April 16, 2025 • 50 mins
Ever wonder why markets seem to overreact to news we all saw coming? Cullen Roche challenges conventional wisdom about market efficiency with a refreshing perspective: "The price is always wrong." This fundamental insight transforms how we should approach investing during uncertain times.
When tariffs send markets plunging, investors face the classic struggle between what they intellectually know they should do versus what feels right in the moment. Roche expertly dissects why traditional risk profiling fails most investors—everyone knows the "correct" answers on questionnaires, but real-world market volatility triggers emotional responses that make seemingly irrational decisions feel completely logical. As uncertainty surges during market corrections, even legendary investors can get caught in this psychological trap.
The conversation introduces a powerful framework called "defined duration investing," which quantifies investment time horizons to match appropriate assets with specific financial needs. The stock market, fundamentally a 17-year instrument, cannot be forced to behave like a money market fund without consequences. This misalignment explains why many investors struggle behaviorally with market volatility—they're trying to "turn water into wine" by expecting short-term stability from inherently long-term assets.
Particularly enlightening is Roche's analysis of treasuries as "deflation insurance" and his critique of popular income strategies. The discussion on dividend stocks versus total return challenges mental accounting habits that separate yield from capital appreciation, while his examination of monetary policy reveals how interventionist approaches can create unintended consequences.
Whether you're navigating current market turbulence or building a portfolio for the long term, this conversation provides critical insights into aligning your investment approach with both market realities and your own psychology. Check out Roche's work at disciplinefunds.com or explore his ETF (DSCF) designed to weather behavioral challenges in volatile markets.
The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
Is there something to the argument that maybe the
stock market is less efficient,more behavioral, more emotional
than ever before?
And just if anything, becauseof the way Al goes, are also
just sloshing money around?
Yeah, I mean.
Speaker 2 (00:12):
I've never, I've never loved the idea of market
efficiency.
I mean, I think that the theway that pricing works in the
market is it's sort of it's adiscovery process all the time.
I mean, I actually prefer tosay that the price is always
wrong.
The price of the stock market,literally every single minute of
(00:32):
the day, is always wrong.
There's always two competingsides in any trade and you know,
you look at any basicinstrument I mean every
instrument in the world has abid, ask, spread, and so you've
got two, a buyer and a seller,that basically fundamentally
disagree about a price, and onehas to settle with the other
eventually.
Speaker 1 (01:01):
Quite the day to be doing two podcasts live
streaming.
Just did one with the alwaysgreat Meb Faber, and now I've
got and also always a great MrColin Orochu, who I've been a
fan of for many, many years withhis content, one of the guys
that I have a lot of respect forin terms of his views on
markets, his take on behavioralanalysis when it comes to
markets, all this stuff.
So this will, of course, be anedited podcast under Lead Lag,
(01:23):
live on all of your favoriteplatforms Apple, youtube,
spotify, top 5% most downloadedpodcasts out there, which I
don't know is not thatimpressive, I guess, given how
many podcasts there are, buthopefully Colin can help me get
more attention there.
So, with all that said, my nameis Michael Guy, a publisher of
the Lead Lag Report.
Joining me here is Mr ColinRoche.
Colin, a lot of people haveseen your work over the years
(01:46):
with your content and interviews, but for those who don't know
your background, introduceyourself.
Who are you?
What have you done throughoutyour career?
What are you doing currently?
Speaker 2 (01:53):
Yeah gosh.
I started my career at MerrillLynch decades ago and spun off
on my own.
I run an independent advisoryfirm called Discipline Funds and
we do have a publicly availableETF the ticker is DSCF and we
focus a lot on a financialplanning based and sort of
(02:16):
behavioral approach to buildingportfolios where, like the
methodology I use, where the ETFis built into, this is I call
it, defined duration investing,and so we take what's similar to
sort of the way that banks andbig pensions manage their
portfolios from an assetliability matching perspective.
We start with a financial planand we quantify someone's
(02:38):
liabilities and expenses overcertain time horizons and then
we're matching the appropriateassets and we've actually
quantified the duration of allthese different assets and
strategies.
For instance, the stock marketis a 17-year instrument.
Inside of this methodology,something like a T-bill is
essentially a zero-durationinstrument.
So I do a lot of planning, alot of personal advisory work,
(03:00):
but my bread and butter reallyis doing where the rubber meets
the road and building theportfolios for people that are
not only behaviorally consistentbut helping them understand how
their portfolio matches theirfinancial lives and their
financial plans.
Speaker 1 (03:17):
Behavior has a funny way of becoming a bigger, bigger
thing when there's volatility,so let's get right into it,
since obviously everyone'sfocused on that in the near term
.
How does behavior change whenprices gyrate like this?
Speaker 2 (03:29):
What happens in environments like this.
You know it's funny because I,as a financial advisor, I used
to go through the sort of cookiecutter standard approach of
risk profiling and for the mostpart that process, I've sort of
come to the conclusion that alot of this is just BS.
The way that a lot of us gothrough this, and a lot of us
are taught to do this is we tryto think through scenarios where
(03:53):
, for instance, let's say,you're walking this through with
a new client or something andyou're thinking of how to
measure their risk profile.
You might ask them a series ofquestions and the bogus part
about all of this is thateverybody knows how to answer
these questions.
So every time I would send outone of these risk profile
questionnaires literallyprobably 90% of the time the
(04:14):
responses are the same, becausethey're typically like how do
you respond to a 30% downturn instocks?
Or do you buy more, do you hold, do you sell, do you overreact?
And of course, everybody knowsthe right answer to this.
And the problem is that whathappens in an environment like
what we're going through todayis that uncertainty surges.
(04:36):
And uncertainty surges becausewhat's going on and the
causality for why stocks aretypically going down.
It seems perfectly rational inthe moment.
And so, for instance, duringCOVID was a great example of a
time where even great investorslike Warren Buffett and Bill
Gates looked at the environmentand they said this has never
(04:57):
happened before.
What is happening to the stockmarket fundamentally makes sense
.
The stock market being down youknow what?
Was it?
Down in March of 2020, downlike 30% or something.
It seems so rational in themoment because the uncertainty
of it all is rational Because,for instance, nobody had seen
nobody living, had seen a globalpandemic occurring.
We'd never seen the governmentcome in and start shutting
(05:20):
everything down.
And so, when you're in themoment, it all makes sense.
And what happens to youpsychologically inside of that
moment is you say it isdifferent this time.
And you look at the stockmarket being down 30 percent and
you say, well, during theSpanish flu, the last time this
happened, stocks went down, say50 percent.
So we have, we have only justbegun this downturn.
(05:45):
And that's the story that youalways tell yourself.
Because in the moment, italways seems to make sense
because the uncertainty is there, the uncertainty, you know.
Morgan Housel famously saidthat risk is what we don't know
and we don't know what causesall of these things when we're
in the moment.
And so it always seems rationaland that's the thing that makes
(06:07):
this profiling process sort ofbogus is that when you're in
that moment where the stockmarket is actually down, you
know the right answer is Ishould be buying more, I should
be indifferent to my instinctualurges.
But in reality you look at itand you say no, this makes total
fundamental sense, and I'mworried that this is only just
(06:30):
begun.
And so you know we're in a sortof similar environment here
where we're potentially upendingthe entire post-war global
trade system.
So you could look at what thestock market is doing today and
you can make up a perfectlyrational argument for why this
is occurring and how this couldgo on for a very long time and
(06:53):
how, potentially stocks beingdown what are they down now?
15%, 16% from the highs.
You could make really rationalarguments that that is nowhere
close to being done.
And so that's the psychology ofwhat happens in big market
downturns, and it's what makesstock investing so difficult
inside of these sorts ofenvironments, because it's
always different this time andit always seems rational the way
(07:17):
the market is behaving.
And so for me personally.
I mean, I think that that sortof profiling process is sort of
bogus and that you can't thinkof things in those sort of, I
(07:39):
think, subjective terms andquantifiably react in a much
more systematic way, whereyou're letting something, a
methodology and a process drivethe way you respond to price,
rather than letting youremotions just respond to price.
Speaker 1 (07:53):
Do you think we're in an era where recency bias is
perhaps the most powerful biasof all, because everyone's got
just an incredibly shortattention span and the behavior
of today is literally based offof the behavior of yesterday?
You know, and that's it.
Speaker 2 (08:09):
Yo for sure.
I mean.
I think that that's the otherthing that makes the stock
market really especially, Ishould say.
You know, all financial marketsare difficult to understand and
digest across different timehorizons, but the immediacy of
the availability of news andeverything that has sort of
(08:30):
compounded the way that ourattention spans have been
reduced over time, it allexacerbates these emotional,
these behavioral biases that weall have and I think we have an
extraordinarily difficult timeprocessing the appropriate time
horizons over which to thinkabout all of these things.
So, for instance, I mentionedthis methodology that I use,
(08:53):
called the defined durationprocess, where I quantify the
stock market.
The global stock market is a isa roughly a 17, 18 year
instrument inside of thismethodology right now, and the
purpose of that, the purpose ofquantifying that, is to
communicate to people that thestock market is this inherently
long term instrument.
If you're taking the stockmarket and you're trying to turn
(09:16):
it into a 17 hour or 17 day or17 month instrument, you are
fundamentally misunderstandinghow this instrument works and
you're misusing the way that itshould be designed to be
utilized inside of a portfolio,because stocks companies, by
definition, are very long-termentities.
(09:37):
It takes a long time to build acompany that ever gets into the
S&P 500.
It takes decades to build afirm big enough to even qualify
for something like that.
And so you're talking aboutfirms that, even though we talk
about initial public offerings Imean even when firms go through
their IPO process most of thosefirms have been around for
years and decades, potentially,before they ever even get to the
(10:00):
point where they can become apublic entity.
And then the average lifetimeon a public stock exchange is
decades and decades.
And so the stock market and theentities that it's comprised of
are these very inherentlylong-term instruments.
And that's what makes investingin these entities also very
difficult is that we've all gotthis recency bias, these very
(10:23):
short perspectives, these veryshort time horizons.
We want the stock market tojust go up every day in a nice
straight line, kind of like theway that a money market fund
works.
You look at a money market fund.
It just goes like this and itgenerates a low but stable
return.
But the reason it generatesthat low and stable return is
because it's an inherently lessrisky instrument.
(10:44):
It's an inherently shortduration instrument.
It's an inherently shortduration instrument is really
what it is.
That's what gives it itspredictability.
And the stock market is sort ofthe opposite.
The stock market is this verylong duration instrument that it
has a higher return, in largepart because there's a risk
premium embedded in the temporalnature of the way that it
(11:05):
accrues its returns over thesevery long time horizons.
And so when people think of thestock market as this very
short-term instrument, they're,in a way, they're trying to turn
water into wine.
They're trying to take thislong-term instrument and they're
trying to think of it and turnit into a very short-term
instrument.
And that's why things like daytrading and very short-term
(11:25):
trading are oftentimesdetrimental, because you
fundamentally cannot turn thewater into wine, you cannot make
this long-term instrumentoperate like a money market fund
.
And so you know, and the trickypart is for all of us how do
you blend all of these things ina way where you can optimize
(11:46):
your portfolio for the highestamount of risk, the highest
amount of returns, butoptimizing it over time horizons
where you're generating astable enough return that
behaviorally, you can stick withit.
And that's the process thatmakes all of this interesting.
It's the thing that makesinvesting fun and challenging
(12:06):
and an ever-changing sort ofenvironment.
Speaker 1 (12:09):
To begin with, I think a cynical person would say
okay, all that's fine and valid, but markets are a discounting
mechanism and yet they react offof tariff news, like we're
seeing, which should alreadyhave been discounted because we
all knew it was coming.
Maybe not to the extent andmagnitude that has been
announced here, but is theresomething to the argument that
(12:30):
maybe the stock market is lessefficient, more behavioral, more
emotional than ever before and,just if anything, because of
the way Al goes, are also justsloshing money around?
Speaker 2 (12:40):
Yeah, I mean I've never loved the idea of market
efficiency.
I mean I think that the waythat pricing works in the market
is it's a discovery process allthe time.
I mean, I actually prefer tosay that the price is always
wrong.
The price of the stock market,literally every single minute of
(13:02):
the day, is always wrong.
There's always two competingsides in any trade and you know,
you look at any basicinstrument I mean every
instrument in the world has abid, ask, spread, and so you've
got to a buyer and a seller thatbasically fundamentally
disagree about a price, and onehas to settle with the other
eventually, and so, but what?
(13:22):
What's happening there is thatsomebody is committing to saying
this price is a little bitwrong, but I'm comfortable with,
you know, extinguishing thisasset or buying this asset at
this price, and so I think it'stotally rational to say that the
price is always wrong in themarket and there's this weird
sort of discovery process.
(13:43):
I think that you think thatwhat's going on right now is
really interesting, because thestock market, when it goes
through, for instance, we talkabout corrections versus bear
markets, and I think that whathappens in a correction so a
correction is typically thoughtof as like a 10% decline,
whereas a bear market is a 20%decline and typically correlates
(14:04):
to something much morefundamental a recession or some
real fundamental market eventthat has discounted prices lower
, basically.
The difference between thesetwo environments, though, is
that the correction environmentis the stock market feeling out
what's going on, so you mightget some worrisome news and
(14:26):
something happens that kind ofstarts to make the stock market
look like maybe it should bediscounted lower, and what
typically happens in anenvironment like this is that,
oftentimes, the stock marketwill fall 10%.
It's kind of feeling out theright price level, and then it
realizes over time, investorsrealize that eight times out of
(14:48):
10, this is an overreaction.
We actually got it wrong.
We were discounting this thingthat never actually materialized
.
So you know, for instance, todayI mean, if, right now, I would
say the stock market isdiscounting this sort of
perpetual and upendingenvironment of the global trade
system, and that's what themarket is now feeling out it's
(15:11):
trying to decide okay, are wereally going to go through with
this sort of a process, becausethat has the potential to be a
very long drawn out process, oryou could wake up on Monday and
Donald Trump could say it wasall a joke, I take it all back,
and stocks would rally 10% onMonday and the market would
(15:32):
slowly start to reprice in thereality that now, okay, global
trade war is not on the table,and so that's the process that
we're going through right now.
So you can very much argue that,yeah, the future forecasts that
are contingent on the pricingmechanism that's going on today,
they're all going to end upbeing wrong to some degree and
(15:52):
at some point the market findsits sort of equilibrium and
things adjust and we'll startrising in price for whatever
fundamental reason there is.
But I think in the moment,especially in moments like this,
where you get extremevolatility, the market is always
sort of wrong because we don'tknow what the future holds.
Speaker 1 (16:14):
Yeah and I made this point on the Meb Faber show I
hosted that the anxiety comesnot necessarily, I think, from
stocks going down.
It's from the whipsaw risk ofexactly your point.
Trump could come out on Mondayand say, yeah, we're fine, it's
a joke.
I don't think that's the case,because it seems like he has to
kind of dig in even further, ifanything, before he loses
credibility.
But that's the issue, right.
(16:34):
It's more than just the anxietyaround the losses.
Speaker 2 (16:38):
It's the anxiety around the losses taking the
loss loss and then we've seenthe comeback.
Yeah, I mean, it's God speakingof Trump, I mean it's.
I was going to ask, you know,my Twitter followers this
morning, what are the chances hewalks this back?
And you know, I don't, I don'tthink he can at this point, I
(16:58):
don't know.
And this is all the thing thatmakes it so sort of worrisome is
that you've got this systemthat was built for, you know,
basically the entire post-warera, and in a lot of ways, we're
sort of upending that,incinerating a lot of agreements
and incinerating a lot ofrelationships that we've had in
(17:18):
the international community.
And what is?
How does that play out goingforward?
I mean, nobody knows.
So this is one of the biggerbehavioral cluster Fs that we've
seen in a long time.
Speaker 1 (17:31):
You, can curse man.
Come on, that curse is not soft.
The algo loves it.
So look, okay, I named thiskind of myth busting around
tariffs because I know youwanted to kind of touch on this.
For the longest time peoplehave been saying tariffs are
inflationary.
Now people are starting to say,well, maybe it's actually
deflationary because of thereverse wealth effect on
equities, and look at what'shappened to oil and slow down
(17:52):
concerns and all this stuff.
How should one think abouttariffs?
I mean, is the classic economicview the right one, or
something odd about this cycle?
The inflation.
Speaker 2 (18:00):
One's great because I mean I wrote about this back in
December that the, thepotential for this to be more
deflationary than anything else,was the, the stronger probable
outcome.
And I think that the causehere's the thing, the, and I
think from a.
So, looking at the macrolandscape of the last, say, 18
months, the economy was alreadysoftening.
(18:22):
We already had softening laborreports, at least a slowdown in
the labor market.
We had, you know, everythingwas kind of mean reverting back
to where it was sort ofpre-COVID, and so this period of
really unusually high growthand you know, huge job market
numbers that we had for a fewyears there.
This was all going to meanrevert and so and the other big
(18:43):
kicker here was that the Fed wasalready tight.
The Fed is still tight, and sothere's a.
There's a lot of pieces inplace where you already had a
macroeconomic landscape forsoftening and I think that you
know going forward, then the,the rationale for everything
sort of being more sort ofdisinflationary, meaning a
(19:05):
declining rate of inflation,made a lot of sense.
The tariffs just were sort ofthe icing on the cake that
created so much uncertainty thatnow you're getting this
deflation.
The potential for deflation ishigher today is because the
assumption of the inflationbeing passed on from tariffs is
that consumers are going to justtake all the price increases,
(19:27):
and I just never thought thiswas going to happen.
And I think the stock market isbehaving in such a way because
what the stock market isbasically saying I mean when you
have a going back to sort of afundamental economic principle,
when you have a tax hike, forinstance, corporate taxes I hate
corporate taxes becausecorporations don't pay corporate
taxes.
The corporation passes thosetaxes on to somebody.
(19:49):
They either pass them on toconsumers, they pass the price
increase on to shareholders, orthey pass it on to labor in some
way.
Those are the three ways thatcorporate taxes really get paid
for Tariff is essentially thesame thing.
It's a corporate tax hike thatgets passed on.
And what's happening with thestock market right now is that
the stock market is telling ushey, if these huge tariffs go
(20:12):
into place, the stock market isgoing to eat this.
Shareholders are going to eatthe price increases, in large
part because their margins aregoing to fall.
Corporate profits are going tofall, so share prices have to
fall in response to that, whichbasically means that the
corporate shareholders are theones that end up eating a lot of
this.
Consumers are also going to endup eating a piece of this.
(20:33):
But I think what we're seeingnow, especially today, I mean
God you have a sort of waterfalldecline in the price of oil
which is indicative of that's,that's, demand falling.
That's indicative of adeflationary sort of environment
where you are now getting apricing mechanism that is
sending a signal that says OK,this is not just an orderly
(20:55):
decline in prices based onsupply and demand.
This is now an imbalance of.
We suddenly had this shock tothe system where demand is
actually getting shocked nowbecause of what's going to go on
with the tariffs, and so you'vegot oil prices down, you know
12, 13 percent in just the lastcouple of days, and that's
indicative of.
You know this is the sort ofstuff that you know not to
(21:18):
necessarily compare this to like2008, but that's the sort of
stuff that happens in a 2008.
Imbalance on one side.
That is indicative of somethingworse going on than just a
garden variety market correctionor even potentially just a
(21:46):
recession.
Speaker 1 (21:47):
It's interesting that seemingly everyone thought that
treasuries were no longer goingto be a safe haven until
suddenly they became a safehaven again Last several years.
As you know, the correlationhas been upended largely because
current spreads kept on gettingtighter and tighter, despite
the fastest rate hike cycle inhistory, and the message of oil
(22:07):
is consistent with the messageof treasury strength, although
you know, obviously I haven'tseen the real yield collapse
just yet.
I personally think that'scoming.
But I want to get your take ontreasuries.
How should one think abouttreasuries?
Because I know that's a bigpart of your own etf.
Should one think abouttreasuries Because I know that's
a big part of your own ETF?
Should one think abouttreasuries from the standpoint
of a tactical position, astrategic position, something
(22:28):
that you just don't worry about?
What are your thoughts there?
Speaker 2 (22:31):
Yeah, well, I created this approach the defined
duration methodology in partbecause I manage a lot of bonds
for people.
I manage a lot of bond laddersfor clients.
The vast majority of people Iwork with are retirees.
They're people who are livingoff of their portfolios and so
they need very specificallytemporally structured portfolios
(22:51):
where we're building, say,t-bill ladders and then bond
ladders out, say, to zero to 10years, for instance, and what
you're doing there is you'retrying to create a lot of
temporal certainty around theway that an investor is going to
generate a specific returnacross very specific time
horizons, and that's really hardto do with the stock market,
because the stock market doesn'tgenerate these stable sorts of
(23:13):
income streams over veryspecific time horizons.
And so to me, when you look atthe bond market, you know I'm
using bonds in a sort of allencompassing term, meaning the
entire fixed income market.
Basically, I think that itreally depends on your time
horizon.
And so you know T-bills, forinstance, are something that
(23:35):
anybody who has a money marketfund the Vanguard money market
fund is filled with just T-billsfor the most part, or something
similar to T-bills, and soT-bills are just a very
short-term instrument.
There's something that you canclip a coupon from, you're
earning 4% or so these days, youhave absolute certainty of the
time horizon, the stability, thecredibility of the instrument
(23:56):
and the income you're going togenerate, most importantly, over
that time horizon.
So you have absolute certaintyof your cash flows and your risk
relative to your expenses overtime.
And the thing that makes fixedincome investing and all
investing difficult is that, bydefinition, we all end up having
to take some level of higherrisk because typically T-bills I
mean T-bills for the last 10years paid virtually zero, so
(24:20):
you couldn't even rely on aninstrument like that over any
time horizon almost to generatereliable income.
And so, in terms of I think, theway that I think about bonds
and more longer durationinstruments, I mean I calculate
something called the escapevelocity of bonds inside of my
bond portfolios, where I look atwhat is sort of the break-even
(24:42):
point between the yield curveand the current interest rates
relative to a bond's interestrate risk.
And so, for instance, right now, if you look at this, the
escape velocity of a T-bill isactually really high because
it's earning 4% or so and itsduration is zero.
(25:02):
So you're earning, in essence,a very reliable return relative
to its duration risk, whereasthe longer out you go, when you
look at a 30-year treasury,you're getting what 3.5% or so,
but the duration of thatinstrument, its interest rate
risk, is like 17 or so, meaningthat if interest rates were to
(25:22):
fall 1%, the price of thatinstrument would rise by 17% and
vice versa.
That's the thing we've seen inthe last few years that you're
basically owning an instrumentthat for the last few years has
been paying you 3.5% or so, butit's been falling 17% for
consecutive years.
(25:43):
So it has this huge amount ofduration risk, meaning that its
escape velocity is I mean, it'snegative, like 12% inside of
that calculation, 12 to 13%.
So when you look at this acrossthe entire yield curve right
now, the sort of sweet spot hereis like the five, six, seven
(26:03):
year treasury note where you'reearning a relative to your
interest rate risk.
You are offsetting it almostentirely by the amount of
interest that you're earning onan annual basis.
So if interest rates were torise or fall by one percent,
especially if they were to fallby 1%, you're basically
offsetting that.
So you've reached what I'mcalling escape velocity inside
(26:25):
of that instrument, and sothat's sort of what I would say
is the perfect sort of point onthe yield curve today where
you're getting a nearly perfectrisk reward relative to the
amount of temporal duration riskyou're taking inside of the
instrument.
But the way I think of, forinstance, like a 30-year
treasury bond is, I basicallythink of instruments like that
(26:47):
as they're almost like a form ofinsurance.
Their deflation insurancereally is the way to think of it
.
If you were to think of this interms of like the sort of the
traditional Harry Brownpermanent portfolio, for
instance, if people are familiarwith that, you buy sort of four
quadrants to match differentenvironments and the deflation
component quadrant is you buytreasury bonds and knowing that
(27:12):
in the long run deflation isunusual and not a very probable
outcome.
But when you get these veryunusual environments,
environments potentially liketoday, treasury bonds perform
very well because they're thissuper long duration instrument
that it literally operates likedeflation insurance, and so
(27:33):
that's what all insurance is inessence.
Insurance is always somethingthat it typically has a long
duration, something that ittypically has a long duration
but it has a very acuteasymmetric return inside of a
very specific type ofenvironment.
So, for instance, if you buylife insurance, you buy 20-year
term life insurance.
Obviously you don't expect todie and that thing has a
(27:53):
negative real return on average.
But if you do die, that thinghas a huge asymmetric positive
real return.
And treasury bonds operate thesame exact way inside of a
deflationary environment.
And you can, you can apply thisto really lots of different
instruments.
I mean a long duration, youknow, put on a stock is
(28:16):
essentially insurance that isvery unlikely to actually come
to fruition, essentiallyinsurance that is very unlikely
to actually come to fruition,but in an anomalous sort of
event, if it does come tofruition it pays you this huge
upside asymmetric return thathas a very insurance-like
payment to you.
And so for me, the longer outyou go on the treasury curve,
(28:38):
the more sort of insurance likeand the more specifically
deflationary type insuranceyou're getting.
So in an environment like this,you know, are we going to get
real a true deflationary outcome?
I don't know if the, if thesetariffs stay in place, the
probability of that is certainlyon the rise and we're seeing
(29:00):
that getting priced into longduration treasury bonds right
now.
Speaker 1 (29:05):
Yeah, I think people forget there are.
The pendulum always swings frominflation to disinflation to
deflation, deflation todisinflation, to reflation to
inflation.
So it's certainly could be thecase.
You mentioned you've got a lotof income investors and you do a
lot of bond letters.
I'm curious your thoughts onthis proliferation of covered
call strategies to generateincome.
I mean, it seems likeeverywhere I look there's an ETF
(29:26):
that does some kind of coveredcall to generate some insanely
high yield.
Any take on that?
Uh yeah, I hate them let's go?
Speaker 2 (29:35):
um, yeah, I, I should .
I should be more more, a littlemore balanced about.
I mean, look, I don't.
Um, I've got nothing againstinsurance.
I mean I it's funny because myfirst job out of college was
selling whole life insurance andand I I fucking hated that it
was.
I thought it was awful.
I you know I actually sat downwith my boss at one day and I
(29:57):
was like you know cause I wentthrough being sort of analytical
thinking.
I actually went through theproduct and I was like I was
comparing it to our sales pitchand I was like I would go
through the quantification and Iwas like this thing doesn't do
what we claim it actually does,like we're, we're selling what
is really like a.
It's based on a lie, almost.
And I went into my boss'soffice one day and I told him
(30:18):
this and he was like you're nota whole life insurance analyst,
you are a whole life insurancesalesperson.
You sell the narrative that wetell you to do.
So go, you know, continuedialing your phone for the next
10 hours and sell some wholelife insurance.
And so I didn't last very longat that job.
But I think that the so there'snothing wrong with insurance
(30:40):
fundamentally, and I think thatwhen you look at something like
these covered call strategies, Ithink you have to assess is
this really a smart form ofinsurance on a portfolio, or are
we just incurring somethingthat is just sort of an
unnecessarily high fee productthat is capturing more of our
(31:01):
returns than we should be to theessentially the insurance
salesman?
And so you know, the basicexample is like I have a 20 year
life term life insurance policyfor myself.
I think it's perfectly rational, I pay a low premium for it.
I think it's perfectly rational, I pay a low premium for it.
I would never buy whole lifeinsurance because I would say
(31:21):
that the whole life insurance issort of the it's the covered
call equivalent of this, whereI'm giving away a lot of the
premium, a lot of the potentialreturn that I could be
generating elsewhere, in returnfor a level of certainty that I
probably don't even need tobegin with to cover my whole
life.
Like I don't need insurance formy whole life because I know
that my dependents, my daughtersand my wife they really only
(31:45):
care about the, probably the 20years over which I'll be working
in the future, those are the.
That's the period over whichthere's the most amount of
financial uncertainty, so itmakes a lot of sense to cover
that period, whereas when youlook at something like these
covered call strategies, theyoftentimes end up being very
expensive or they throttle thepotential returns.
(32:05):
You know, where they'reprotecting the downside so much
that the underlying contractsend up costing the investor in a
lot of ways, where they'regiving up so much of the
potential upside in these thingsbecause they're getting a very,
very high degree of certainty,a degree of certainty that the
investor potentially doesn'tneed.
(32:25):
And so, like me, personally, Iwould say that an investor can
embed a lot of insurance into aportfolio without necessarily
creating these thresholds wherewe're paying an excessive amount
for it.
So I mean, for instance, Iwould argue today, what's
probably the best form ofinsurance today?
It's probably treasury bills.
(32:45):
I mean treasury bills today,paying a real return.
You're getting four and aquarter or so still on a
one-year treasury bill.
You're getting a real return.
You're getting the optimalamount of certainty inside of a
portfolio.
Why do you need something thatis, a contract that costs you 2%
per year, that gives you agreater degree of certainty
(33:09):
potentially, but ends upthrottling your returns in a lot
of different ways.
I think that when you startassessing this on a more
quantifiable level, I think thatpeople overpay for certainty
and what they really end uppaying is they end up paying a
huge amount in fees and taxinefficiencies and potential
(33:30):
returns because of this.
So I get it.
I think there are use caseswhere these things make sense
and everyone's different, soeveryone's got different
behavioral needs and if you'resomeone that you really like
owning these things because,let's just say, you understand
them and they give you comfort,they're keeping you calm in an
(33:51):
environment like today, there'snothing wrong with that.
Me personally, I mean, I don'tlike these things because I
think they just end up costingtoo much in the long run
relative to other insuranceoptions.
So you know, I don't love.
I think a lot of it is thenarrative, especially when you
take the sort of high yieldnarrative of it all.
You can't take stocks and calloptions and things like that and
(34:18):
call it yield in a way that iscomparative to traditional plain
vanilla bonds, for instance.
It's just they're not the samethings.
They don't generate theirincome the same way, they don't
generate it in the same safesort of way, and so I think
there's a little bit of trickerygoing on in the narrative
(34:38):
behind these that you're tryingto again sort of turn water into
wine, where you're taking astock instrument and you're
trying to turn it into a highyield income generating
instrument, which itfundamentally is.
Not that thing mentalaccounting right.
Speaker 1 (34:54):
It's like people tend to separate yield from capital
appreciation, when you should bethinking about total return,
and the role of financialadvisor has always been to try
to get people away from that tothink about total return.
Now it's like to your pointabout the narrative.
It's marketing leans into theidea that yield is different
from capital appreciation andthat total return isn't really a
(35:16):
thing that anybody should thinkabout.
Speaker 2 (35:20):
Well, you mentioned that you interviewed Meb earlier
.
I mean, meb is brilliant onthis stuff because Meb has spent
a lot of the last decade tryingto differentiate the yield on
stocks from the shareholderyield and the real way that
these total returns aregenerated.
And people you know I get thisquestion all the time with my
clients that people lovedividends, they love seeing the
(35:42):
income come in, and I thinkthere's a certain degree of sort
of behavioral comfort.
But really, at a morefundamental level, I mean using,
for instance, a really simplewhen you run an ETF, for
instance, you see the way thisreally works at a more
fundamental level and you seethat when something pays a
dividend, when we pay a dividendout of our ETF, well, that's
(36:04):
just a hit to NAV, to the NAV,to the net asset value of the
fund.
So if the fund is worth $50today and we pay a $5 dividend
tomorrow, well, the NAV justfalls to $45.
You get your five bucks, butthe fund falls $5.
And so the alternative scenariois that you don't pay a
(36:28):
dividend.
Let's just say that we capturethe total return inside of the
instrument and you just maintainthat $50 NAV.
Well, is the investor anydifferent?
Well, you know, meb, and Ithink every smart investor would
argue that the differencethat's crucial here is that
oftentimes the dividendrecipient has received an unfair
(36:50):
tax treatment relative toalternatives.
So, you know, maybe they'regetting an unqualified dividend
where they end up paying, youknow, a higher tax rate than
they should.
Or let's say that you know theargument for buybacks, for
instance.
A lot of people hate buybacks,but buybacks make sense because,
in large part because they giveshareholders optionality.
I don't want the income, say Idon't need it.
If the company is paying adividend, they're imposing a
(37:21):
taxable event on me, whereas thealternative is what if you held
on to the cash?
The firm maintain the cash, orthe fund maintains the cash,
doesn't pay out thisdistribution and you use it in a
more, you know, optionalitybased way, where you say you
know what, I'll take my cashwhen I need it, but you know how
I'm going to do.
That is, I'll reduce the NAV ata personal level when I want to
(37:46):
by selling some of this, andthat gives you optionality to,
say, manage your tax rate, andthat's the.
That's sort of the genius inthe.
You know, the simple reasonthat buybacks are a thing is
because you're giving theshareholder more optionality
over whether or not they'regoing to be forced into paying
taxes.
And so you know someone thatMeb works with who's a genius on
(38:07):
all this stuff is Wes Gray.
Wes Gray is firm AlphaArchitect.
They built the box ETF B-O-X-Xspecifically to structure this,
because things like T-billsT-bills when they pay out, when
they ultimately mature, theyimpose a taxable event on their
investors.
And so what this ETF does is itallows the investor to
(38:29):
basically decide for themselveswhen am I going to?
They're using a box spread,basically not to get overly
complex with this, but in doingso they're avoiding this taxable
event.
They're allowing theshareholder to create a more tax
efficient vehicle where it'sstill a T-bill.
In essence, it's a syntheticT-bill, but it gives the
(38:51):
investor the optionality to beable to decide okay, I'm gonna
sell some of this, I'm gonnasell it at a long-term capital
gain rate, and that gives me theoptionality to be able to
decide whether or not I'm goingto incur income and a taxable
event ultimately.
And so that's.
The other big kicker inside ofall of this is that when we talk
about yield, especially from adividend perspective, especially
(39:20):
from a dividend perspective,yield is different for different
instruments and I would saythat the biggest, I think,
behavioral trap with especiallydividend paying stocks is that
dividend paying stocks are stillstocks.
They're oftentimes less riskythan, say, a tech stock or a
high beta stock or somethingthat is a momentum fund or
something like that, but theyare still stocks at the end of
the day, they're stillcorporations with the long
(39:42):
duration uncertainty that Imentioned before, and that means
that these instruments arefundamentally more risky than
things like, say, the five-yeartreasury note that I mentioned
before.
Over a five-year period, thattreasury note has a hell of a
lot more certainty of the styleof return it's going to generate
versus something like along-duration dividend-paying
(40:04):
stock.
And I think a lot of people getcaught up in this sort of trap
of thinking that a dividend or adividend-paying stock gives you
income-like certainty.
That is very similar to a bondand I try to communicate to
people that you know, don't getit twisted, don't mix these two
things.
These are not the same things.
You cannot rely on dividendpaying stocks over the same time
(40:26):
horizons as, say, a T-bill or afive year treasury note.
So they're very, they're veryfundamentally different things
and they shouldn't be treatedthe same way, even if I get
again that people love seeingthe dividends come in and I get
it.
There's a certain sort ofbehavioral comfort to seeing you
know the cash flow from thatand I can appreciate that and
(40:47):
I'll you know, if somebody lovesdividends, I'll build a
dividend paying portfolio forthem If that'll help them stay
the course.
You've got to navigate all ofthis to your behavioral and your
preferences to some degree.
But I think you do have to beclear that high yield dividend
paying stocks are not the samething as bond yields and the
(41:08):
certainty that those type ofinstruments create across
different time horizons.
Speaker 1 (41:11):
Well, and certainly they're not consumer stable
stocks, healthcare stocks,utility stocks, which are lower
beta, less economicallysensitive, which is when you'd
want dividend payers anyway.
It's a totally differentdynamic.
Over a decade ago, youpublished a book Pragmatic
Capitalism Whatever InvestorNeeds to Know About Money and
Finance.
And I mentioned that over adecade because a lot's happened
(41:32):
over the last decade when itcomes to money and finance.
Has the monetary system changed, in your view at all?
I mean, it seems to me thatCOVID really created a very ugly
precedent, more along the linesof what the BOJ does in terms
of intervention.
The fact that Powell basicallysaid we'll buy junk debt ETFs in
(41:52):
the midst of the COVID crash tome was actually a very
dangerous type of dynamic, butI'm curious your thoughts on
that.
Speaker 2 (41:58):
Yeah, you know, I wouldn't say that the monetary
system at sort of a fundamentallevel has changed.
I would say that certainly, asyou alluded to, the policy
response has changed a lot.
I mean, I've been reallycritical of quantitative easing
since it ever started.
I mean in large part becauseyou know, like a lot of people
(42:20):
might probably know of my work,in the first place, because I
predicted back in 2009 that QEwould actually it would
exacerbate the disinflationaryor deflationary sort of
environment we were in, and Ijust kind of had the good
fortune of knowing a lot ofpeople that worked in Japan and
Japan had been going throughthis for, you know, 20 years
(42:40):
before this, and so I was ableto, you know, get the ear of a
lot of accountants and financialanalysts who had gone through
this, and it was funny when theywere we were first beginning to
implement these sorts of things, the Japanese who I spoke to
were always saying you Americans, you have it all wrong.
You misunderstand what this isgoing to do.
You're even your, your highestlevel economists and Fed bankers
(43:02):
, have this all wrong.
This isn't going to stimulatethe economy.
This is it's, if anything, it'sjust going to exacerbate the
sort of disinflation, the lowinflation, low demand sort of
environment we're in.
So that was my sort of basisfor for that prediction back in
2009, in that period, and Iagree, I think that I think that
things like QE, I think thatthe Fed to a large degree has
(43:28):
become too interventionist.
I think I mean you could arguethat a lot of the reason why
Well, god, I don't even think alot of the reason I think one of
the main reasons why Trump iseven president today is because
people are tired of seeing howinterventionist the government
is with everything.
You know, people saw COVID andthey saw us.
We we threw, you know, seventrillion dollars of money
(43:48):
printing, of deficit spendingfrom the fiscal side of
everything at COVID.
And people saw the highinflation and I think that
people came out of that and saidthis is crazy, we're paying
these insane prices foreverything.
And yeah, we saved the economyfrom COVID, but we did way too
much.
(44:08):
And I think those are totallyrational, totally correct
arguments to be making thesedays, and so we're kind of
potentially going in theopposite sort of extreme here of
upending the whole global tradesystem.
But I think there's a lot ofrationale for that basis.
I mean me personally.
I would never do QE.
(44:29):
If you put me in the Fed chair,I would never implement QE.
I just don't think it'ssomething that is necessary.
I think that even the wayinterest rates are managed, I
think that to me again, I liketo do everything sort of
systematically.
I'm a big fan of justautomating interest rates.
If you hired me to be Fed chairtomorrow, I would fly back to
(44:50):
DC, where I was born, and Iwould walk into the Federal
Reserve building.
I would give them an equationfor how to manage interest rates
and I would walk into theFederal Reserve Building.
I would give them an equationfor how to manage interest rates
and I would say this is yourFed funds rate, updated every
month.
I don't want 12 people sittingaround a table talking about
this.
I want you to look at thequantified numbers and I want
the number to be this number,and this is based on fundamental
(45:12):
data.
This isn't based on how I feeltoday or what Trump is doing, or
any personal subjectiveassessment of the economy.
Is a purely data based metric.
That interest rates should beset by this sort of systematic
methodology rather than a lot ofthis guesswork that we undergo
with this process where, youknow, we're sitting around
(45:33):
watching somebody at a pressconference decide the future of
the most important price in theentire economy, and I think
that's something that I think alot of people fundamentally sort
of understand and agree with.
They see 12 people in a roomdeciding the most important
price in the world and theredoesn't seem to be a lot of
rationality behind it.
There doesn't even seem to be alot of correct predictability
(45:56):
behind what they're doing andwhy they're doing.
They're more often than notreactive and you know some of
that is by necessity.
But at the same time, I thinkit's I think it's fair to look
at a lot of this and say youknow, the processes through
which we implement a lot of thisstuff are they're too
subjective, they're tooemotional and people would
prefer something that you know.
(46:17):
Gosh, gosh.
I mean you've got people likethe MMT people who, I think,
make irrational arguments abouta lot of stuff, but they would
just say, you know, set interestrates at zero percent and leave
it there forever, which youknow.
To me that's probably not avery smart way to do it, but
it's at least.
It's a, it's a methodology that, at least I think you know,
(46:38):
takes away a lot of the you knowthe man in the tower sort of
approach to this, you know,setting of interest rates in the
way that the Fed is run.
Speaker 1 (46:47):
You got some some fans saying God damn, this dude
is on points.
Thanks for that comment, colin.
For those who want to trackmore of your thoughts, analysis
and maybe learn more about yourfunds, where would you point
them to?
Speaker 2 (47:00):
Yeah, so I write a blog at disciplinefundscom.
It's under the DisciplineAlerts tab under News, and we
operate the Discipline Fund.
It's DSCF, the Discipline FundETF, etf, the Discipline Fund
ETF.
And yeah, that fund is, it'sholding up well in an
(47:20):
environment like this becauseit's designed with this sort of
counter cyclical methodologythat we built.
It's designed to weather thebehavioral challenges of this
sort of an environment.
Speaker 1 (47:29):
Everybody.
I'm a big fan of Cullen's.
I'm sincere when I say thatI've tracked your writings for a
number of years Cullen for overa decade.
I think I may have reached outto you when I was still very
early in my writing career,before I started publishing on
MarkerWatch and for Ritholtz andall these other places.
Congrats on all of your success.
Thank you, buddy, for watching.
Try not to lose your minds,folks.
We don't have 24-7 trading yet,so enjoy at least the fact that
(47:50):
the bleeding will stop at 4Eastern.
Thank you, I appreciate it.
Enjoy the two day break beforeall hell breaks loose again next
week.
Amen, amen, thank you, buddy.
Cheers All right.
Thanks, michael.
Have a good one.
Is there something to the argument that maybe the
stock market is less efficient,more behavioral, more emotional
than ever before?
And just if anything, becauseof the way Al goes, are also
just sloshing money around?
Yeah, I mean.
Speaker 2 (00:12):
I've never, I've never loved the idea of market
efficiency.
I mean, I think that the theway that pricing works in the
market is it's sort of it's adiscovery process all the time.
I mean, I actually prefer tosay that the price is always
wrong.
The price of the stock market,literally every single minute of
(00:32):
the day, is always wrong.
There's always two competingsides in any trade and you know,
you look at any basicinstrument I mean every
instrument in the world has abid, ask, spread, and so you've
got two, a buyer and a seller,that basically fundamentally
disagree about a price, and onehas to settle with the other
eventually.
Speaker 1 (01:01):
Quite the day to be doing two podcasts live
streaming.
Just did one with the alwaysgreat Meb Faber, and now I've
got and also always a great MrColin Orochu, who I've been a
fan of for many, many years withhis content, one of the guys
that I have a lot of respect forin terms of his views on
markets, his take on behavioralanalysis when it comes to
markets, all this stuff.
So this will, of course, be anedited podcast under Lead Lag,
(01:23):
live on all of your favoriteplatforms Apple, youtube,
spotify, top 5% most downloadedpodcasts out there, which I
don't know is not thatimpressive, I guess, given how
many podcasts there are, buthopefully Colin can help me get
more attention there.
So, with all that said, my nameis Michael Guy, a publisher of
the Lead Lag Report.
Joining me here is Mr ColinRoche.
Colin, a lot of people haveseen your work over the years
(01:46):
with your content and interviews, but for those who don't know
your background, introduceyourself.
Who are you?
What have you done throughoutyour career?
What are you doing currently?
Speaker 2 (01:53):
Yeah gosh.
I started my career at MerrillLynch decades ago and spun off
on my own.
I run an independent advisoryfirm called Discipline Funds and
we do have a publicly availableETF the ticker is DSCF and we
focus a lot on a financialplanning based and sort of
(02:16):
behavioral approach to buildingportfolios where, like the
methodology I use, where the ETFis built into, this is I call
it, defined duration investing,and so we take what's similar to
sort of the way that banks andbig pensions manage their
portfolios from an assetliability matching perspective.
We start with a financial planand we quantify someone's
(02:38):
liabilities and expenses overcertain time horizons and then
we're matching the appropriateassets and we've actually
quantified the duration of allthese different assets and
strategies.
For instance, the stock marketis a 17-year instrument.
Inside of this methodology,something like a T-bill is
essentially a zero-durationinstrument.
So I do a lot of planning, alot of personal advisory work,
(03:00):
but my bread and butter reallyis doing where the rubber meets
the road and building theportfolios for people that are
not only behaviorally consistentbut helping them understand how
their portfolio matches theirfinancial lives and their
financial plans.
Speaker 1 (03:17):
Behavior has a funny way of becoming a bigger, bigger
thing when there's volatility,so let's get right into it,
since obviously everyone'sfocused on that in the near term
.
How does behavior change whenprices gyrate like this?
Speaker 2 (03:29):
What happens in environments like this.
You know it's funny because I,as a financial advisor, I used
to go through the sort of cookiecutter standard approach of
risk profiling and for the mostpart that process, I've sort of
come to the conclusion that alot of this is just BS.
The way that a lot of us gothrough this, and a lot of us
are taught to do this is we tryto think through scenarios where
(03:53):
, for instance, let's say,you're walking this through with
a new client or something andyou're thinking of how to
measure their risk profile.
You might ask them a series ofquestions and the bogus part
about all of this is thateverybody knows how to answer
these questions.
So every time I would send outone of these risk profile
questionnaires literallyprobably 90% of the time the
(04:14):
responses are the same, becausethey're typically like how do
you respond to a 30% downturn instocks?
Or do you buy more, do you hold, do you sell, do you overreact?
And of course, everybody knowsthe right answer to this.
And the problem is that whathappens in an environment like
what we're going through todayis that uncertainty surges.
(04:36):
And uncertainty surges becausewhat's going on and the
causality for why stocks aretypically going down.
It seems perfectly rational inthe moment.
And so, for instance, duringCOVID was a great example of a
time where even great investorslike Warren Buffett and Bill
Gates looked at the environmentand they said this has never
(04:57):
happened before.
What is happening to the stockmarket fundamentally makes sense
.
The stock market being down youknow what?
Was it?
Down in March of 2020, downlike 30% or something.
It seems so rational in themoment because the uncertainty
of it all is rational Because,for instance, nobody had seen
nobody living, had seen a globalpandemic occurring.
We'd never seen the governmentcome in and start shutting
(05:20):
everything down.
And so, when you're in themoment, it all makes sense.
And what happens to youpsychologically inside of that
moment is you say it isdifferent this time.
And you look at the stockmarket being down 30 percent and
you say, well, during theSpanish flu, the last time this
happened, stocks went down, say50 percent.
So we have, we have only justbegun this downturn.
(05:45):
And that's the story that youalways tell yourself.
Because in the moment, italways seems to make sense
because the uncertainty is there, the uncertainty, you know.
Morgan Housel famously saidthat risk is what we don't know
and we don't know what causesall of these things when we're
in the moment.
And so it always seems rationaland that's the thing that makes
(06:07):
this profiling process sort ofbogus is that when you're in
that moment where the stockmarket is actually down, you
know the right answer is Ishould be buying more, I should
be indifferent to my instinctualurges.
But in reality you look at itand you say no, this makes total
fundamental sense, and I'mworried that this is only just
(06:30):
begun.
And so you know we're in a sortof similar environment here
where we're potentially upendingthe entire post-war global
trade system.
So you could look at what thestock market is doing today and
you can make up a perfectlyrational argument for why this
is occurring and how this couldgo on for a very long time and
(06:53):
how, potentially stocks beingdown what are they down now?
15%, 16% from the highs.
You could make really rationalarguments that that is nowhere
close to being done.
And so that's the psychology ofwhat happens in big market
downturns, and it's what makesstock investing so difficult
inside of these sorts ofenvironments, because it's
always different this time andit always seems rational the way
(07:17):
the market is behaving.
And so for me personally.
I mean, I think that that sortof profiling process is sort of
bogus and that you can't thinkof things in those sort of, I
(07:39):
think, subjective terms andquantifiably react in a much
more systematic way, whereyou're letting something, a
methodology and a process drivethe way you respond to price,
rather than letting youremotions just respond to price.
Speaker 1 (07:53):
Do you think we're in an era where recency bias is
perhaps the most powerful biasof all, because everyone's got
just an incredibly shortattention span and the behavior
of today is literally based offof the behavior of yesterday?
You know, and that's it.
Speaker 2 (08:09):
Yo for sure.
I mean.
I think that that's the otherthing that makes the stock
market really especially, Ishould say.
You know, all financial marketsare difficult to understand and
digest across different timehorizons, but the immediacy of
the availability of news andeverything that has sort of
(08:30):
compounded the way that ourattention spans have been
reduced over time, it allexacerbates these emotional,
these behavioral biases that weall have and I think we have an
extraordinarily difficult timeprocessing the appropriate time
horizons over which to thinkabout all of these things.
So, for instance, I mentionedthis methodology that I use,
(08:53):
called the defined durationprocess, where I quantify the
stock market.
The global stock market is a isa roughly a 17, 18 year
instrument inside of thismethodology right now, and the
purpose of that, the purpose ofquantifying that, is to
communicate to people that thestock market is this inherently
long term instrument.
If you're taking the stockmarket and you're trying to turn
(09:16):
it into a 17 hour or 17 day or17 month instrument, you are
fundamentally misunderstandinghow this instrument works and
you're misusing the way that itshould be designed to be
utilized inside of a portfolio,because stocks companies, by
definition, are very long-termentities.
(09:37):
It takes a long time to build acompany that ever gets into the
S&P 500.
It takes decades to build afirm big enough to even qualify
for something like that.
And so you're talking aboutfirms that, even though we talk
about initial public offerings Imean even when firms go through
their IPO process most of thosefirms have been around for
years and decades, potentially,before they ever even get to the
(10:00):
point where they can become apublic entity.
And then the average lifetimeon a public stock exchange is
decades and decades.
And so the stock market and theentities that it's comprised of
are these very inherentlylong-term instruments.
And that's what makes investingin these entities also very
difficult is that we've all gotthis recency bias, these very
(10:23):
short perspectives, these veryshort time horizons.
We want the stock market tojust go up every day in a nice
straight line, kind of like theway that a money market fund
works.
You look at a money market fund.
It just goes like this and itgenerates a low but stable
return.
But the reason it generatesthat low and stable return is
because it's an inherently lessrisky instrument.
(10:44):
It's an inherently shortduration instrument.
It's an inherently shortduration instrument is really
what it is.
That's what gives it itspredictability.
And the stock market is sort ofthe opposite.
The stock market is this verylong duration instrument that it
has a higher return, in largepart because there's a risk
premium embedded in the temporalnature of the way that it
(11:05):
accrues its returns over thesevery long time horizons.
And so when people think of thestock market as this very
short-term instrument, they're,in a way, they're trying to turn
water into wine.
They're trying to take thislong-term instrument and they're
trying to think of it and turnit into a very short-term
instrument.
And that's why things like daytrading and very short-term
(11:25):
trading are oftentimesdetrimental, because you
fundamentally cannot turn thewater into wine, you cannot make
this long-term instrumentoperate like a money market fund
.
And so you know, and the trickypart is for all of us how do
you blend all of these things ina way where you can optimize
(11:46):
your portfolio for the highestamount of risk, the highest
amount of returns, butoptimizing it over time horizons
where you're generating astable enough return that
behaviorally, you can stick withit.
And that's the process thatmakes all of this interesting.
It's the thing that makesinvesting fun and challenging
(12:06):
and an ever-changing sort ofenvironment.
Speaker 1 (12:09):
To begin with, I think a cynical person would say
okay, all that's fine and valid, but markets are a discounting
mechanism and yet they react offof tariff news, like we're
seeing, which should alreadyhave been discounted because we
all knew it was coming.
Maybe not to the extent andmagnitude that has been
announced here, but is theresomething to the argument that
(12:30):
maybe the stock market is lessefficient, more behavioral, more
emotional than ever before and,just if anything, because of
the way Al goes, are also justsloshing money around?
Speaker 2 (12:40):
Yeah, I mean I've never loved the idea of market
efficiency.
I mean I think that the waythat pricing works in the market
is it's a discovery process allthe time.
I mean, I actually prefer tosay that the price is always
wrong.
The price of the stock market,literally every single minute of
(13:02):
the day, is always wrong.
There's always two competingsides in any trade and you know,
you look at any basicinstrument I mean every
instrument in the world has abid, ask, spread, and so you've
got to a buyer and a seller thatbasically fundamentally
disagree about a price, and onehas to settle with the other
eventually, and so, but what?
(13:22):
What's happening there is thatsomebody is committing to saying
this price is a little bitwrong, but I'm comfortable with,
you know, extinguishing thisasset or buying this asset at
this price, and so I think it'stotally rational to say that the
price is always wrong in themarket and there's this weird
sort of discovery process.
(13:43):
I think that you think thatwhat's going on right now is
really interesting, because thestock market, when it goes
through, for instance, we talkabout corrections versus bear
markets, and I think that whathappens in a correction so a
correction is typically thoughtof as like a 10% decline,
whereas a bear market is a 20%decline and typically correlates
(14:04):
to something much morefundamental a recession or some
real fundamental market eventthat has discounted prices lower
, basically.
The difference between thesetwo environments, though, is
that the correction environmentis the stock market feeling out
what's going on, so you mightget some worrisome news and
(14:26):
something happens that kind ofstarts to make the stock market
look like maybe it should bediscounted lower, and what
typically happens in anenvironment like this is that,
oftentimes, the stock marketwill fall 10%.
It's kind of feeling out theright price level, and then it
realizes over time, investorsrealize that eight times out of
(14:48):
10, this is an overreaction.
We actually got it wrong.
We were discounting this thingthat never actually materialized
.
So you know, for instance, todayI mean, if, right now, I would
say the stock market isdiscounting this sort of
perpetual and upendingenvironment of the global trade
system, and that's what themarket is now feeling out it's
(15:11):
trying to decide okay, are wereally going to go through with
this sort of a process, becausethat has the potential to be a
very long drawn out process, oryou could wake up on Monday and
Donald Trump could say it wasall a joke, I take it all back,
and stocks would rally 10% onMonday and the market would
(15:32):
slowly start to reprice in thereality that now, okay, global
trade war is not on the table,and so that's the process that
we're going through right now.
So you can very much argue that,yeah, the future forecasts that
are contingent on the pricingmechanism that's going on today,
they're all going to end upbeing wrong to some degree and
(15:52):
at some point the market findsits sort of equilibrium and
things adjust and we'll startrising in price for whatever
fundamental reason there is.
But I think in the moment,especially in moments like this,
where you get extremevolatility, the market is always
sort of wrong because we don'tknow what the future holds.
Speaker 1 (16:14):
Yeah and I made this point on the Meb Faber show I
hosted that the anxiety comesnot necessarily, I think, from
stocks going down.
It's from the whipsaw risk ofexactly your point.
Trump could come out on Mondayand say, yeah, we're fine, it's
a joke.
I don't think that's the case,because it seems like he has to
kind of dig in even further, ifanything, before he loses
credibility.
But that's the issue, right.
(16:34):
It's more than just the anxietyaround the losses.
Speaker 2 (16:38):
It's the anxiety around the losses taking the
loss loss and then we've seenthe comeback.
Yeah, I mean, it's God speakingof Trump, I mean it's.
I was going to ask, you know,my Twitter followers this
morning, what are the chances hewalks this back?
And you know, I don't, I don'tthink he can at this point, I
(16:58):
don't know.
And this is all the thing thatmakes it so sort of worrisome is
that you've got this systemthat was built for, you know,
basically the entire post-warera, and in a lot of ways, we're
sort of upending that,incinerating a lot of agreements
and incinerating a lot ofrelationships that we've had in
(17:18):
the international community.
And what is?
How does that play out goingforward?
I mean, nobody knows.
So this is one of the biggerbehavioral cluster Fs that we've
seen in a long time.
Speaker 1 (17:31):
You, can curse man.
Come on, that curse is not soft.
The algo loves it.
So look, okay, I named thiskind of myth busting around
tariffs because I know youwanted to kind of touch on this.
For the longest time peoplehave been saying tariffs are
inflationary.
Now people are starting to say,well, maybe it's actually
deflationary because of thereverse wealth effect on
equities, and look at what'shappened to oil and slow down
(17:52):
concerns and all this stuff.
How should one think abouttariffs?
I mean, is the classic economicview the right one, or
something odd about this cycle?
The inflation.
Speaker 2 (18:00):
One's great because I mean I wrote about this back in
December that the, thepotential for this to be more
deflationary than anything else,was the, the stronger probable
outcome.
And I think that the causehere's the thing, the, and I
think from a.
So, looking at the macrolandscape of the last, say, 18
months, the economy was alreadysoftening.
(18:22):
We already had softening laborreports, at least a slowdown in
the labor market.
We had, you know, everythingwas kind of mean reverting back
to where it was sort ofpre-COVID, and so this period of
really unusually high growthand you know, huge job market
numbers that we had for a fewyears there.
This was all going to meanrevert and so and the other big
(18:43):
kicker here was that the Fed wasalready tight.
The Fed is still tight, and sothere's a.
There's a lot of pieces inplace where you already had a
macroeconomic landscape forsoftening and I think that you
know going forward, then the,the rationale for everything
sort of being more sort ofdisinflationary, meaning a
(19:05):
declining rate of inflation,made a lot of sense.
The tariffs just were sort ofthe icing on the cake that
created so much uncertainty thatnow you're getting this
deflation.
The potential for deflation ishigher today is because the
assumption of the inflationbeing passed on from tariffs is
that consumers are going to justtake all the price increases,
(19:27):
and I just never thought thiswas going to happen.
And I think the stock market isbehaving in such a way because
what the stock market isbasically saying I mean when you
have a going back to sort of afundamental economic principle,
when you have a tax hike, forinstance, corporate taxes I hate
corporate taxes becausecorporations don't pay corporate
taxes.
The corporation passes thosetaxes on to somebody.
(19:49):
They either pass them on toconsumers, they pass the price
increase on to shareholders, orthey pass it on to labor in some
way.
Those are the three ways thatcorporate taxes really get paid
for Tariff is essentially thesame thing.
It's a corporate tax hike thatgets passed on.
And what's happening with thestock market right now is that
the stock market is telling ushey, if these huge tariffs go
(20:12):
into place, the stock market isgoing to eat this.
Shareholders are going to eatthe price increases, in large
part because their margins aregoing to fall.
Corporate profits are going tofall, so share prices have to
fall in response to that, whichbasically means that the
corporate shareholders are theones that end up eating a lot of
this.
Consumers are also going to endup eating a piece of this.
(20:33):
But I think what we're seeingnow, especially today, I mean
God you have a sort of waterfalldecline in the price of oil
which is indicative of that's,that's, demand falling.
That's indicative of adeflationary sort of environment
where you are now getting apricing mechanism that is
sending a signal that says OK,this is not just an orderly
(20:55):
decline in prices based onsupply and demand.
This is now an imbalance of.
We suddenly had this shock tothe system where demand is
actually getting shocked nowbecause of what's going to go on
with the tariffs, and so you'vegot oil prices down, you know
12, 13 percent in just the lastcouple of days, and that's
indicative of.
You know this is the sort ofstuff that you know not to
(21:18):
necessarily compare this to like2008, but that's the sort of
stuff that happens in a 2008.
Imbalance on one side.
That is indicative of somethingworse going on than just a
garden variety market correctionor even potentially just a
(21:46):
recession.
Speaker 1 (21:47):
It's interesting that seemingly everyone thought that
treasuries were no longer goingto be a safe haven until
suddenly they became a safehaven again Last several years.
As you know, the correlationhas been upended largely because
current spreads kept on gettingtighter and tighter, despite
the fastest rate hike cycle inhistory, and the message of oil
(22:07):
is consistent with the messageof treasury strength, although
you know, obviously I haven'tseen the real yield collapse
just yet.
I personally think that'scoming.
But I want to get your take ontreasuries.
How should one think abouttreasuries?
Because I know that's a bigpart of your own etf.
Should one think abouttreasuries Because I know that's
a big part of your own ETF?
Should one think abouttreasuries from the standpoint
of a tactical position, astrategic position, something
(22:28):
that you just don't worry about?
What are your thoughts there?
Speaker 2 (22:31):
Yeah, well, I created this approach the defined
duration methodology in partbecause I manage a lot of bonds
for people.
I manage a lot of bond laddersfor clients.
The vast majority of people Iwork with are retirees.
They're people who are livingoff of their portfolios and so
they need very specificallytemporally structured portfolios
(22:51):
where we're building, say,t-bill ladders and then bond
ladders out, say, to zero to 10years, for instance, and what
you're doing there is you'retrying to create a lot of
temporal certainty around theway that an investor is going to
generate a specific returnacross very specific time
horizons, and that's really hardto do with the stock market,
because the stock market doesn'tgenerate these stable sorts of
(23:13):
income streams over veryspecific time horizons.
And so to me, when you look atthe bond market, you know I'm
using bonds in a sort of allencompassing term, meaning the
entire fixed income market.
Basically, I think that itreally depends on your time
horizon.
And so you know T-bills, forinstance, are something that
(23:35):
anybody who has a money marketfund the Vanguard money market
fund is filled with just T-billsfor the most part, or something
similar to T-bills, and soT-bills are just a very
short-term instrument.
There's something that you canclip a coupon from, you're
earning 4% or so these days, youhave absolute certainty of the
time horizon, the stability, thecredibility of the instrument
(23:56):
and the income you're going togenerate, most importantly, over
that time horizon.
So you have absolute certaintyof your cash flows and your risk
relative to your expenses overtime.
And the thing that makes fixedincome investing and all
investing difficult is that, bydefinition, we all end up having
to take some level of higherrisk because typically T-bills I
mean T-bills for the last 10years paid virtually zero, so
(24:20):
you couldn't even rely on aninstrument like that over any
time horizon almost to generatereliable income.
And so, in terms of I think, theway that I think about bonds
and more longer durationinstruments, I mean I calculate
something called the escapevelocity of bonds inside of my
bond portfolios, where I look atwhat is sort of the break-even
(24:42):
point between the yield curveand the current interest rates
relative to a bond's interestrate risk.
And so, for instance, right now, if you look at this, the
escape velocity of a T-bill isactually really high because
it's earning 4% or so and itsduration is zero.
(25:02):
So you're earning, in essence,a very reliable return relative
to its duration risk, whereasthe longer out you go, when you
look at a 30-year treasury,you're getting what 3.5% or so,
but the duration of thatinstrument, its interest rate
risk, is like 17 or so, meaningthat if interest rates were to
(25:22):
fall 1%, the price of thatinstrument would rise by 17% and
vice versa.
That's the thing we've seen inthe last few years that you're
basically owning an instrumentthat for the last few years has
been paying you 3.5% or so, butit's been falling 17% for
consecutive years.
(25:43):
So it has this huge amount ofduration risk, meaning that its
escape velocity is I mean, it'snegative, like 12% inside of
that calculation, 12 to 13%.
So when you look at this acrossthe entire yield curve right
now, the sort of sweet spot hereis like the five, six, seven
(26:03):
year treasury note where you'reearning a relative to your
interest rate risk.
You are offsetting it almostentirely by the amount of
interest that you're earning onan annual basis.
So if interest rates were torise or fall by one percent,
especially if they were to fallby 1%, you're basically
offsetting that.
So you've reached what I'mcalling escape velocity inside
(26:25):
of that instrument, and sothat's sort of what I would say
is the perfect sort of point onthe yield curve today where
you're getting a nearly perfectrisk reward relative to the
amount of temporal duration riskyou're taking inside of the
instrument.
But the way I think of, forinstance, like a 30-year
treasury bond is, I basicallythink of instruments like that
(26:47):
as they're almost like a form ofinsurance.
Their deflation insurancereally is the way to think of it
.
If you were to think of this interms of like the sort of the
traditional Harry Brownpermanent portfolio, for
instance, if people are familiarwith that, you buy sort of four
quadrants to match differentenvironments and the deflation
component quadrant is you buytreasury bonds and knowing that
(27:12):
in the long run deflation isunusual and not a very probable
outcome.
But when you get these veryunusual environments,
environments potentially liketoday, treasury bonds perform
very well because they're thissuper long duration instrument
that it literally operates likedeflation insurance, and so
(27:33):
that's what all insurance is inessence.
Insurance is always somethingthat it typically has a long
duration, something that ittypically has a long duration
but it has a very acuteasymmetric return inside of a
very specific type ofenvironment.
So, for instance, if you buylife insurance, you buy 20-year
term life insurance.
Obviously you don't expect todie and that thing has a
(27:53):
negative real return on average.
But if you do die, that thinghas a huge asymmetric positive
real return.
And treasury bonds operate thesame exact way inside of a
deflationary environment.
And you can, you can apply thisto really lots of different
instruments.
I mean a long duration, youknow, put on a stock is
(28:16):
essentially insurance that isvery unlikely to actually come
to fruition, essentiallyinsurance that is very unlikely
to actually come to fruition,but in an anomalous sort of
event, if it does come tofruition it pays you this huge
upside asymmetric return thathas a very insurance-like
payment to you.
And so for me, the longer outyou go on the treasury curve,
(28:38):
the more sort of insurance likeand the more specifically
deflationary type insuranceyou're getting.
So in an environment like this,you know, are we going to get
real a true deflationary outcome?
I don't know if the, if thesetariffs stay in place, the
probability of that is certainlyon the rise and we're seeing
(29:00):
that getting priced into longduration treasury bonds right
now.
Speaker 1 (29:05):
Yeah, I think people forget there are.
The pendulum always swings frominflation to disinflation to
deflation, deflation todisinflation, to reflation to
inflation.
So it's certainly could be thecase.
You mentioned you've got a lotof income investors and you do a
lot of bond letters.
I'm curious your thoughts onthis proliferation of covered
call strategies to generateincome.
I mean, it seems likeeverywhere I look there's an ETF
(29:26):
that does some kind of coveredcall to generate some insanely
high yield.
Any take on that?
Uh yeah, I hate them let's go?
Speaker 2 (29:35):
um, yeah, I, I should .
I should be more more, a littlemore balanced about.
I mean, look, I don't.
Um, I've got nothing againstinsurance.
I mean I it's funny because myfirst job out of college was
selling whole life insurance andand I I fucking hated that it
was.
I thought it was awful.
I you know I actually sat downwith my boss at one day and I
(29:57):
was like you know cause I wentthrough being sort of analytical
thinking.
I actually went through theproduct and I was like I was
comparing it to our sales pitchand I was like I would go
through the quantification and Iwas like this thing doesn't do
what we claim it actually does,like we're, we're selling what
is really like a.
It's based on a lie, almost.
And I went into my boss'soffice one day and I told him
(30:18):
this and he was like you're nota whole life insurance analyst,
you are a whole life insurancesalesperson.
You sell the narrative that wetell you to do.
So go, you know, continuedialing your phone for the next
10 hours and sell some wholelife insurance.
And so I didn't last very longat that job.
But I think that the so there'snothing wrong with insurance
(30:40):
fundamentally, and I think thatwhen you look at something like
these covered call strategies, Ithink you have to assess is
this really a smart form ofinsurance on a portfolio, or are
we just incurring somethingthat is just sort of an
unnecessarily high fee productthat is capturing more of our
(31:01):
returns than we should be to theessentially the insurance
salesman?
And so you know, the basicexample is like I have a 20 year
life term life insurance policyfor myself.
I think it's perfectly rational, I pay a low premium for it.
I think it's perfectly rational, I pay a low premium for it.
I would never buy whole lifeinsurance because I would say
(31:21):
that the whole life insurance issort of the it's the covered
call equivalent of this, whereI'm giving away a lot of the
premium, a lot of the potentialreturn that I could be
generating elsewhere, in returnfor a level of certainty that I
probably don't even need tobegin with to cover my whole
life.
Like I don't need insurance formy whole life because I know
that my dependents, my daughtersand my wife they really only
(31:45):
care about the, probably the 20years over which I'll be working
in the future, those are the.
That's the period over whichthere's the most amount of
financial uncertainty, so itmakes a lot of sense to cover
that period, whereas when youlook at something like these
covered call strategies, theyoftentimes end up being very
expensive or they throttle thepotential returns.
(32:05):
You know, where they'reprotecting the downside so much
that the underlying contractsend up costing the investor in a
lot of ways, where they'regiving up so much of the
potential upside in these thingsbecause they're getting a very,
very high degree of certainty,a degree of certainty that the
investor potentially doesn'tneed.
(32:25):
And so, like me, personally, Iwould say that an investor can
embed a lot of insurance into aportfolio without necessarily
creating these thresholds wherewe're paying an excessive amount
for it.
So I mean, for instance, Iwould argue today, what's
probably the best form ofinsurance today?
It's probably treasury bills.
(32:45):
I mean treasury bills today,paying a real return.
You're getting four and aquarter or so still on a
one-year treasury bill.
You're getting a real return.
You're getting the optimalamount of certainty inside of a
portfolio.
Why do you need something thatis, a contract that costs you 2%
per year, that gives you agreater degree of certainty
(33:09):
potentially, but ends upthrottling your returns in a lot
of different ways.
I think that when you startassessing this on a more
quantifiable level, I think thatpeople overpay for certainty
and what they really end uppaying is they end up paying a
huge amount in fees and taxinefficiencies and potential
(33:30):
returns because of this.
So I get it.
I think there are use caseswhere these things make sense
and everyone's different, soeveryone's got different
behavioral needs and if you'resomeone that you really like
owning these things because,let's just say, you understand
them and they give you comfort,they're keeping you calm in an
(33:51):
environment like today, there'snothing wrong with that.
Me personally, I mean, I don'tlike these things because I
think they just end up costingtoo much in the long run
relative to other insuranceoptions.
So you know, I don't love.
I think a lot of it is thenarrative, especially when you
take the sort of high yieldnarrative of it all.
You can't take stocks and calloptions and things like that and
(34:18):
call it yield in a way that iscomparative to traditional plain
vanilla bonds, for instance.
It's just they're not the samethings.
They don't generate theirincome the same way, they don't
generate it in the same safesort of way, and so I think
there's a little bit of trickerygoing on in the narrative
(34:38):
behind these that you're tryingto again sort of turn water into
wine, where you're taking astock instrument and you're
trying to turn it into a highyield income generating
instrument, which itfundamentally is.
Not that thing mentalaccounting right.
Speaker 1 (34:54):
It's like people tend to separate yield from capital
appreciation, when you should bethinking about total return,
and the role of financialadvisor has always been to try
to get people away from that tothink about total return.
Now it's like to your pointabout the narrative.
It's marketing leans into theidea that yield is different
from capital appreciation andthat total return isn't really a
(35:16):
thing that anybody should thinkabout.
Speaker 2 (35:20):
Well, you mentioned that you interviewed Meb earlier
.
I mean, meb is brilliant onthis stuff because Meb has spent
a lot of the last decade tryingto differentiate the yield on
stocks from the shareholderyield and the real way that
these total returns aregenerated.
And people you know I get thisquestion all the time with my
clients that people lovedividends, they love seeing the
(35:42):
income come in, and I thinkthere's a certain degree of sort
of behavioral comfort.
But really, at a morefundamental level, I mean using,
for instance, a really simplewhen you run an ETF, for
instance, you see the way thisreally works at a more
fundamental level and you seethat when something pays a
dividend, when we pay a dividendout of our ETF, well, that's
(36:04):
just a hit to NAV, to the NAV,to the net asset value of the
fund.
So if the fund is worth $50today and we pay a $5 dividend
tomorrow, well, the NAV justfalls to $45.
You get your five bucks, butthe fund falls $5.
And so the alternative scenariois that you don't pay a
(36:28):
dividend.
Let's just say that we capturethe total return inside of the
instrument and you just maintainthat $50 NAV.
Well, is the investor anydifferent?
Well, you know, meb, and Ithink every smart investor would
argue that the differencethat's crucial here is that
oftentimes the dividendrecipient has received an unfair
(36:50):
tax treatment relative toalternatives.
So, you know, maybe they'regetting an unqualified dividend
where they end up paying, youknow, a higher tax rate than
they should.
Or let's say that you know theargument for buybacks, for
instance.
A lot of people hate buybacks,but buybacks make sense because,
in large part because they giveshareholders optionality.
I don't want the income, say Idon't need it.
If the company is paying adividend, they're imposing a
(37:21):
taxable event on me, whereas thealternative is what if you held
on to the cash?
The firm maintain the cash, orthe fund maintains the cash,
doesn't pay out thisdistribution and you use it in a
more, you know, optionalitybased way, where you say you
know what, I'll take my cashwhen I need it, but you know how
I'm going to do.
That is, I'll reduce the NAV ata personal level when I want to
(37:46):
by selling some of this, andthat gives you optionality to,
say, manage your tax rate, andthat's the.
That's sort of the genius inthe.
You know, the simple reasonthat buybacks are a thing is
because you're giving theshareholder more optionality
over whether or not they'regoing to be forced into paying
taxes.
And so you know someone thatMeb works with who's a genius on
(38:07):
all this stuff is Wes Gray.
Wes Gray is firm AlphaArchitect.
They built the box ETF B-O-X-Xspecifically to structure this,
because things like T-billsT-bills when they pay out, when
they ultimately mature, theyimpose a taxable event on their
investors.
And so what this ETF does is itallows the investor to
(38:29):
basically decide for themselveswhen am I going to?
They're using a box spread,basically not to get overly
complex with this, but in doingso they're avoiding this taxable
event.
They're allowing theshareholder to create a more tax
efficient vehicle where it'sstill a T-bill.
In essence, it's a syntheticT-bill, but it gives the
(38:51):
investor the optionality to beable to decide okay, I'm gonna
sell some of this, I'm gonnasell it at a long-term capital
gain rate, and that gives me theoptionality to be able to
decide whether or not I'm goingto incur income and a taxable
event ultimately.
And so that's.
The other big kicker inside ofall of this is that when we talk
about yield, especially from adividend perspective, especially
(39:20):
from a dividend perspective,yield is different for different
instruments and I would saythat the biggest, I think,
behavioral trap with especiallydividend paying stocks is that
dividend paying stocks are stillstocks.
They're oftentimes less riskythan, say, a tech stock or a
high beta stock or somethingthat is a momentum fund or
something like that, but theyare still stocks at the end of
the day, they're stillcorporations with the long
(39:42):
duration uncertainty that Imentioned before, and that means
that these instruments arefundamentally more risky than
things like, say, the five-yeartreasury note that I mentioned
before.
Over a five-year period, thattreasury note has a hell of a
lot more certainty of the styleof return it's going to generate
versus something like along-duration dividend-paying
(40:04):
stock.
And I think a lot of people getcaught up in this sort of trap
of thinking that a dividend or adividend-paying stock gives you
income-like certainty.
That is very similar to a bondand I try to communicate to
people that you know, don't getit twisted, don't mix these two
things.
These are not the same things.
You cannot rely on dividendpaying stocks over the same time
(40:26):
horizons as, say, a T-bill or afive year treasury note.
So they're very, they're veryfundamentally different things
and they shouldn't be treatedthe same way, even if I get
again that people love seeingthe dividends come in and I get
it.
There's a certain sort ofbehavioral comfort to seeing you
know the cash flow from thatand I can appreciate that and
(40:47):
I'll you know, if somebody lovesdividends, I'll build a
dividend paying portfolio forthem If that'll help them stay
the course.
You've got to navigate all ofthis to your behavioral and your
preferences to some degree.
But I think you do have to beclear that high yield dividend
paying stocks are not the samething as bond yields and the
(41:08):
certainty that those type ofinstruments create across
different time horizons.
Speaker 1 (41:11):
Well, and certainly they're not consumer stable
stocks, healthcare stocks,utility stocks, which are lower
beta, less economicallysensitive, which is when you'd
want dividend payers anyway.
It's a totally differentdynamic.
Over a decade ago, youpublished a book Pragmatic
Capitalism Whatever InvestorNeeds to Know About Money and
Finance.
And I mentioned that over adecade because a lot's happened
(41:32):
over the last decade when itcomes to money and finance.
Has the monetary system changed, in your view at all?
I mean, it seems to me thatCOVID really created a very ugly
precedent, more along the linesof what the BOJ does in terms
of intervention.
The fact that Powell basicallysaid we'll buy junk debt ETFs in
(41:52):
the midst of the COVID crash tome was actually a very
dangerous type of dynamic, butI'm curious your thoughts on
that.
Speaker 2 (41:58):
Yeah, you know, I wouldn't say that the monetary
system at sort of a fundamentallevel has changed.
I would say that certainly, asyou alluded to, the policy
response has changed a lot.
I mean, I've been reallycritical of quantitative easing
since it ever started.
I mean in large part becauseyou know, like a lot of people
(42:20):
might probably know of my work,in the first place, because I
predicted back in 2009 that QEwould actually it would
exacerbate the disinflationaryor deflationary sort of
environment we were in, and Ijust kind of had the good
fortune of knowing a lot ofpeople that worked in Japan and
Japan had been going throughthis for, you know, 20 years
(42:40):
before this, and so I was ableto, you know, get the ear of a
lot of accountants and financialanalysts who had gone through
this, and it was funny when theywere we were first beginning to
implement these sorts of things, the Japanese who I spoke to
were always saying you Americans, you have it all wrong.
You misunderstand what this isgoing to do.
You're even your, your highestlevel economists and Fed bankers
(43:02):
, have this all wrong.
This isn't going to stimulatethe economy.
This is it's, if anything, it'sjust going to exacerbate the
sort of disinflation, the lowinflation, low demand sort of
environment we're in.
So that was my sort of basisfor for that prediction back in
2009, in that period, and Iagree, I think that I think that
things like QE, I think thatthe Fed to a large degree has
(43:28):
become too interventionist.
I think I mean you could arguethat a lot of the reason why
Well, god, I don't even think alot of the reason I think one of
the main reasons why Trump iseven president today is because
people are tired of seeing howinterventionist the government
is with everything.
You know, people saw COVID andthey saw us.
We we threw, you know, seventrillion dollars of money
(43:48):
printing, of deficit spendingfrom the fiscal side of
everything at COVID.
And people saw the highinflation and I think that
people came out of that and saidthis is crazy, we're paying
these insane prices foreverything.
And yeah, we saved the economyfrom COVID, but we did way too
much.
(44:08):
And I think those are totallyrational, totally correct
arguments to be making thesedays, and so we're kind of
potentially going in theopposite sort of extreme here of
upending the whole global tradesystem.
But I think there's a lot ofrationale for that basis.
I mean me personally.
I would never do QE.
(44:29):
If you put me in the Fed chair,I would never implement QE.
I just don't think it'ssomething that is necessary.
I think that even the wayinterest rates are managed, I
think that to me again, I liketo do everything sort of
systematically.
I'm a big fan of justautomating interest rates.
If you hired me to be Fed chairtomorrow, I would fly back to
(44:50):
DC, where I was born, and Iwould walk into the Federal
Reserve building.
I would give them an equationfor how to manage interest rates
and I would walk into theFederal Reserve Building.
I would give them an equationfor how to manage interest rates
and I would say this is yourFed funds rate, updated every
month.
I don't want 12 people sittingaround a table talking about
this.
I want you to look at thequantified numbers and I want
the number to be this number,and this is based on fundamental
(45:12):
data.
This isn't based on how I feeltoday or what Trump is doing, or
any personal subjectiveassessment of the economy.
Is a purely data based metric.
That interest rates should beset by this sort of systematic
methodology rather than a lot ofthis guesswork that we undergo
with this process where, youknow, we're sitting around
(45:33):
watching somebody at a pressconference decide the future of
the most important price in theentire economy, and I think
that's something that I think alot of people fundamentally sort
of understand and agree with.
They see 12 people in a roomdeciding the most important
price in the world and theredoesn't seem to be a lot of
rationality behind it.
There doesn't even seem to be alot of correct predictability
(45:56):
behind what they're doing andwhy they're doing.
They're more often than notreactive and you know some of
that is by necessity.
But at the same time, I thinkit's I think it's fair to look
at a lot of this and say youknow, the processes through
which we implement a lot of thisstuff are they're too
subjective, they're tooemotional and people would
prefer something that you know.
(46:17):
Gosh, gosh.
I mean you've got people likethe MMT people who, I think,
make irrational arguments abouta lot of stuff, but they would
just say, you know, set interestrates at zero percent and leave
it there forever, which youknow.
To me that's probably not avery smart way to do it, but
it's at least.
It's a, it's a methodology that, at least I think you know,
(46:38):
takes away a lot of the you knowthe man in the tower sort of
approach to this, you know,setting of interest rates in the
way that the Fed is run.
Speaker 1 (46:47):
You got some some fans saying God damn, this dude
is on points.
Thanks for that comment, colin.
For those who want to trackmore of your thoughts, analysis
and maybe learn more about yourfunds, where would you point
them to?
Speaker 2 (47:00):
Yeah, so I write a blog at disciplinefundscom.
It's under the DisciplineAlerts tab under News, and we
operate the Discipline Fund.
It's DSCF, the Discipline FundETF, etf, the Discipline Fund
ETF.
And yeah, that fund is, it'sholding up well in an
(47:20):
environment like this becauseit's designed with this sort of
counter cyclical methodologythat we built.
It's designed to weather thebehavioral challenges of this
sort of an environment.
Speaker 1 (47:29):
Everybody.
I'm a big fan of Cullen's.
I'm sincere when I say thatI've tracked your writings for a
number of years Cullen for overa decade.
I think I may have reached outto you when I was still very
early in my writing career,before I started publishing on
MarkerWatch and for Ritholtz andall these other places.
Congrats on all of your success.
Thank you, buddy, for watching.
Try not to lose your minds,folks.
We don't have 24-7 trading yet,so enjoy at least the fact that
(47:50):
the bleeding will stop at 4Eastern.
Thank you, I appreciate it.
Enjoy the two day break beforeall hell breaks loose again next
week.
Amen, amen, thank you, buddy.
Cheers All right.
Thanks, michael.
Have a good one.
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