Are Covered Calls a Replacement for Bonds?

00:00:00.000 | Welcome back to Portfolio Rescue. Duncan, we had a week off, so our inbox is overflowing

00:00:22.000 | with questions. Remember, email is askthecompoundshow@gmail.com. Today's sponsor is Liftoff, our automated

00:00:28.480 | platform provided by Betterment. It's kind of an uncertain time these days, right? It

00:00:33.920 | seems like one week we have stagflation, the next week the economy is too strong, one week

00:00:37.520 | we have a hard landing, the next week a soft landing, the years are constantly changing.

00:00:42.340 | In that context, I don't mind just automating and setting and forgetting. That's kind of

00:00:45.680 | what I do with my account at Liftoff. My fund's going automatically, my dividends are reinvested

00:00:50.840 | automatically, tax loss harvested automatically. All this stuff happens automatically. I don't

00:00:54.520 | have to do it. Emotions are taken out of the equation. If you want to check it out, Liftoff

00:00:58.160 | invest.com.

00:00:59.160 | Duncan, last time we had a show, we looked at some charts, some long-term 10-year rolling

00:01:04.120 | returns, 20-year rolling returns, 30-year rolling returns. John, throw up this tweet.

00:01:07.900 | They've got to be rolling, you know?

00:01:10.080 | Yes. Well, yeah, that's a more honest way of looking at it. I put this up, and I did

00:01:15.520 | all the different ones, and someone responded, "This was comforting to me in my 30s, not

00:01:19.320 | so much anymore looking at the 10 and 20 charts." And I feel like this is a constant back and

00:01:23.360 | forth we're having on the show with people with questions. Should I be 100% in stocks?

00:01:27.520 | Should I hedge a little bit and have more money in cash or bonds or alternatives or

00:01:31.080 | whatever it is? And this person was saying, "Hey, when I'm 20 and 30, having all my money

00:01:35.120 | in stocks is pretty easy, because the very long term looks pretty darn good. When I'm

00:01:39.980 | in my middle age, 40s, 50s or so, maybe 60s, it doesn't look so good, because 10 years

00:01:45.300 | you can still have really bad returns." And I think this is the constant push and pull

00:01:50.520 | for investors, is thinking through this idea of when to balance and when to take a bunch

00:01:54.920 | of risk. And the good thing is that no one has the right answer. Unfortunately or fortunately,

00:02:01.640 | there is no good. Some people are fine taking on that 100% equity risk. Some people aren't

00:02:05.920 | and need to do more of a glide path. The good thing is that you just have to do what works

00:02:10.400 | for you. Also, there are plenty of people out there that will tell you they know the

00:02:13.800 | answer. Yes. And that's the thing, is it's circumstantial, and it matters. It not only

00:02:17.800 | matters your financial situation, but also your personal makeup. If you know that you

00:02:22.560 | simply can't handle taking so much risk, then you have to do what works for you. And if

00:02:26.680 | you know that you can, and you're going to be okay with it, then yes. That's the thing

00:02:30.560 | I've come to learn, is just do what works for you. All right. Let's get into the questions.

00:02:34.400 | Right. I always feel really good about risk until things go against me. First up today,

00:02:40.800 | we have a question from me, actually. I was asking the other day, and we were like, "Let's

00:02:45.800 | just do it on the show." I was asking you, "Is it okay to stop contributing to your 401(k)

00:02:50.160 | to save up for a down payment?" Yeah. This sounds like a sharp, sharp guy here asking

00:02:53.680 | this question. So you were saying, "Listen, I'm looking to buy a house. We're trying to

00:02:58.040 | figure out how much we can afford. We're trying to figure out down payment. Is it ever okay?"

00:03:02.680 | And I think you also said, "Your wife might get a match regardless, but you, if you stop

00:03:07.480 | your 401(k), you don't get the match anymore." Right? Right. I understand the hesitancy here,

00:03:11.760 | because a lot of these personal finance experts will shame you, because do you know what those

00:03:15.680 | contributions could be worth in 30 years if you don't put them on? And it is true that

00:03:19.680 | like a match is free money. But it's not like you're turning them off to do Fandu parlays

00:03:24.320 | all day. Right? Probably not. You're turning them off for a good reason. Sometimes life

00:03:28.800 | gets in the way of the spreadsheets when it comes to financial planning. You just have

00:03:31.720 | to divert your savings into other avenues. So the first house we ever bought, it was

00:03:36.240 | a split-level ranch. And the upper half of it was finished. The lower level was unfinished.

00:03:40.000 | And we kind of said, "Hey, this is great. We can grow into it a little bit. And then

00:03:42.880 | when the time is right, we can finish out the basement." And it was more expensive than

00:03:47.880 | I thought. Now, I will say this. To save some money, my father-in-law knows what he's doing

00:03:51.280 | in terms of building and such. So I'd say 50 or 60% of it we did ourselves. I'm not

00:03:56.680 | handy at all, so I did what I was told. I held this and moved this. But we framed it,

00:04:01.600 | and we did some of the stuff ourselves. So we did two bedrooms, a bathroom, put a little

00:04:06.080 | bar in, big TV area. But it cost us. And so for probably a period of like, I don't know,

00:04:12.320 | 18 to 24 months, that was our big saving focus. And I didn't completely turn off savings elsewhere,

00:04:16.800 | but that was money that could have gone into saving money elsewhere.

00:04:21.120 | So would it have been nice to have those dollars go into the market? This is probably 10 years

00:04:25.720 | later. Yeah, they'd be worth a lot more money, but my 401(k) wouldn't have added 1,900 square

00:04:30.420 | feet to our house either. Right? So I think, listen, it's not easy to save for down payment

00:04:36.920 | these days, especially in an expensive real estate market like you're in. So I think if

00:04:40.800 | you have to go for 6, 12, 18 months, and that's where your personal finance focus is, and

00:04:44.960 | you know that afterwards you can turn them back on, what's going to make you happier?

00:04:49.880 | Getting your living situation figured out? You've already learned that it's kind of tricky

00:04:53.960 | when you're renting, right? Having your own place might make things a little easier. So

00:04:57.040 | yes, I bless this decision. If you have to do it, you have to do it. Right?

00:05:01.360 | Okay. Yeah. And the other part that I was just having trouble figuring out is, so if

00:05:05.680 | you have a traditional 401(k) contribution that's before taxes or whatever, then you

00:05:12.120 | have to factor in, okay, well, how much is this actually going to end up netting me for

00:05:18.380 | a down payment, savings, all that kind of stuff. So yeah, it's a little confusing to

00:05:22.300 | figure out. I think if you're doing Roth contributions, I guess it's more straightforward.

00:05:27.360 | That's a very stressful process too. Buying your first home especially. Buying a home

00:05:31.320 | at any time is stressful, but knowing you have that sort of fallback for the down payment

00:05:35.320 | and having it be ready, that if you find a place you really love, that you can go ahead

00:05:39.720 | and do it, and you already got the letter from the bank saying, "Yes, you're signed

00:05:42.680 | off at this level." That's good peace of mind. That money sitting in your 401(k) is

00:05:48.080 | not going to give you nearly as much peace of mind as having that down payment sitting

00:05:51.080 | there ready to go. Yeah. That makes sense. Cool.

00:05:54.280 | Also, good luck with the housing search. It's a really easy, as we're going to talk about

00:05:59.320 | some questions here, it's not the easiest housing market.

00:06:01.360 | Yeah. No, it's not looking great, but the good news is we're about to sign. We're getting

00:06:06.240 | into another place finally after the flood for all those of you that follow along week

00:06:09.640 | to week. We're actually signing another 12-month lease, so it will be probably 12 months anyway.

00:06:14.320 | I bet you have some time then. All right. Let's do another one.

00:06:19.640 | Up next, we have, "I'm in my mid-40s and have been running my own RRSP, Canadian 401(k)

00:06:27.760 | for a while now. I have almost no exposure to bonds, and I ran it by an advisor and her

00:06:32.240 | reply was, 'Why would you want bonds?' I could see her panic as bonds had been paying next

00:06:37.360 | to nothing for years and didn't appear to offer much protection when stocks dropped.

00:06:41.480 | Instead of bonds, I've been buying covered call ETFs for what would be the fixed income

00:06:45.480 | portion of my portfolio. They pay a nice 6% to 10% distribution, and looking at charts,

00:06:50.440 | seem to be more secure than even a bond ETF. I'm not expecting to make a massive of capital

00:06:56.440 | gains from the value of the individual shares, but using a drip and watching the shares multiply

00:07:00.440 | over time seems like a much better play than making almost nothing on a bond ETF. Does

00:07:04.840 | this make sense, or have the rate hikes changed things?"

00:07:07.800 | Before we get into this one, someone actually in the live comments here said, "How about

00:07:11.240 | a 401(k) loan for Duncan?" We're going to get into that in a couple weeks, actually.

00:07:14.280 | Blair Ducanet is going to come talk about her situation with that. So, put a pin in

00:07:18.320 | that one.

00:07:19.320 | Also, a drip just for our young and new investors watching, that's an automated dividend reinvestment

00:07:25.360 | plan.

00:07:26.360 | Dividend reinvestment plan, right? Yep.

00:07:27.360 | Okay.

00:07:28.360 | So, we're going to start off with questions, and the section on investing has been filling

00:07:31.680 | up with covered call questions for the better part of a year. There are a ton of investors

00:07:35.400 | who swear by this strategy. Jason Zweig at the Wall Street Journal actually just had

00:07:39.480 | a piece about this a couple weeks ago, how covered call strategies are just exploding

00:07:44.440 | in popularity. And the reason why, because the strategy outperformed last year. And given

00:07:49.860 | how it works, it kind of makes sense. So, some people might not understand exactly how

00:07:52.360 | these work, so let's do a quick tutorial here.

00:07:55.240 | So, selling a call option, a call option itself gives the buyer of that option the right to

00:08:01.720 | buy at a specified price by a specified date. So, if it hits a certain price by a date,

00:08:06.480 | you have the right to buy that. To get that option, you have to pay a premium. So, let's

00:08:10.720 | look at an example.

00:08:11.720 | So, let's say you own 50 shares of a stock currently trading for $20. Call options with

00:08:15.520 | a strike price of 25 bucks, say, cost 50 cents a piece. So, the person who's selling these

00:08:20.920 | options would earn $25 in income on their $1,000 position. That's good enough for you

00:08:24.440 | at 2.5%. So, now, though, if you own this stock, your upside is limited to 25%, going

00:08:30.520 | from $20 to 25, plus that 2.5% option premium. And if the stock goes to 30 or 35 or higher,

00:08:39.640 | you're over and above 25, you're sort of off the walk, right? You're capped there.

00:08:45.240 | So, this is a type of strategy that, in a bull market, you assume it's going to underperform.

00:08:49.800 | The income on the sale of options can help in a hard-charging bull market, but you're

00:08:53.320 | likely to miss out on some gains and lag the market, because you're probably going to get

00:08:55.520 | taken out on some of those call options. However, in a bear market, this thing should outperform

00:08:59.040 | from the option income alone, right? Plus, in a bear market, volatility spikes, and that

00:09:03.160 | actually increases some of that income, maybe because it helps with the pricing of options.

00:09:07.120 | So, essentially, what you're doing with a covered call strategy is you are reducing

00:09:10.600 | both upside and downside volatility. And so, many of these covered call strategies also

00:09:16.240 | target lower volatile stocks or low volatile sectors. So, that can also help lessen the

00:09:20.520 | blow from stock losses. So, I think one of the reasons so many investors are clamoring

00:09:25.240 | for these strategies is because last year, they were much less volatile and they outperformed

00:09:28.480 | in a bear market. Still, I would not go so far as to call this strategy a bond replacement.

00:09:33.320 | I think that's a stretch. A lot of people will say the same thing for dividends. I think

00:09:36.120 | dividends are a bond replacement. I'm not willing to go that far. I also think it's

00:09:40.080 | a stretch to call option income the same as fixed income yield, because it's so much more

00:09:43.960 | volatile and the pricing can change on it. You're not locking in a yield. That yield

00:09:48.560 | can change. I don't think it's the same thing. These strategies still carry equity risk.

00:09:53.320 | That risk might be blunted a little bit, but if stocks get crushed, these strategies are

00:09:56.360 | going to go down a lot, too. They might not go down as much, but they're still going to

00:09:58.720 | get hit. So, I think this strategy can act as a form of diversification, but I don't

00:10:03.680 | think it's a bond or cash substitute by any means, especially as far as my risk tolerance

00:10:07.320 | is concerned. There's a little fixed income slander here. I want to stick up for bonds

00:10:12.040 | a little bit. I know bonds had a dreadful year last year. They got crushed. And I hate

00:10:16.640 | the term "perfect storm" when it comes to finance, but last year was basically like

00:10:21.240 | a tornado mixed with a hurricane mixed with a tsunami for bonds.

00:10:24.380 | Like a sharknado.

00:10:25.380 | There you go. My kids are always talking about, "Is there a tornado with lightning in it or

00:10:30.240 | something?" There's some weird thing like that.

00:10:32.400 | I'm sure, yeah.

00:10:33.400 | I mean, the pandemic drove bond yields to levels that we've never seen before. I think

00:10:37.560 | the 10-year got to 37 basis points intraday or something. It was ridiculous. So, that

00:10:41.720 | was unstable before we even got to 9% inflation. So, there was absolutely no margin of safety

00:10:46.620 | built into bonds. And they rose so fast last year because the Fed went on one of their

00:10:50.400 | most aggressive hiking cycles ever. And that's just never happened before.

00:10:54.120 | So, John, give me a chart of stock and bond returns historically. These are all the years

00:10:58.040 | since 1928 that the U.S. stock market has been down. It's happened 26 times by my count.

00:11:03.580 | And on the right side there is what happened in 10-year treasuries in those same down years.

00:11:07.600 | So, by my calculations, the average loss for a down year in stocks is a loss of almost

00:11:11.800 | 14%. The average gain for 10-year treasuries in those years is a gain of a little more

00:11:16.640 | than 4%. Now, 21 out of the 26 years bonds have been up. So, that average includes last

00:11:22.960 | year's almost 18% massacre in 10-year treasuries. So, the biggest loss in bonds during a down

00:11:27.900 | year in stocks before last year was 5%. And that happened in 1969. So, 21 out of 26 years

00:11:33.120 | for bonds being up and stocks are down, that's not a perfect batting average, but there's

00:11:36.500 | always exceptions to the rule.

00:11:37.840 | So, I don't think you can just throw bonds out the window because they had one bad year.

00:11:41.940 | I think last year there was a lot of stuff going on that caused that. Plus, yields could

00:11:46.760 | always move higher from here, but we're talking 4-5% in U.S. government bonds now. You can

00:11:50.640 | get 5% on a 6- or 12-month T-bill, which basically has zero duration or interest rate risk. And

00:11:56.200 | so, I understand people not wanting to be involved when rates are 1%, but that's not

00:12:00.040 | the world we live in anymore. Maybe bonds aren't for you, that's fine, depending on

00:12:03.320 | your risk tolerance. They're not for everyone. But I just think you have to remember that

00:12:07.800 | any sort of income-producing strategy that involves a little bit of equity risk, whether

00:12:11.480 | it's dividend stocks or covered call strategies or high-yield bonds, whatever it is, that

00:12:16.080 | always, always, always with higher yields comes higher risk. So, I'm not going to try

00:12:19.560 | to talk you out of a covered call strategy. I'm not going to try to talk you into it either.

00:12:22.760 | I just want people to go into it with their eyes wide open and understand how it works

00:12:25.200 | before investing in something like this.

00:12:27.440 | Also, it's probably worth reiterating, but this is something that works much better in

00:12:33.520 | a tax-advantaged account because of all those distributions.

00:12:37.280 | Good call, Duncan. Yes, the taxes and the options, even if it's an ETF, you still get

00:12:40.800 | dinged a little bit. So, yes, just know what you're getting yourself into. I'm always weary

00:12:47.240 | of bond substitutes because I don't think there really is a substitute for government

00:12:50.520 | bonds.

00:12:52.320 | Right. And they call it secure, but really what they're talking about is low beta, right?

00:12:57.200 | Yes.

00:12:58.200 | Which, like you're saying, means that it's capped on the upside some, too, right?

00:13:01.440 | The same thing works with defensive stocks or dividend-producing stocks that are in consumer

00:13:05.840 | staples or utilities. Those kind of sectors are probably going to outperform in a bear

00:13:09.080 | market. They're going to underperform in a bull market. And I think you just have to

00:13:12.960 | get used to that kind of thing where you're not getting into it after the bear market

00:13:17.920 | already happened and, you know, jumping in and out at the wrong time.

00:13:21.680 | Cool.

00:13:22.680 | All right. Let's do another one.

00:13:24.920 | All right. And that question was from Mike, I believe. So, thanks, Mike. Okay. Up next,

00:13:30.640 | we have, "You mentioned previously that you took out a HELOC during COVID. I'm wondering

00:13:35.840 | why you chose that instead of a home equity one. We moved into a new home and we're going

00:13:39.940 | to sell it, but I've chosen to rent it out instead. Without having the proceeds from

00:13:43.360 | a prior home sale, we are considering either a HELOC or a home equity loan, now that we

00:13:48.860 | have equity in two homes."

00:13:50.680 | So this is the kind of thing that became very popular during the ultra-low mortgage rate

00:13:54.160 | phase of the pandemic. If you hold a 3% mortgage and have the ability to rent out your house

00:13:58.200 | and that covers all or most of your needs, why would you give up on a 3% mortgage? I

00:14:02.480 | think that's what a lot of people are thinking. Obviously, there's another thing here with

00:14:05.960 | being a landlord, but yeah, I kind of get it. Also, side note, I think eventually some

00:14:11.240 | bank is going to step in and let you port your 3% mortgage to another loan. I think

00:14:15.400 | they're going to have to, to get housing activity back up. I think they're going to tell people,

00:14:18.920 | "Listen, if you have a 3% mortgage, we'll let you trade it once for a new house. This

00:14:24.200 | is going to happen. Someone is going to do this. Fintech people, call me."

00:14:27.320 | Listen, homeowners have plenty of equity to deal with these days, so it makes sense people

00:14:31.360 | are trying to think about what to do with it. John, the chart we've used before. This

00:14:34.440 | is homeowners' equity since the end of 2019, which is essentially the start of the pandemic.

00:14:39.480 | It's up 50%. It's up to $29 trillion or something. You'd probably take off, I don't know, $1

00:14:44.080 | or $2 trillion now, based on maybe where housing prices are now, because this is as of the

00:14:48.560 | end of last year. You'd expect it to fall a little bit, but we're talking about a $10

00:14:52.520 | trillion increase in home equity. What do you do with it? As Taylor pointed out, I went

00:14:55.600 | with a HELOC during the pandemic. Here's how it works. I have a 10-year draw period. It

00:15:01.520 | works like a line of credit. The bank gave me an amount based on my loan-to-value ratio.

00:15:05.760 | In that 10-year window, I can draw on that credit as needed. I just have to write a check.

00:15:08.920 | It's really easy. I can use it as many times as I want. If I use the money, then pay it

00:15:12.440 | off and use it again and pay it off in that 10-year window as many times as I want. During

00:15:15.760 | this time, the loan is interest-only, so I don't have to pay it on the principal if I

00:15:19.480 | don't want to. I could just pay the interest after that 10-year draw period is done. Then,

00:15:24.200 | it essentially converts to a 15-year mortgage with minimum principal and interest payments.

00:15:28.160 | It's like another mortgage, basically. It's a 25-year period.

00:15:31.440 | The upside to this approach is it has a ton of flexibility. When I took out my HELOC,

00:15:34.940 | we really didn't need it for anything. I just did it because I wanted to use it as a backstop,

00:15:38.000 | or if I needed to write a big check for some reason, I didn't want to have to shuffle a

00:15:40.560 | bunch of other things around. I could just go here and take it out immediately. Since

00:15:44.720 | we didn't have any huge projects on the horizon, we thought we might have some in the future.

00:15:48.640 | I just wanted to have it there. The downside is that the rate is floating.

00:15:51.760 | When I first took out my HELOC, the rate was sub-3% in 2020. Now, it's over 7%. I think

00:15:57.200 | it's 7.25%. The good news is you can use that. If you use it for home renovations, you can

00:16:03.360 | write off that as tax deductible, the interest. Obviously, looking at the benefit in hindsight,

00:16:09.160 | a home equity loan or refinance cash out would have been better if I just put that money

00:16:13.040 | in cash and let it sit in T-bills. I'm a process guy, not an outcomes guy. I didn't know interest

00:16:17.800 | rates were going to do that at the time. The problem with that, if you took out a home

00:16:22.320 | equity loan against your house's collateral or cash out refinance, is that that's a loan

00:16:26.000 | you have to pay back immediately. I didn't want to have monthly payments unless I knew

00:16:28.720 | I was going to do something with it. There's not as much flexibility there. You kind of

00:16:32.640 | have to ask yourself two questions. When do I need this money? Do I need it right now

00:16:36.200 | or can it wait? Then, are you willing to lock in a 7% rate right now with a home equity

00:16:39.960 | loan, or do you want to roll the dice with the HELOC and maybe those rates fall and come

00:16:42.480 | back down to earth? They are variable. They'll move. It's kind of prime plus something, basically.

00:16:48.320 | I think liquidity needs probably matter most. Do you need this money for something? Do you

00:16:52.400 | need it for a down payment to cover some cash since you now have two houses you're sitting

00:16:56.400 | on? Anyway, like all personal finance decisions, do what works for you. Whether that's borrowing

00:17:02.840 | money at 7% if you need the money now and make the payments, or taking out a HELOC

00:17:06.760 | and seeing what happens. For what it's worth, HELOC sounds cooler to

00:17:11.000 | tell people about. Home equity line of credit, right? Yeah. Not bad. All right, let's do

00:17:18.120 | another one. That one was from Taylor. Up next, we have

00:17:20.920 | a question from Jimmy. This is a two-parter, so hang in there. With interest rates rising

00:17:29.920 | quickly, I know it makes sense for housing prices to stagnate or fall in the short and

00:17:33.400 | probably medium term. However, this still makes me think that in the long run, housing

00:17:37.600 | will keep getting more and more expensive. I find it hard to imagine in 5 to 10 years,

00:17:42.040 | rates will be as high as they are whenever the Fed raises rates to the peak. Assuming

00:17:46.360 | there continues to be a shortage of housing, as soon as there is any sort of combined or

00:17:50.400 | continued rate cutting, prices would skyrocket. It may never go down to 2% again, but even

00:17:55.960 | a 4 to 5% rate would likely see a huge increase in prices if rates keep climbing.

00:18:01.000 | Page two. My fiance and I bought a house in December of 2021, so I'm biased to try and

00:18:07.320 | look at the positive side since we didn't get the COVID equity bump. We also plan on

00:18:11.360 | staying in this house for 5 to 10 years, so we aren't overly stressed about what our house

00:18:15.200 | is worth right now. But I feel like housing is in a weird spot where if interest rates

00:18:19.000 | go up and no one can afford a house, supply won't increase. But if interest rates go down,

00:18:23.680 | there will be a lot of demand, so prices will go up. Curious to hear your thoughts.

00:18:26.960 | All right. I love talking about the housing market, so let's bring on one of the very

00:18:30.260 | first people I ever read blogging about the housing market. This is pre-2008 crisis. Mr.

00:18:35.000 | Barry Ritholtz. The blog father himself.

00:18:37.600 | Barry, I was at your house this summer. Before we get into this question, you did a lot of

00:18:43.060 | work too. Did you do the HELOC or home equity line of credit?

00:18:46.680 | It's funny you said that. We bought a house that was a wreck, and it was the only way

00:18:52.240 | we could afford it because we knew how much work it needed. We set up a HELOC. If you

00:18:59.240 | go back to the '08, '09 crisis, people really abused both home equities and HELOCs. When

00:19:06.120 | we set up a $300,000 HELOC, we said, "We're only going to use it for home repairs. It's

00:19:13.320 | a flat roof, not cheap to repair. Take out 50 grand, put in a new roof, pay it down,

00:19:19.000 | do the next project." Year after year, we've been doing project after project. It just

00:19:24.960 | gives you a lot of flexibility. The risk with the HELOC, as so many people see, they use

00:19:31.080 | it to subsidize their lifestyle, and that's where people get into a lot of trouble.

00:19:36.280 | Right. Yeah. You want to use it for a big project. You don't want to just go on vacations

00:19:40.360 | with it and then be forced to pay back the rate spikes.

00:19:42.920 | Right, which is what people did in the 2000s. Rather than admit that their salaries weren't

00:19:49.800 | keeping up with inflation, that their standard of living was dropping, they just tapped into

00:19:54.200 | that equity. For a lot of people, their home is going to be their most valuable holding.

00:20:00.600 | As that grows, when you retire, you get the benefit of all that built-in inflation. You

00:20:05.440 | cash out and sail off into the sunset, not if you keep tapping that home equity.

00:20:10.600 | Right. I want to ask you about the current housing market. John, throw out my tweet from

00:20:13.760 | this week. I basically said, "The economy gets really strong, mortgage rates go up,"

00:20:18.400 | which is kind of what we've seen for the last three or four weeks, and then no one wants

00:20:21.640 | to sell. You see mortgage purchase applications just fall to the floor. The economy gets weaker,

00:20:27.260 | mortgage rates might go down, but then demand comes back, and more people want to buy. So,

00:20:30.120 | I said it kind of feels like we're in a no-win situation for prospective homebuyers. Duncan,

00:20:33.880 | cover your ears. This isn't an earmuff situation for you. Unless prices come down substantially.

00:20:39.680 | Well obviously, we're not going to be in this situation forever, but how do you see this?

00:20:43.360 | I think the point of the emailer's question here is basically, we just didn't build enough

00:20:48.760 | homes, so the supply issue is going to constantly cause problems. I don't necessarily think

00:20:52.960 | that means that prices have to continue rising, but I think it probably, I don't know, puts

00:20:57.480 | a floor where people want to see housing prices crash 30%. I think the floor is probably there

00:21:01.600 | because so many people want to buy houses.

00:21:04.000 | Yeah, no doubt about it. First, when we talk about houses, recognize it's so variable.

00:21:10.880 | People tend to talk about real estate as if it's all the same. Geography makes a difference.

00:21:16.360 | The type of house, is it a starter house, is it a move-up house? Makes a big difference

00:21:20.640 | that the price range, the million dollars and up, and the $5 million and up are their

00:21:26.840 | own animals. Rates make a difference. If you look at new home starts, I like to use FRED

00:21:35.680 | as my data source. If you look at the new home starts, they really cranked up since

00:21:41.400 | the lows in '09. We were way, way below average. We probably under-built two years.

00:21:47.520 | Hang on, John, throw my chart up here. I did houses built by decade, and this goes back

00:21:54.480 | to the '70s. You can see that huge drop in the 2010s when all the builders got scared

00:21:58.980 | after the last housing boom and bust. I just get the feeling that the home builders are

00:22:04.680 | just not incentivized to build right now. They build these, you talked about maybe some

00:22:08.920 | higher priced homes, and the people on the lower end are out of luck.

00:22:13.560 | They also pivoted to multifamily homes during the 2010s. There's a huge apartment shortage

00:22:18.600 | in lots of cities. I think you now have more housing starts. The peak was 1.8 million around

00:22:29.520 | spring of last year, which is still way above anywhere in the 2010s. Even now, we're probably

00:22:36.840 | running about a million and a half rate, which would put us at the peak of the last decade.

00:22:44.440 | That said, rates matter, but they're not the only factor that matter. Now, the US is 330

00:22:51.160 | million people. Go back to the '90s, we were 290 million people. There are more people

00:22:57.320 | looking for houses. Following the financial crisis, track household formation, how often

00:23:03.080 | people get married, move in together. That really plummeted. People were living in their

00:23:07.280 | basements. They weren't forming families. That, during the pandemic, picked up.

00:23:13.200 | Suddenly, we went from too many houses to not enough houses. All that said, everything

00:23:20.520 | is always specific. I've looked at some houses online. We all go Zillow surfing. You could

00:23:28.480 | look at the price history, and I'm genuinely shocked that someone buys a house for $800,000

00:23:34.840 | in 2015, and then flips it for $900,000, and then someone buys it and puts a few hundred

00:23:40.920 | thousand dollars in it, and has $3 million. The HDTV home flipper stuff, I don't know

00:23:48.680 | if that's going to happen anymore. Ben, you did a great piece on 75% of mortgage holders

00:23:57.440 | have rates at 4% or less. Not only is that stimulative to the economy because they're

00:24:03.280 | not spending money, they're just not going anywhere.

00:24:06.000 | Lewis: Right. I think your point about it being circumstantial is really helpful. Unless

00:24:12.100 | you get a 2008 scenario where most housing prices fall, you're right, it's going to depend

00:24:18.080 | on your neighborhood, where you're located, or the price point you're at. National housing

00:24:22.200 | prices for most people are not going to matter. It's going to matter what's going on in your

00:24:25.160 | local region. If you're buying houses or flipping them, or just trying to make some money on

00:24:29.600 | your own house, it's going to be very specific to where you live. Unfortunately, the Case

00:24:34.560 | Shiller Index is probably not going to matter to you, personally.

00:24:38.920 | Yup. When you look around at how things are going, we're in the midst of a, maybe once

00:24:46.720 | in a generation, rejiggering of where people are going to work and live. If you don't have

00:24:54.480 | to be in the office, if you don't need to be near a big city center, what does that

00:24:59.520 | mean? New York saw a population drop like a few hundred thousand, California, three

00:25:07.280 | or 400,000, Texas increased, Florida increased, and a lot of inland cities are seeing increases.

00:25:14.160 | If you're no longer tied to New York, D.C., Boston, San Francisco, L.A., it frees people

00:25:22.200 | up. I think you're going to see prices find a new level as the country moves around and

00:25:30.640 | finds new places to live. Hey, if I could be someplace warmer where the taxes are lower,

00:25:35.680 | maybe it's worth selling a house and going elsewhere. I think we're seeing some of that.

00:25:40.440 | A lot of people don't want to stay where their family is, and they may not want to pick up

00:25:44.600 | and move a thousand miles away, but it's definitely shifting in a pretty substantial way. I think

00:25:50.920 | of it as a giant reset that's taking place. Please do not tell everyone how affordable

00:25:55.640 | it still is in the Midwest here, because traffic is fine here. I never have to wait in traffic.

00:25:59.880 | I never get stuck. It's fine. No one come here. Actually, I saw Grand Rapids on a list

00:26:03.880 | of best places to live. Here's the funny thing. You look at the big cities in Florida that

00:26:09.320 | are attracting all these transplants from the Northeast, and their infrastructure already

00:26:16.320 | is past capacity. They have traffic issues. They have school issues, even sewage and electrical

00:26:23.320 | issues. They're just not prepared for the influx. What looks really desirable, actually,

00:26:30.080 | you may be five years behind in your belief system. You have to go kick some tires and

00:26:35.080 | hang with the locals. Disney can't even handle the capacity, which is the main perk of being

00:26:39.280 | in Florida. All right. We've got one more question. One thing I was going to share real

00:26:44.120 | fast on the housing thing. I told you about this, Ben, recently, but I just want our audience

00:26:48.360 | to hear. I saw when I was looking at places recently, a place for $600,000 in the Upper

00:26:54.200 | West Side somewhere. I was like, "Wow, that doesn't sound that bad for the Upper West

00:26:57.800 | Side." The HOA fee was $3,000 something a month. Can you imagine? What do you get for

00:27:05.200 | that? I don't know. They take the garbage to the curb from the front. Everyone gets

00:27:11.040 | a Bugatti to drive or something. I don't know. Not for $3,000 a month. Sign me up for a Bugatti

00:27:15.600 | at $3,000 a month. I'm in. Okay. Last but not least. Also, I feel like we have to point

00:27:21.360 | out the name that Barry has here. That was auto-generated by this platform that we're

00:27:25.200 | using and he liked it. I may have to get that website. I kind of dig that. Okay. Yeah. Bartholomew.

00:27:33.080 | Okay. Last but not least, we have a question from Peter. Some say that U.S. equity valuations

00:27:38.540 | are generally driven higher over time by the large, relatively constant stream of increasing

00:27:42.520 | contributions coming from 401(k) plans. Based on known U.S. population demographics, when

00:27:48.640 | does this macro driver switch from a net positive to a net drag because net contributions turn

00:27:53.360 | into net withdrawals? What did Josh say about this when he wrote about it? The constant

00:27:57.720 | bid or something? The relentless bid. Relentless bid, yeah. So, I think it makes sense that

00:28:04.400 | fewer barriers to entry would drive up valuations somewhat. Like, Barry, I'm not trying to age

00:28:08.160 | you here, but your first stock was probably purchased over the phone. No, my first stock

00:28:13.960 | was E*TRADE, was on E*TRADE. Okay, E*TRADE. So, that's what brought me in. But back in

00:28:19.160 | the day, you had to go get on the phone or go to an office and fill out some paperwork

00:28:23.040 | and maybe write a check. And now, you can just link your bank to an app and be investing

00:28:27.920 | in five minutes. So, if you take those barriers down, I think that that should in some ways

00:28:31.800 | help take away the frictions that should help valuations. But do you put much – we get

00:28:35.840 | questions about this all the time. Do you put much stock in the idea that baby boomers

00:28:39.560 | will eventually have to sell en masse and that will make it more difficult for the stock

00:28:42.840 | market going forward? Do you think there's anything to this?

00:28:47.800 | Very very little. First, 401(k)s are one factor out of many. I think the US has about $6 trillion

00:28:55.480 | in 401(k)s across six or 700,000 plans, and each plan has multiple employees. So, it's

00:29:02.120 | just a little bit of money every month. It's not an incredible amount of money. That's

00:29:07.240 | number one. Number two, we have a very distorted viewpoint of the average investor versus where

00:29:15.760 | all the money is. The vast majority of the assets in the stock market – and again,

00:29:21.020 | you and I, Ben, have both written about this – the vast majority are in the top 1% and

00:29:26.000 | the top 10%.

00:29:27.000 | I think it's 90% is owned by the top 10%, right? They're not going to have to sell

00:29:31.200 | all at once.

00:29:32.280 | Not only are they not going to have to sell all at once, they're going to not want to

00:29:35.680 | sell because it's going to generate a giant tax hit. And what's much better to do is

00:29:42.040 | you give the appreciated stock to either your grad or your trust or your kids or whoever

00:29:46.440 | it is, and so they get a lower cost basis for ownership. There are all sorts of ways

00:29:51.580 | to do this that minimize the tax burden. Selling highly appreciated stock is probably the least

00:29:59.040 | efficient way to transfer wealth.

00:30:02.280 | And in fact, we've had these conversations with some very wealthy clients about, "Hey,

00:30:06.560 | the most efficient way to give money to philanthropies is to take some of that appreciated stock,

00:30:13.240 | give it to them. It goes into their foundation and they tap it as they need." So, okay,

00:30:21.720 | so there's 60 million baby boomers who are retiring. A quarter of them have a substantial

00:30:27.860 | pile of assets that are below the top 10%. It's not enough money to really move the needle.

00:30:35.360 | Here, Jon, throw this chart from Goldman Sachs. This is one of my favorite charts. Goldman

00:30:39.200 | Sachs has this ownership of US equity markets since 1949 or 1945. And it shows that, maybe

00:30:46.560 | we don't have the chart, but it shows that back in like the 1940s and 50s, US households

00:30:50.520 | owned, there you go, 95% of all stocks. Individually, they owned them in a brokerage account or

00:30:56.080 | something, right? Now you have ETFs and mutual funds and index funds and pensions and foreign

00:31:00.880 | investors and hedge funds and all this other stuff. And obviously a lot of individuals

00:31:04.440 | hold their stock through these things, but it's just so much more diverse now than it

00:31:08.480 | used to be. And it's not just mom and pop buying AT&T stock and what happens if they

00:31:12.400 | all go to sell? Oh no, the market's screwed. It doesn't really work like that anymore.

00:31:16.900 | The market is so much bigger and more professionalized and institutionalized. And you also have millennials

00:31:24.040 | stepping in to buy, like millennials kind of match the boomers one for one in terms

00:31:27.480 | of there's 70 million of you and 70 million of us, and people are going to be stepping

00:31:32.380 | in to sort of buy that, I think. And the other part is, baby boomers living longer means

00:31:37.920 | they're going to have to continue to own some stocks.

00:31:39.500 | Right. That's exactly right. I would love to see that chart from 1945 to today, broken

00:31:44.660 | up by decile of wealth. And the bottom, forget even bottom half, the bottom 90% are such

00:31:52.700 | a tiny chunk of the assets. Now it's expanded over the past century or so, but it's still

00:31:58.500 | 8, 10, 12% of total equity. They're not really moving the needle. The people who are the

00:32:05.220 | wealthy people in America, they're not sellers. They're long-term investors.

00:32:10.100 | Yeah. Robert Shiller did some great work on this in Irrational Exuberance, where he kind

00:32:13.460 | of said, plus you think the market doesn't know this demographic stuff is happening?

00:32:18.300 | This is the most telegraphed thing that you could possibly think of. And it's not like

00:32:21.900 | the market is just going to be surprised by it all of a sudden one of these days.

00:32:25.440 | That's my answer every time someone says, you know, there's the buying season for gold

00:32:29.580 | is coming up in India. It's like, yeah, for the past 5,000 years, is it not already? Does

00:32:35.180 | the market not understand that? Unless you're teasing out something that's extremely novel,

00:32:41.740 | it's probably already in the price.

00:32:44.500 | Right. Exactly. Okay, Barry, any good masters of business guests coming up for you?

00:32:49.420 | Yeah. So last week was Tim Buckley, CEO of Vanguard. That was a lot of fun. I have coming

00:32:57.140 | up Cliff Asness of AQR, who's having a fantastic couple of years. He's been defending value

00:33:04.240 | investing, which the past decade has been an uphill battle. And wherever they fell behind

00:33:10.940 | in the previous decade, they now just leapfrogged. AQR is putting up crazy numbers.

00:33:15.980 | Cliff is great. He's always good for some quotes.

00:33:17.940 | And always, always fun. This week is David Leighton, CEO of The Partners Group, which

00:33:24.180 | is the largest publicly listed private equity firm in Europe, which coincidentally is headquartered

00:33:30.660 | in Colorado. It's kind of interesting that they're a fascinating company and their approach

00:33:36.180 | to looking at the difference between public and private equity is really intriguing. It's

00:33:42.140 | all about valuation. He points out we've switched. Public equities used to be cheap. Private

00:33:47.540 | equities used to be expensive. Now they see the world as, "Hey, public equities are 18,

00:33:52.260 | 20 PE. Private is still 10 to 13." He obviously sees more upside for his side of the street.

00:34:00.460 | Some really interesting people coming up.

00:34:02.340 | If you could have anyone alive or dead on Masters of Business, who would you have?

00:34:06.180 | My experience has been dead people make for terrible guests. So I would skip all the people

00:34:10.780 | who are dead. But my white whales are essentially Jim Simons, who I met when I was looking at

00:34:17.740 | colleges in 1979 or '80. And that's a whole nother story. Druckenmiller and Paul Tudor

00:34:25.100 | Jones are the other. And I got to interview Steve Cohen at SALT a couple of years ago,

00:34:31.740 | but it was a panel interview. And I really want to sit down one-on-one with him, especially

00:34:36.620 | since he just bought the Mets. And part of the conversation would absolutely be about

00:34:41.740 | baseball.

00:34:42.740 | Duncan wants you to bring on the CEO of Oatly.

00:34:44.700 | Of Oatly?

00:34:45.700 | Yeah, that'd be interesting.

00:34:46.700 | Oatmilk.

00:34:47.700 | I'd be up for that.

00:34:48.700 | All right, there you go.

00:34:49.700 | All right.

00:34:50.700 | I want to thank-

00:34:51.700 | That is a booming segment of the market, isn't it?

00:34:52.700 | I want to thank Barry for coming on again.

00:34:53.700 | Stock's been hurting.

00:34:54.700 | Thanks, Duncan. We want to give a big shout out to John, the man behind the scenes, who's

00:34:58.940 | doing all our charts live from Belgium today.

00:35:01.420 | Actually, I told you right, he's in Amsterdam now.

00:35:04.140 | Amsterdam, okay. John is just a world traveler. Remember, if you have a-

00:35:06.940 | The Netherlands.

00:35:07.940 | Email for us any questions, askthecompoundshow@gmail.com, or leave a question. Thanks to all the people

00:35:12.220 | who tuned in live. We always appreciate your comments. Remember, if you want some Compound

00:35:16.420 | merch, idontshop.com. No other shows this week, but everything will be back to regularly

00:35:20.140 | scheduled programs next week. Right, Duncan?

00:35:22.300 | Next week, we're back.

00:35:23.300 | All right, we'll see you then.

00:35:24.300 | See you, everyone.

00:35:24.860 | [music]

Are Covered Calls a Replacement for Bonds? | Portfolio Rescue 64

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