers. 90 % of this stuff won't work. 10 % will. Very few financial advisors are capable of determining in advance which is going to be the 10%, which is going to be the 90%.

14:46So we'll replay the whole thing. In three years, in five years, my firm will be unwinding all of these bad investments. And so I love it. It's great. We'll write blog posts and we'll do our thing. And then I think you'll be exactly right. And that's what's great about what your firm does. You have so many writers with such a large platform, educating not just the public, but the advisor community, who is probably not as educated as I would prefer them to be. I realized the new advisor today knows a lot about taxes, knows a lot about financial planning, at least the good ones. But people are always going to want to chase what worked and asset managers are always going to want to put out what just worked into the market.

15:28So after the tech bubble, it was hedge funds. After the great financial crisis, it was managed futures. At some point in the 20-teens, it was liquid alts, and you see the 60-40 is dead. But I'm one, and I think you are too, who just generally prefer simplicity over complexity. Wall Street sells complexity. I mean, is it really just as simple as they're giving people what they want? Yes. So this is important. Why is private equity so hot? we know why it's hot from the selling perspective. Like why are companies selling private equity funds to wealth matter? Because there's a lot of money to be made.

16:04Why are people buying it? Why are advisors recommending it? Because everything is sold on a backward looking basis. So if I am creating an investment proposal for you, I just met you. Maybe we played golf. Maybe we shared a couple of laughs over cigars at the club after. And then you said, Josh, what do you do? And I said, oh, I manage money. And you say, oh, I actually, I've been looking for a new financial advisor. Maybe let's swing by my office. Let's have a conversation, blah, blah, blah, a couple of meetings. And now I'm making the portfolio presentation to you. So you say, all right, Peter, we talked about your goals.

16:43We did a financial plan. You agreed with me that the portfolio should be based on the plan. Well, here's the portfolio, and these are the holdings that I'm proposing to you. So I want you to have X percent in US stocks, X percent in international stocks. This is what we're going to do in tax-free munis. This is what we're going to do in treasuries, blah, blah, blah. And here's a 10 % sleeve in private equity. Why did I do that? I'll explain to you why. I'm a fiduciary, so I'm not getting an extra fee for doing that. Okay. But here's what I get. I get to show you a historical track record of private equity as an asset class back to the 1980s.

17:23It's going to include the returns of Carlisle, Bain, and KKR from when they were managing like$10 million. Of course, they're now managing a trillion dollars, but forget about that part. So I'm showing you historical returns that will never, ever be replicated. Can't be. Mathematically impossible. But still, I'm baking that into a back test of, okay, so that makes me look really good. The second thing, it looks different than what the RIA down the street is showing you. The RIA down the street is showing you a portfolio with 80 ETFs, five are BlackRock, one is State Street, two are Vanguard, or whatever.

18:05And looking at that, you're like, oh, I could do that myself. Anyone could do that. I can call Fidelity and the clerk who answers the 1-800 number could build that portfolio. So I'm showing you something different. I have an interval fund from KKR. Ooh, how does that work? Well, you see, it's very exclusive. These are private assets. They don't trade all the time. You're only going to get an update on the valuation every quarter when they remark the portfolio. There's a liquidity constraint. So even if people are panicking, you can't pull your money out all at once. And this is how billionaires invest.

18:41So I tell you, and it's true. Now, billionaires don't invest through a mutual fund, but that's another conversation. The point is, I get to show you a level of sophistication on my part as the advisor that separates me from the other RIA in town who's doing eight ADTFs from Vanguard. I get to utilize historic private equity asset class returns as part of my backtest. And even though I don't get paid any more or less to build a portfolio with that 10 % alt sleeve, in your eyes as the prospective client, I have materially elevated myself as an advisor and the value of what I bring to the table. And it's as simple as that.

19:27And anybody who wants could say, no, no, it's not true. It's non-correlated. No, that's not why you're doing it. So it's okay. I'm not against private equity, but just keep it real. Tell the truth. We think this asset class has some non-correlated attributes. We think the benefit of the illiquidity premium will exist. Okay, that's legitimate. We think private equity could potentially outperform the S &P 500. Okay, it might. You're not buying private assets at the same valuations that people were in the 90s. But sure, maybe it's still outperforming. But just be honest with your client. Why are you doing a 10 % alt sleeve?

20:10Why are you selling private credit to a dentist who's looking for 7 % returns? What are you doing? So you and I understand this. I think most people listening to this who are advisors understand this. The clients, there's a spectrum. Most of them have no idea what's going on. Have I been canceled yet? No, not at all. I mean, I think if I think of the advisor, I'm not going to go trashing advisors per se, but I do feel like it's also just another place to, if it doesn't work, it's really easy to come up with some narrative about the Fed or geopolitics on why the thesis didn't work out and, oh, that's why this underperformed.

20:49But here's a new manager. Does you just keep this cycle going? 100%. And can I also tell you, if I sound overly cynical, it's because I did this already. We did this in the 2000s. You had a lost decade for stocks in the 2000s. The S &P 500, it was flat with a ton of volatility. Two 50 % crashes inside of five years and a decade of 0 % returns. So what do you think people did in 2010? They started recommending commodities funds. All of a sudden, commodities should be a 10 % sleeve in a long-term asset allocation. I swear to God, that was the standard advice. Why? Because commodities did really well during the 2000s decade.

21:35So you could point to a client and backtest and say, if you had been working with me for the last 10 years and you had the portfolio I'm recommending to you today, look what commodities would have done to offset the weakness in stocks. They did it with emerging markets, the BRICS trade. They said, oh, here's your problem. You know why you're dissatisfied with your current advisor? Because you're all US. Had you been working with me for the last 10 years with the portfolio I'm proposing today, we would have been 10 % emerging markets, BRIC stocks, Brazil, Russia, India, China. And look how well those did while your S &P funds were put to sleep.

22:14So all of a sudden, between 2010 and 2014, everybody's being recommended a portfolio that is an answer to the last war. Every general fights the last war. So now all of a sudden, people are walking around like, oh, I'm 10 % commodities. This commodity sleeve never goes up. Or it goes up and down and up and down. What is the point of this? There is no point. The point is you were willing to buy that because you were mad about stocks having done nothing for 10 years. This is human nature. It's not the advisor's fault. In the end, if you're selling and you're trying to close business, you will default to whatever the customer is willing to buy.

22:55It's really hard to insist that they do something that looks like it just was a complete failure for the last 10 years. Even if you think it's the right thing to do, it's not the easiest way to close new business. 100 % and it's hard to retain business sometimes because people still today think that the value we add on the investment side is investment selection. And I'm not saying there's no value add there. But for the most part, we're here to just make sure that you don't make mistakes. And I feel like at least in my career, so I started in 07, my first bear market, I remember being like, Oh, so this is what a bear market feels like.

23:31Cool. So like I'm anchored to the 60 % drop thinking that's normal. And in all of 2022, I keep saying like, wake me up when we're down 30. Yeah, this is nothing. Yeah, but I feel like a big part of the value is where especially people with platforms get to shine is during market corrections. That said, I mean, you've been in the profession longer than I have. But I'd be curious, do you feel like market corrections are going either faster because people hear from voices like yourself, or they're getting more educated that like, hey, this is temporary. You just have to sit through it. What do you think has changed on that front, if anything at all?

24:07It's better than that. I think the public is getting smarter, but I think the mechanisms with which we invest are programmed to negate the effects of bear markets and it's working. So people assume like fear and greed and nobody ever changes. Eh, I don't know. I think that's probably true, but like what if we all default to a method of investing whereby our money is automatically being added to asset classes that are falling and automatically rebalancing. And then we've got$11 trillion in 401k money in this country. The money being added to those portfolios is price insensitive. It's coming in no matter what.

24:51We have data. 2022 is the worst year for a 60-40 portfolio allocation in the history of the universe. These are facts. The absolute worst. And bonds were down as much as stocks. S &P down 20, bond market down 18, just a slaughterhouse. There was nowhere to hide except for cash. Okay, fine. What did Vanguard 401k participants do during that year? Literally nothing. They continued to invest. They didn't log in and stop the investments. They didn't tinker with the allocation of their existing investments. They didn't change the new money coming in, like how that would be allocated. Because people, they're staying the course.

25:37They're emotionally more intelligent. They've seen how fast the recovery was in 2020. They saw how dumb people looked for selling at the bottom of the pandemic. And they've just learned. But then also, the way that people's money is being invested, it's a more automated thing. Schwab Intelligent Portfolios, Vanguard's RoboAdvisor, Betterment, the 401k at Fidelity, the 401k at Vanguard. This is now, I think, dampening volatility, shortening market cycles, making it so that corrections don't go all the way down 60%. I think it's having a positive effect. that it's a combination of technology and the end client, the end investor, just being a little bit more aware of their own behavior.

26:25I'm so glad that you mentioned the wealth fronts, the betterments, the Schwab intelligent portfolios, because the 401k story, a lot of people get. I remember when the robo advisors were starting to make a name for themselves coming out of the great financial crisis. And most financial advisors were worried about them taking our jobs and they didn't, But they did start to serve a portion of the population that previously didn't have that kind of good advice. And here's what I think is interesting about that. So I survey my email list and my listeners like once a year. And there's a huge part of my audience that's do-it-yourself investors.

27:01And when I serve them and they say the cost of advice is the reason they don't hire an advisor, I do sometimes wonder if that's because they never came up with the automation of the robos. they maybe had the 401k, but it wasn't as automated as it is today. You and I both know that a good financial advisor, worth their weight in gold. A bad one, maybe not, but a good one, definitely worth it. So in your mind, what would you say to that do it yourself investor who follows you, follows me, follows lots of good thinkers, has made lots of good choices, but still can't get over the cost of hiring somebody?

27:35So don't. I think a third of investors or do it yourself, that's fine. This is personal preference. All right, let me tell you something. This is interesting. When we hear from a self-directed investor who wants to hire us, do you know what the main reason that we hear the most often for why they've come to us? This is true. What would you guess it is? I mean, I would say either it's a backup plan for their spouse. Yeah. No, that's it. You got it. That's it. Okay. Yeah. That's usually what I get. Yeah. Okay. So hi, guys. Big fan of Barry's. I'm 65 years old. I've been managing my own money since my 30s.