Episode 302 - Michael Green: Market Efficiency Is Not The Question

26:08So unfortunately, I think it's something worse than that. I wouldn't be out here raising the alarm if I thought the problem was that we'd see a 4 % correction in the S &P. Who cares? That's not the issue. The issue is that we have effectively allowed a system to persist that mechanically inflates valuations, inures us to that process, allows us to create all sorts of narratives around both why it's happening and what the degree of wealth that is being created is. And then we rely on that wealth for our future consumption expenditures. So when you have an aggregate, something like a baby boomer demographic or a passive penetration strategy that starts to run in reverse, and the passive investors become net sellers and require liquidity from the market, the market can't provide it.

27:00That's the XIV event. And unfortunately, when you run the simulations around how this plays out in the S &P, it looks very much like the Chinese stock market crash in 2015, in which the market fell 85 % in a matter of months. So not just a little bit of volatility. That's a permanent decline. I mean, the real risk is that you just end up shutting the markets. I realize that sounds insane, but remember that you have 100 million Americans and untold number of people around the world who believe that their deposits in the S &P 500 are safe. Take that away from them. They try to take that money out and suddenly the world changes in a quite dramatic fashion.

27:39What about stuff like, and this is an off the cuff question, but like circuit breakers and markets. Does that help any of this? 100%. Absolutely. Circuit breakers, that's part of the reason why I highlighted that at the start. The behavior of the S &P would be almost certainly quite different than the behavior of the XIV, which could fall 85 % to 95 % in a single day. That's obviously not possible with the S &P, but the problem is that you create the dynamics of a bank run. A bank run effectively can only be solved by shutting the bank. That's wild. So we've talked about the S &P 500 just now.

28:14How big of a deal is this in other countries? Like we're in Canada. Is the TSX exposed to the same kind of issues? So it's not as much. And this is kind of one of the interesting features. So if you look at the behavior of US markets and you look at the market share gain, one of the charts that I would draw people's attention to, we're going to skip around and you'll have access to the full presentation. And I encourage people to check out other podcasts where I've given the full presentation. but I just want to show you a very quick chart, which is slide 11. How does the market transitioning from active to passive behave?

28:45The chart on the right-hand side actually shows the exponential feature of the growth of passive strategies and how that actually becomes a exponential curve in terms of rising valuations. The reason why that matters is because when you think about the US, which had a head start in passive investing and is far further along in passive investing than any other market around the world, this helps to explain why we ultimately continue to gain share versus the rest of the world. While the rest of the world is moving towards passive and is adopting it, their share of passive is lower. And as a result, it's a red queen effect from Alice in Wonderland.

29:21They're running really fast to try to just stay in place. We're running just a little faster. So we continue to gain share relative to global market capitalizations, even though our GDP really doesn't suggest that that should be happening. There's a lot of debates around the quality of the companies. You're looking at antitrust lawsuits against each one of our largest entities, and yet we continue to price them more richly than ever. So how do systematic firms like Dimensional or Avantis that tilt away from cap waste fit into these dynamics you talk about? They're playing a slightly different game.

29:53When you think about what's ultimately happening with strategies like Dimensional Fund Advisors, where they're engaged and systematic value strategies is really what they're well known for. It actually turns out that really what that is, it's just a volatility sale. So it's a portfolio construction technique where you agree in advance that you're going to sell stuff that goes up and you're going to buy stuff that goes down. Mechanically, that's the same thing as saying I've sold call options and I've sold put options. I should capture a premium associated with that volatility short. This is why the value factor is so closely correlated with short volatility in general.

30:27When volatility spikes, the value factor tends to underperform quite significantly. They're interesting in that they have different exposures. I do want to emphasize, I don't have it in this presentation, I have it in another one. I could send a copy of it afterwards. And if you wanted to share the slides, you could. But remember the part of what you're looking for in a robust market is diversification in terms of the participants. And so actually there's nothing wrong with a passive strategy, a quote unquote passive strategy. And I do think it's actually really important. Let me pause for a second and just make sure that your investors or your listeners understand what the academic definition of a passive investor is.

31:05The academic definition of a passive investor is somebody who never transacts. They simply hold. And if you actually read the original literature behind the idea of passive investing, it's put forward by Bill Sharp in his 1991 paper, The Arithmetic of Active Management, which is what Cameron's referring to when he talks about all passive managers are the same as all active managers. Again, And I don't think that's actually true for reasons I've talked about. But the part that's equally less true is the idea that passive investors can simply hold because they can't. They have to get into the market and they ultimately have to get out of the market in order to realize their gains.

31:41And as a result, there is no such thing as the academic definition of passive investors. It's so perverse that in Bill Sharp's paper and footnote number four, it actually refers to transactions theoretically happening in the liminal hours when the market doesn't actually exist. That's awesome. I mean, a little bit of magic in your life is a wonderful thing. It's not a great thing in your expectations for retirement, but it's a wonderful thing in thinking about markets. And I would actually go so far as to suggest we've kind of hit that Arthur C. Clark point where any sufficiently advanced technology is indistinguishable from magic.

32:13If you ask most people how markets go up, they're like, well, it's kind of magic. It just happens. That is really the definition of passive investing. That was highlighted by Lasse-Peterson in his 2016 paper called Rethinking the Arithmetic, or Sharpening the Arithmetic of Active Management, in which he noted this footnote number four and said, hey, wait a second, on index reconstitution, this is exactly the Marco Salmon approach, they have to transact. My observation was something slightly different than that. And I pushed Lasse hard on this. He fully acknowledges it, that passive investment as we define it today transacts every single day.

32:51Vanguard takes in about a billion and a half dollars every single day. That is a large hedge fund every single day. So the idea that they're not transacting in the market, that they are somehow passive investors is prima facie absurd. What they have been is contributors of liquidity to the market by providing an investment philosophy that says, if you give me cash, thank you for the billion and a half dollars every single day, then buy. What should I buy? Everything. What price should I buy it at? Whatever the last idiot priced it at. That's interesting. So that's basically saying that Bill Sharp ignored flows.

33:30Absolutely. You talked about Dimensional and Avantis. What about non-cap weighted index funds more generally? I don't know, fundamental weighting? or? I'm not even sure that really exists. But again, you're just talking about slight variations on it. So if I equal weight it, am I removing some of the misspecifications on liquidity versus market cap? Sure. But I'm replacing them with others. Yeah. Okay. That makes sense. The real issue again, and just go back to the diversification component, it's hugely valuable to have people transact for different reasons. You may want to buy a house, therefore you sell.

34:04I may look at a valuation and say, wow, that's too high. Therefore I'm going to sell. Somebody who has even more conviction may say, wow, that valuation is so crazy. I'm going to short it and synthetically make more shares available for people. That's what shorting really is. That diversity creates robustness within the market. And really all we're describing with the growth of passive and more importantly, the regulatory support for the growth of passive is that we're effectively narrowing down the diversity and heterogeneity of the marketplace and making it more and more homogeneous into a group of strategies that basically boil down to, did you give me cash?

34:42If so, then buy. Did you ask for cash? If so, then sell. The regulation is, I can't remember what it's called in the States, the qualified, whatever it is, the auto enrollment. Slightly differently. But so under the Pension Protection Act of 2006, we switched 401ks from opt-in frameworks. In other words, you had to choose to participate to opt-out frameworks. In other words, you had to choose not to participate. That was a substantive change in the market that was done under lobbying from primarily Vanguard and BlackRock. The second key change was the designation of qualified default investment alternatives.

35:16So if you're going to default somebody into participating, you have to put them into something. It actually turned out that the vast majority of people, or not the vast majority, but many people, when they chose to participate in their 401k, would look at the plethora of choices available to them and say, man, I have no idea, and just hold cash. And so the QDIA changed that. It started to force people into the market and therefore led to far greater participation. And so interestingly enough, when that was done in 2006, that led to the explosion of the growth of firms like PIMCO that could manage balanced funds that combined bonds and equities into a single product.

35:51That was then replaced as the Qualified Default Investment Alternative, QDIA, in 2012 by target date funds. And today, I want to say the number is somewhere in the neighborhood of 95 cents of every retirement dollar in the United States now flows into a target date fund. Wow. Crazy. We talked about this on Twitter a while ago. The issue that we're talking about, the elasticity issue that index funds create, how is that distinct from market efficiency? So this is actually a really interesting dynamic because this is one of those things where the academic definition can really pollute the underlying information set.

36:26So the academic definition of efficiency is effectively how much of the price change can be explained by the release of fundamental events. So information is released, the price changes. If the price changes a lot, then actually the market is theoretically quite efficient. And if the market doesn't change, or if the security doesn't change in a substantive way different from the market, in other words, you need to think about the behavior of a security as being idiosyncratic in its relation to things like an earnings release and systematic in its relation to behavior with the market. And so perversely, the definition of efficiency is when there's not information released, it behaves very much like the market.

37:10When information is released, it behaves very differently than the market. And so the irony is, is that by making securities less elastic, you know, more inelastic, you're actually increasing the responsiveness to those fundamental events, which can lead to the confusing articulation that the markets are becoming more efficient. Things that we look for, things like post-earnings announcement drift are one of the metrics that are used to measure efficiency. Well, those are diminished if the reaction to an earnings report is the stock rises 100%. The proportion of movement that's tied to post-earnings announcement drift becomes smaller and smaller.

37:47Now, most people are beginning to wake up to this and say, wait a second, it's not at all efficient for the stock price to rise 50 % on a trillion dollar market capitalization on an earnings report, clearly there's something wrong with the efficiency in terms of information diffusion that's going on. Most people are starting to wake up to that. Most people are starting to recognize that it's not efficient for a company to triple or quadruple in its price post-bankruptcy announcement. We're starting to actually say, hey, wait a second, that's a stupid definition, even if I understand why you arrived at it.

38:20So now we're actually starting to recognize that markets are becoming less efficient, even as that elasticity is leading to many of the academic measures of efficiency to be like, hey, nothing's ever been better. One of the other big measures is active manager performance. How does this situation affect the ability of active managers to beat the market? Perversely, what it does is it creates a drift in the marketplace that penalizes holding cash or being quote unquote safe, maintaining the optionality of cash. But it also perversely corrupts measures like the Sharpe ratio or alpha in its behavior.

39:01And so again, jumping to a slide, and this one has to be a little bit interactive. I apologize to your listeners. If you jump to slide 25 in my deck, this is titled, When Time Becomes a Proxy for Passive Penetration, alpha vanishes for active management. And what I'm pointing out here is that the historical model of how stock prices behave or how markets behave is that there is a central tendency, equity is return 8 % a year, and then there's cyclical variation around that. When you introduce something like passive, this is the pale blue line, the convex curve that you see. When you introduce something like passive, it pushes valuations up over time.

39:47It actually changes that underlying return function from a flat line to a convex line. Now, this is where it gets really tricky. And I apologize for your listeners that there is math involved. The solution sets that we use in finance, we're all very good at math, but alpha is actually just the intercept on a linear equation. The behavior of your portfolio is equal to its beta times the market return plus some idiosyncratic measure we call alpha. Y equals MX plus B. If you use a linear solution to a curved surface, over time, mechanically, your alphas get pushed lower. It's just math. And it's a function of the fact that we're really not as good at math as we like to talk about being.

40:33We're just using the wrong metrics. So then if you flip to the next slide, you can actually see the impact that this has. The theoretical model, you're looking at alpha in this context and the impact of passive is identical to the empirical data. Alpha is going down. Because of the growth of passive. It's not because active managers have a harder job or because there's fewer idiots out there, et cetera. There's plenty of idiots. Just look at GameStop. But what we're actually experiencing is a market that is being distorted from the growth of passive is that becomes larger over time. It creates this exponential curve of rising valuations that in turn forces mechanically the alphas lower for active managers, which causes us to fire the active managers because they're idiots and replace them with the oh so efficient passive investing, which further exacerbates the problem.

41:26Man, active management is getting harder as indexing grows, harder to generate alpha. Correct. The exact opposite of what most people think. Yeah, it's wild. It is wild. So how should or should investors change their strategy in response to this current market structure? Well, this is where it gets really hard, Cameron, because what we're describing is the same phenomena as the Chuck Prince soliloquy and the lead into the global financial crisis. I just showed you it's impossible for active managers to beat passive and it becomes harder and harder as passive gains larger and larger share. So the answer is you invest passively.

42:04But that then exacerbates the societal risk that we face when ultimately we try to take that money out. So the answer is, it's unfortunately not your client's responsibility to say, hey, I want to make less money than my peers. I want to save less efficiently for my retirement. The music is playing. We still got to dance. But that is the societally significantly less than optimal response to these underlying conditions. And so it really, unfortunately, relies on the grownups in the room. I would include RAAs and asset managers and investment advisors to begin to communicate this. And candidly, Vanguard and BlackRock should be taking the lead and saying, oh man, we've really screwed this up.

42:45We need to start unwinding this. But their paychecks depend on not revealing that information. So we're really trapped, unfortunately. Their paychecks rely on things being the way that they are, but their paychecks are going to go down if the market crashes 85%. Why wouldn't Vanguard and BlackRock want to do something? Well, the simple answer is one, I just don't think the people at Vanguard are that good. It's a cult organization. And so I'm not convinced that Vanguard really understands this. Although I know for a fact that individuals within their organization do know some of these elements.

43:21BlackRock, I think, is a little, let's just be honest, they're true capitalists. They just want to make money. And I think part of the irony is that you're starting to see the signs that they are aware of this. What has Larry Fink now come out and done? He's replaced his ESG fixation with Americans are not saving enough for retirement. We should adopt the superannuation systems of Australia. That's possibly the only system that is more aggressively moving passive than the US system. So what he's really saying is, I, Larry Fink at BlackRock, want to do the same thing I did in the aftermath of the pandemic.

43:53I want to be tapped by the US government to manage all assets. I want to solve the high yield problem. I'm going to be the guy who's tapped to go out and buy all this sort of stuff. So even more attractive than managing 15 % of a market that is up 100 % would be managing 100 % of a market that's down 85%. That's a great gig. Just on the topic of active strategy, being able to beat the market with the way that it's set up now, is there anything cross-sectional like momentum or I don't know, is there a way to measure elasticity and select securities based on that? No, it's super interesting. So I mean, guys, you and I both know, Ralph Coygen at Chicago, he's developing some tools and systems that allow you to effectively predict the behavior and elasticity around individual securities.

44:40I have a ton of respect for the work that he's doing in that area. Others, I think, certainly are aware of this. And so part of what you're referring to is almost like the Andrew low adaptive markets hypothesis. People are going to respond to this. Unfortunately, the easiest answer is, hey, I just recognize that this is happening. I can't stop it. And therefore, I become even more venal in my prosecution of it. A really simple example of that would be the nonsense around SMCI and its inclusion within the S &P 500. Among the most profitable businesses out there for the multi-strat hedge funds like Millennium or D.E.

45:14Shaw or others is index inclusion arbitrage. And so recognizing that something like SMCI, having exceeded the$12.5 billion threshold for the S &P 500, was going to be included in the S &P 500, they're able to buy as many shares as they want, effectively pushing it further into the S &P 500 and guaranteeing themselves exit liquidity when the event occurs. So that's one of the strategies that works. The other one, I would argue, is that the public is starting to wake up to the dynamics of momentum and, quote unquote, technology in the same way that they did in the late 1990s, where a similar phenomenon happened.

45:54Cameron, this actually goes back to one of your points. We used to have market cap weighted indices. We don't, actually, just to be very clear. We have float adjusted market cap indices. The irony is that the dot-com was version 1.0 of this dynamic. In the 1990s, the unique features of the market were that you had companies that had gone public that were relatively large market cap, but had many of their shares held by insiders, companies like Microsoft, Cisco, Dell, et cetera. There was a very substantive change in the passive rules and regulations in 1994, where they moved from trying to statistically sample or buy every individual share to increasingly relying on futures for replication.

46:36That's shifted the problem away from the risk of Vanguard having tracking error to the dynamics of tracking error existing in futures merchants who refuse to accept it because that's where their profits are generated from. That meant that every time that you went in to buy shares of Microsoft in proportion to its market capitalization, you were effectively trying to buy twice as many shares as would otherwise exist. We used to call this the insider ownership effect. It led to outperformance. It was the single best performing factor from roughly 1995, soon after the adoption of those dynamics, until 1998, when, of course, people started to wake up and they're like, hey, wait a second.

47:12It's not really insider ownership that matters. It's technology. And it turned out that the single best correlation to insider ownership was a relatively recent IPO. And so the street began to manufacture all sorts of these things that people suddenly wanted. We called them technology IPOs. That's what the dot-com cycle was. Now, perversely, we're at the same stage. We bought ourselves capacity by changing the markets from cap-weighted to float-adjusted cap weights, but now we've exhausted it. And so we're seeing the same underlying behavior. And people are, of course, waking up and saying, hey, this whole value thing, boy, that was stupid.

47:50I should be a momentum investor. I should be a technology investor. Just get me some of that sweet, sweet AI stuff and I'm going to be rich like Croesus. Now, ironically, all they're doing is accelerating the termination point, but that's what's underway right now. So you're a portfolio manager. How do you incorporate your views on passive into your investment strategies? That's one of the wonderful things about adaptive markets. So in the past couple of weeks, you've been treated to all sorts of individuals who have identified different ways to do this. David Einhorn, who I spoke with and identified these with, he was one of the early people I spoke to, figured out that he was going to approach markets in a totally different way than I chose to approach them.

48:29His has worked out really, really well in some ways. My view was very straightforward, that you ultimately wanted to stay exposed to the large cap indices, that you wanted to participate in this. And candidly, if you can, you want to actually leverage that exposure. So doing things like buying call options, which historically had delivered significantly negative returns, now actually largely offer positive returns because the market has shifted in that drift feature. That would be one way that you incorporate it. You embed long-term or you embed call option type strategies that capture elements of this drift and are candidly not properly priced for those underlying dynamics.

49:08The other way that you identify this or you deal with this is you recognize that the information content that we're receiving on the health of the economy and the health of individual securities is actually wrong. It's being corrupted by these underlying dynamics. That's trickier because it effectively requires you to start saying, where do I start to bet against this? Where do I think this starts to unwind? Now, my models would suggest that what this largely means is that markets are increasingly reliant on employment, that contribution from 401ks, and ultimately that you start unwinding this process, again, it is really tricky because there's multiple levels to thinking through how this plays out.

49:49One way in which markets have continued to power higher is people have started saying, well, I don't want to buy the Vanguard total market index, or I don't want to buy a total market index, just buy everything. Cameron's observation of I'll just mimic the entire market. Instead, they're now cheating. And so they're starting to buy the technology funds again, and they're starting to buy the momentum funds again, and they're starting to focus on certain areas of the market effectively concentrating their firepower. And so the great irony is, is we look at a fantastic year like last year, or we look at a year like this year in which the S &P is, I think, up somewhere in the 10 % neighborhood.

50:25Forget where it is after yesterday's retreat. I think today we're just totally reversing it. But when you actually start thinking about that and you concentrate that firepower, that can push markets higher, even as the median stock is actually down this year and was for the vast majority of last year. People are loving the technology. Look, it's a natural component. We are a narrative species. You've asked me onto the show because I have a compelling narrative. If I had an uncompelling narrative, you'd be like, all right, that's a crazy guy sitting on a corner. But because I have a compelling narrative, you want people to listen to it.

50:59As a species, we gravitate to compelling narratives. We believe for thousands of years that the sun transited the sky, pulled behind a golden chariot. It's not unrealistic to tell people that the reason why stock markets go up is because they can't go down. It certainly feels that way. And once you tell them they can't go down, then they start trying to figure out, wow, how can I gain more wealth relative to everybody else? You know what? I'm going to buy the stuff that goes up the most because that can never go down even more or who knows. That's an interesting question, actually. I want to ask more about the US market in general later, but just on tech, do you think that tech stocks have done well because tech is doing well or because of this whole index fund problem we're talking about?

51:36What a question. So I think there's a mixture of the two. One of the other components that, of course, comes out of this is if you recognize that what I'm saying is that markets are less elastic than we think they are. And there's an entire paper written on this in 2020 by Gabay and Koijin called the Inelastic Market Hypothesis. So I'm not adopting any unique language or anything else. But if you accept that there is more friction from flows than the theoretical models would suggest. And just to parameterize that for individuals, the work of Gabay and Koijin suggests that a dollar into the market on average creates about$5 of market cap.

52:15The theory of efficient markets, under which we rely on for the insights of passive, assumes that a dollar into the market because somebody had to sell you those shares only creates one penny of market cap. So Gabay and Koijin would tell us that we've misspecified our theoretical models that underpin the growth of passive by 500 to one. Now, my math says it's much worse than that, actually, but that is a pretty bad measure. That's not even good enough for government work, as I like to joke. Crazy. That's back to the sharp thing, where the arithmetic of active management makes sense unless you account for flows.

52:54And now we're saying that flows are even more impactful than what people thought previously. Correct. Yeah, super interesting. You mentioned briefly that RIAs should be communicating this, and you mentioned the adults in the room. Who actually fixes this? Who needs to step up and do something? This is where I hate to say it, but the answer is unfortunately regulation. And so at the tail end of the presentation, I've got a series of recommendations for individuals or for regulators. The simple reality though is it's not going to happen because Vanguard and BlackRock spend more on lobbying than all of the rest of the industry combined.

53:28They control the regulatory apparatus at this point. They are the quote unquote good guys because they're facilitating savings at very low cost. And it's worked out brilliantly so far. And as a result, they have a degree of mindshare that is almost impossible to overcome. It's a crazy situation. It is a crazy situation. Now you understand why I'm so passionate about it. Yeah, I do. I started to understand it because I started reading your stuff and then And it's worth people hearing. One of the crazy things though, from the individual investor's perspective, and you said this earlier, is that other than recognizing that it is a societal problem, they shouldn't do anything.

54:04The best thing to do is continue buying index funds. Yeah, that's exactly right. That's wild. It is. I want to ask about US expected returns. US market's been on this crazy run for the last 20 years. I hear people all the time saying that the US is going to keep getting 10 % returns forever. The other thing people say that's crazy is who cares about the US market? Look at QQQ. It's going to keep getting 14 % returns forever. What's your outlook on US expected returns? First of all, that's that complex adaptive phenomenon that you're talking about. So a decade ago, nobody would have talked to you about QQQ, a little bit longer than that.

54:4012 years ago, if you remember David Einhorn, again, one of the smartest individuals I know in these markets was highlighting that nobody was paying attention to Apple or Microsoft. Part of the reason that changed was because the growth of target date funds that mechanically pushed that money in. But the simple reality was at that point, people were looking at the companies themselves and saying, hey, wait a second, these margins are largely unsustainable. Now, one of the great ironies is that when you create this type of feedback loop that advantages the largest companies with a dramatically lower cost of capital, I would actually estimate that it's a negative cost of capital for many of these companies, they're able to do crazy things like subsidize the acquisition of the highest quality labor and talent through the use of stock options.

55:25The stock options in turn actually need to be exercised. That is effectively like them selling shares. Those shares are then mechanically bought by the index investors with no consideration as to value. And so what it does is it actually becomes very much the Soros reflexivity dynamic where Microsoft and Google and Apple become endowed in a manner that the other lesser companies are not. And so it actually consolidates real resources into these entities and makes them more powerful than we think they really should be. It's truly perverse. If you jump back to that slide that I showed you before, and I want to be very clear, I don't think that this is ultimately going to happen because the volatility will become so extreme.

56:10But if you jump back to slide 11, that shows that exponential curve, that orange line going higher. The easiest way to think about that is as you get to somewhere in the neighborhood of 80 % passive. And remember, we're only about 45 % right now. At around 80 % passive, the Shiller PE would be somewhere around 400 to 500. Sounds great, right? What's the problem? You could more easily see an 85 % correction maybe when PEs are that high. That is ultimately one of the things that's really important for people to recognize is I don't know how to say get out of the way of this thing when I can realistically look at it and say, wait a second, I think it could actually go up another 400, 500, 600, 700 % simply on valuation.

56:52Now, I don't think that's going to happen because I think we're actually approaching the inflection point where the passive has become so large that it creates its own enemy. And this is where it gets super interesting because remember, withdrawals are always a function of asset levels. You think about something like a 401k in the United States, you have a required minimum distribution. And again, under lobbying from Vanguard and BlackRock, they've changed the rules to keep assets in 401ks longer than they otherwise would have. So they're doing everything they can to stop this outcome from occurring.

57:24but you're entering into an environment in which a 4 % redemption from a 401k that is appreciated three, four, 500 % overwhelms any contribution that people could make. And so ironically, actually 401ks went negative in terms of their net contributions back in the fourth quarter of 2018. Now we immediately changed the rules to address that, but ultimately we can't fight it that much because of this dynamic of withdrawals being tied to asset levels, while contributions are always going to be a function of income. When you talk about what are the returns, I have to make it completely conditional and say, do we see outflows?

58:05If we see outflows, then we unwind a massive fraction of what we've seen so far, and returns will probably be the most negative in history. On the flip side of that, if we don't get to that point, and they continue to change the rules, and they suddenly say, hey, wouldn't it be a great idea if we actually had the government put an additional 5 % into retirement savings into the S &P 500 for every American? Well, then the answer is, of course, we're going to see much higher returns and fantastic returns. So it really is flow dependent. It's super complex communication. I've seen some of your really good commentary on US economic fundamentals.

58:40If we hold flows neutral, just forget about flows. What do you think about US market expected returns based on economic fundamentals? Unfortunately, I think there's a whole host of separate issues as it relates to US economic fundamentals tied to the pandemic and the behaviors that we have around the pandemic. And then more broadly to a discussion of what societal wealth really is. So when you think about societal wealth, it's very easy to add up the dollar value of all the buildings and all the companies and all the cars we own and the dishwashers we own, et cetera. Those are all certainly contributors to our quote unquote wealth.

59:17But remember, that's just an accounting entry. A car is worth$30 ,000. Well, that's true until you're dying of thirst and then you're willing to trade your car away for a glass of water. So these are all just simply accounting entries. The real value that exists across the world is in human capital. And every corporation gives lip service to this. Our most valuable assets go down the elevator every day, right? Now, we negotiate against them as much as we possibly can. We try not to pay them reasonably. And in fact, if you're Apple, we're going to engage in outright collusion with our peers to make sure that our employees are underpaid relative to the value that they're creating.

59:54And we, of course, forgive that. But that human capital is really the value. And unfortunately, because we don't measure that in any way, shape or form, I'd suggest that almost every metric that we have is deeply distorted. If I look at that human capital component, I would suggest that both in the United States and Canada, we're seeing a significant dumbing down of the general population as our educational institutions increasingly fail. We're looking at an increasing failure in terms of our health care systems and our ability to keep people alive and healthy and in good spirits for an extended period of time.

1:00:29We're seeing a society that is becoming increasingly fractured in the United States and Canada across multiple metrics. And so all of those should ultimately play into the valuation that we ascribe to assets. And yet, ironically, we don't include those. And so we're not thinking about that underlying dynamic. On that basis, I would simply point out that the US is far less stable than it's been in periods in the past. And as a result, you should be applying a country discount versus history. We're doing the opposite. People investing in US stocks, they shouldn't get out on either the index fund or the economic fundamentals piece.

1:01:04Still be an index investor, I guess, but maybe don't count on the recent returns repeating forever when you think about your future. That is the core issue. And most people have kind of woken up to the giant joke. You can't allow a retirement system to fail. And the U.S. markets have become our retirement system. And so the U.S. government is going to be forced to intervene. Now, ironically, if we know that the U.S. government is going to be forced to intervene, that makes us more comfortable investing. Therefore, we push prices up higher, which in turn means a larger sell-off is required for the US government to intervene and how the game plays out in that moral hazard, I got to be honest with you, is beyond my IQ.

1:01:46Man, I think it's beyond everybody's IQ. That's a big one. You just had great commentary on Bitcoin that I've really appreciated. Can you briefly talk about why Bitcoin is not the solution to all of our monetary and fiscal policy problems? The easiest way to think about this is, and it should be very clear from what I just said, that at the core of any value system has to be belief in the value of human beings and human innovation. The interesting thing about the gold standard, which is really very similar to what Bitcoiners would propose as a new monetary system that places meaningful constraints on the power of government.

1:02:20You can't magically create gold unless you happen to have control of a supernova. You can create gold in a supernova. That's awesome. But then it ceases to work. It's a bit like the quantum calculations breaking Bitcoin. I'm not going to spend that much time worrying about harnessing supernovas yet. But what it does actually have is the advantage that everybody in Bitcoin talks about is the opposite of an advantage. If the price of gold goes up a lot, suggesting effectively that there is a shortage of the underlying security, the underlying asset, human innovation can be directed to the production of additional gold to solve that problem, to effectively bring the price of money down so that it's competitive with other assets or other things that you might want to spend your money on.

1:03:06It's actually exactly what happened at the tail end of the 19th century as William Jennings Bryan and the cross of gold speech, which Canadians will be less familiar with, and candidly, Americans who no longer really learn anything in high school are less familiar with. But the simple reality is that that cross of gold was solved through technology. We changed the methodologies that we used for extracting gold from gold reserves using the cyanide process that dramatically increased the quantity of gold, lowered the price of gold, and was able to actually restore some level of normalcy. Bitcoin doesn't have that capacity.

1:03:40You can work as hard as you want. It's under a fixed release schedule. And as a result, there is no reward to human innovation. And that actually is a really messed up system. That's the easiest way to think about it. And so if you actually mechanically run through the gameplay of Bitcoin, it actually consolidates down to an autocratic system in which one entity has all the wealth. That's not a good system. Preston Pyshaw Man, that's such an interesting way to explain it and think about it. Preston Pyshaw How have the Bitcoin ETFs changed the nature of Bitcoin? David Gardner Well, I think the actual irony is that the Bitcoin ETFs expose the true fragility and lack of value in Bitcoin.

1:04:18And I know that sounds like I'm effectively searching for the right answer. But remember that gold ETFs own roughly 1 % of the global share of gold. Bitcoin ETFs already own about 6 % of all the recoverable reserves of Bitcoin. And you only managed to get the price to go up about 60%. Stop and think about that for a second. That means that all the other Bitcoiners had to dump their assets onto the unsuspecting boomers who bought into those Bitcoin ETFs in order to keep the price, which should be nearly perfectly inelastic, from rising to extraordinary levels. The great irony is you've got all sorts of Bitcoin proponents who have absolutely no hesitation to run out.

1:05:00So I think the Bitcoin price should be a million dollars by the end of the year. And people criticize Bitcoin and their response is, well, it's the best performing asset of the last decade. This is just silliness, honestly. If anything, the Bitcoin ETFs, as remarkable as they have been from a flow standpoint, are a testament to how unvaluable this asset actually is. Final question, Mike. How do you define success in your life? Oh, you got to define success in totally non-financial terms. I've been incredibly lucky. I've got a wonderful wife. I've got three amazing kids, and they really are amazing.

1:05:34I'd like to brag about them, but they are absolutely incredible. I've been gifted relatively good health and the rest of it, I'm just not going to worry about. Awesome. All right, Mike, this has been a great conversation. We really appreciate you coming on the podcast. Ben, thank you very much, Cameron. It was a pleasure. I appreciate you guys having me on. Yeah. Great to meet you. Thanks, Mike.