Bogleheads® Conference 2013 - John Bogle & Bill Bernstein Fireside Chat

00:00:00.000 | A number of years ago, Jack Eisgott, he and Bill Bernstein could do an informal chat as

00:00:13.200 | part of the agenda.

00:00:14.200 | We all know what Jack wants, Jack gets.

00:00:15.200 | So it's become a regular part of our conference agenda ever since.

00:00:16.200 | It's now affectionately known as the Fireside Chat.

00:00:17.200 | Jack is here, but Jack's companion for the Fireside Chat is a retired neurologist.

00:00:18.200 | He's written a number of best-selling titles on both finance and economics history.

00:00:37.200 | He holds both a Ph.D. in chemistry and an M.D.

00:00:51.880 | Please welcome one of the smartest guys I know, Bill Bernstein.

00:00:58.720 | [Applause]

00:00:59.720 | Well, you know, before we start, you know, Steve Dunn told this lovely story.

00:01:03.720 | I'm going to tell a little bit of a story out of this, out of school, because it had

00:01:08.560 | to do with a lunch I had with a representative from another large passively-based mutual

00:01:15.120 | fund company that has, I think it's no secret, a succession problem.

00:01:21.320 | This company has excellent management, this management has no succession issues at all.

00:01:26.300 | They have a very deep bench in that regard.

00:01:29.800 | But their problem is ownership.

00:01:30.800 | They've got two owners, and the owners want to get their, justifiably, their just deserts

00:01:36.240 | out of it.

00:01:37.240 | And there's, in their eyes, really only two ways to do this.

00:01:41.040 | One is to have an initial public offering, which would be bad news.

00:01:48.400 | And then the other solution would be to sell to a larger financial corporate entity, which

00:01:54.040 | would be even worse news.

00:01:56.560 | And so I've suggested to them multiple times that they Vanderbiltize, which is basically

00:02:01.720 | to sell themselves to their shareholders, so that after ten years or so, they wind up

00:02:10.000 | being owned by their shareholders, like Vanderbilt does.

00:02:13.260 | And they looked at me and said, "Well, Jack Bogle did this, how much did he charge?"

00:02:19.640 | And I said, "Zero.

00:02:20.640 | Gave it away for free."

00:02:21.640 | And they said, "Well, why would he do that?"

00:02:26.440 | And you have to know me, I tend to blurt things out.

00:02:31.440 | I said, "Well, because he's a Mitch."

00:02:34.440 | [laughter]

00:02:35.440 | So, you know, of course they're not going to listen to me.

00:02:41.080 | But I thought I'd, excuse me, start off, Jack, and ask you about your personal feelings

00:02:48.860 | about the recent Nobel Prize laureates.

00:02:52.560 | I'm not going to ask you about Hanson, because he's kind of a mechanic.

00:02:57.600 | And so I'll ask you about what you think the legacy of Schiller and Thomin is, what you've

00:03:04.920 | learned from them, where you disagreed from them, and, you know, their work is not entirely

00:03:09.640 | consistent with each other.

00:03:10.640 | >> To say the least.

00:03:11.640 | >> Yeah.

00:03:12.640 | And so I'd like your opinion on that, too.

00:03:13.640 | >> Well, I talked a little bit about this, I think, before you got here, Bill, but let

00:03:15.640 | me just kind of reiterate what I think.

00:03:20.680 | One is, I don't see how efficient markets can even be a hypothesis, because it's sometimes

00:03:27.720 | right and sometimes wrong.

00:03:28.720 | A hypothesis does not have a whole lot of Swiss cheese in it.

00:03:32.440 | And the, I think the one place that both Schiller and Thomin agree is that in the long run the

00:03:40.120 | markets are a lot more efficient than they are in the short run, and I would totally

00:03:43.360 | endorse that.

00:03:44.360 | But the data are crystal clear that they tend to move toward, if you want to call it an

00:03:50.100 | equilibrium, I don't want to use too high-powered, highfalutin phrases, because that's just not

00:03:55.560 | my style and not my preference, but it's, efficient markets, however, have nothing to

00:04:02.860 | do, zero, nada, with my creation of the index funds.

00:04:06.720 | I never heard of Thomin then, as you all know, and I didn't believe in efficient markets,

00:04:12.760 | and I spent a lot of time in my books saying, you know, there is the quantitative school,

00:04:17.640 | guys out of Wells Fargo were very good, and they rented some money for us for a while,

00:04:23.720 | it didn't work that well for about 15 years, and then it didn't work out any more, other

00:04:27.720 | than the sort of asset allocation stuff.

00:04:30.020 | They're all quants deeply into trying to prove the market is efficient.

00:04:34.320 | The Sansonite well-known pension plan, it was the first pension account to do this,

00:04:41.760 | and it failed, because they picked the wrong index.

00:04:45.360 | I take some pride in the fact that they finally picked the right index after Payne-Garden

00:04:49.520 | 500 came out.

00:04:50.520 | I don't think they were necessarily following it, they needed a good index, and they picked

00:04:56.560 | the bad one.

00:04:57.560 | So, the efficient markets have never had anything to do with my idea.

00:04:58.560 | My idea was that, this is, I've mentioned it before and I'll mention it again, is all

00:05:03.680 | you need is the CNH, which is the Consistent Cost Matters Hypothesis, and that is true

00:05:11.720 | under any momentary time period or any internal time period.

00:05:12.720 | And that is the less cost you pay, the more your share of the market returns goes up,

00:05:13.720 | whether the market is efficient or inefficient, long-term, short-term, whatever it is.

00:05:14.720 | So, I think efficient markets is overrated, but not as bad as Shiller says, has done more

00:05:27.860 | damage to economic thinking than any idea in the history of economic thought, or some

00:05:32.160 | understatement like that.

00:05:33.480 | He really did say that in one of his books.

00:05:38.040 | So they disagree, and I think it's kind of interesting, and in a way I like it when they

00:05:43.480 | award the Nobel Prize to two people who think exactly the opposite of one another.

00:05:48.760 | As to Bob Shiller, he's very creative, very smart.

00:05:51.720 | I like the idea of an ease of the 15-year moving earnings target to calculate the PE.

00:05:58.440 | It's a long way from perfect, but it's probably better than using the last year or the next

00:06:02.800 | year pumped up with expectations, and so, and he's a good thinker.

00:06:09.600 | He has some very complicated ideas, which I think are oversimplified.

00:06:12.840 | For example, he wants to create a whole bunch of new financial instruments to protect us

00:06:17.840 | from problems of our home mortgages and that kind of thing.

00:06:21.240 | And the problem with any aggregator of any kind of asset class, or whatever you want

00:06:27.240 | to call it, or any kind of derivative, is they cost money.

00:06:31.320 | The system takes money out.

00:06:33.520 | So it works less well for investors in the group that does when it's on paper, because

00:06:38.360 | they don't count, they do the pricing, they don't count the intermediary share.

00:06:43.080 | So are they both worthy of the Nobel Prize?

00:06:46.080 | I would have no idea, but heck, the Nobel Prize Committee has been all over this, and

00:06:49.680 | they decide they are.

00:06:50.840 | So I salute them, but that doesn't mean I have to follow every word that they have.

00:06:54.880 | And I am, this will really surprise you, totally un-intimidated by the idea of taking them

00:07:00.640 | both on a little bit, which I did in that Wall Street Journal letter, which may or may

00:07:04.040 | not ever get published.

00:07:05.040 | And it's such a good letter, Emily hated it, Michael hated it, and the more they hated

00:07:10.440 | it, the more I wanted it.

00:07:11.440 | I mean, I did try to adjust to what they said a little bit, kind of smack in the face sort

00:07:16.440 | of thing.

00:07:17.440 | But anything that gets us thinking about these issues, and particularly issues, I mean, I've

00:07:23.440 | always spent a lot of time on issues that are opposed to what I say, I think it's much

00:07:28.480 | more valuable.

00:07:29.480 | And by the way, what an honor it is for me to be with this guy, right off the hospital

00:07:33.520 | bed.

00:07:34.520 | Now you're making me look like a piper.

00:07:35.520 | I hate that.

00:07:36.520 | And so, anything that makes you think, you know, maybe I'm wrong, and I have been known

00:07:45.520 | to think that for a moment or two.

00:07:50.200 | So you try and learn, you try and keep up with the academic journals, and I can say

00:07:54.920 | this about what Taylor mentioned, his citation for the journal, news story, and op-ed on

00:08:04.240 | Monday, the efficient markets had nothing to do with my creation of the index fund.

00:08:10.840 | But it's worthwhile to look at that hypothesis, to challenge it, and I'm pretty good at that,

00:08:17.920 | but I just want to add that there was an article from a Nobel Prize winner that in fact did

00:08:23.840 | inspire my creation of the first index fund, and that would be Paul Samuelson's article

00:08:28.160 | in the first edition of the Journal of Portfolio Management, called "Challenge to Judgment".

00:08:38.880 | And Paul Samuelson, and he's in my group, he doesn't get into what efficient markets

00:08:42.480 | are, he says, "Show me the root evidence that managers can win."

00:08:48.960 | And no one ever showed him any root evidence that managers can win, and they haven't shown

00:08:52.760 | him yet.

00:08:53.760 | So he and I were, he's the inspiration for me, not Gene Plomkin.

00:09:00.120 | So I said that to the Wall Street Journal, and Paul's, if someone like Paul Samuelson

00:09:05.040 | turns out to be one of the nicest guys you'll ever meet, he's just so brilliant, it's an

00:09:08.520 | embarrassment to be in the same room with him, but I get over it.

00:09:11.760 | And he's a very, in a lot of ways, a humble guy, not, I mean, like academics, he maybe

00:09:20.240 | has a touch of arrogance, but I know a particular person who's not an academic who has a touch

00:09:25.280 | of arrogance too.

00:09:26.280 | I'm not gonna identify him.

00:09:27.280 | He's right in front of me, and I'm not talking about Bill.

00:09:32.440 | So I think he should get his credit, 'cause it really did help me sell the IDD index fund

00:09:39.320 | to the board.

00:09:40.320 | I'd done all the data myself, and then, you know, line by line, calculator by calculator,

00:09:46.280 | in 1975, before, that was the first thing I did, was bring that index fund to the board

00:09:51.120 | of directors, after Vanguard started in May, and it was on their desk by, I think, September,

00:09:56.880 | August or September, and they didn't know what to do about it, you know, it had, it

00:10:01.360 | was being managed, but not actively managed, and that was a hurdle.

00:10:05.560 | The data was a hurdle, but when you have Paul Samuelson, you've got a pretty potent weapon.

00:10:11.600 | I mean, it shows you're not nuts, it may be all it shows, but that was enough.

00:10:16.760 | Yeah, I'm gonna do two very fast observations, and then I'll segue into another question.

00:10:22.080 | The first observation is that when I fall face-first into my mashed potatoes, I will

00:10:27.680 | not want for lack of medical attention in this audience.

00:10:32.280 | The second is more serious, that, you know, I think Schiller is one of the most brilliant,

00:10:37.840 | he has a peculiar intellect, a peculiar personality, that makes, that gives him his brilliant intellect,

00:10:42.840 | I think.

00:10:43.840 | It's sort of a very dissociated way of looking at the world, and he's one of the few people

00:10:48.520 | whose macroeconomic analyses and financial terms I listen to, because he's so rational,

00:10:53.320 | he's so divorced from popular thinking, but a lot of the ideas that he has are truly bad

00:10:59.440 | ideas, and one of the ones is the one that Jack just mentioned, which is derivatizing

00:11:04.480 | housing markets, you know, theoretically they can be used to hedge, wonderful, so can most

00:11:11.040 | other derivatives be used to hedge, but you know that's not what they're going to be used

00:11:13.680 | for.

00:11:14.680 | You know they're going to be used to destabilize the system, and not to stabilize it, they're

00:11:19.680 | going to be used for speculating.

00:11:20.680 | With that said, I want to come up with something, talk about something else that Gene Fonda

00:11:24.680 | has said, which gets him off the reservation, at least, but I think it's extremely important,

00:11:29.000 | which is that one thing I think we've learned over the past several years, and we didn't

00:11:35.840 | know it already, is how important banks are, alright?

00:11:39.560 | You know, first there's police stations and courts, then there's banks, then there's hospitals,

00:11:43.840 | because if you don't have banks, there aren't hospitals, and we have an unstable banking

00:11:49.000 | system, and one of Gene Fonda's ideas, Jack, is that about a quarter of bank capitalization

00:11:56.800 | should be equity, alright?

00:11:59.200 | Equity can be loaned, it's not going to be idle money sitting there, it's money that

00:12:03.400 | can earn a profit for the owners, and it's kind of a naive idea, but at the same time,

00:12:11.600 | it has a certain appeal and also a certain support within some of the more serious members

00:12:18.200 | of the banking industry, so I want to know what you think about our banking structure

00:12:21.800 | in general, and also what you think about Professor Obama's suggestion.

00:12:26.800 | Okay, well, on the banking system, I even go beyond that, Bill, and say, you know, what's

00:12:33.600 | happening to the world of capitalism, and I think the most worrisome trend is growing

00:12:42.800 | concentration everywhere, larger and larger, and the banks say, I mean, listen to Jamie

00:12:48.800 | Dimon, listen to anybody else in the banking area, we have to be large because our clients

00:12:53.400 | are so large, our customers, the borrowers, and the lenders are so large, we have to be

00:12:58.000 | able to accommodate them, and that is true, so I don't know how to get out of this mess,

00:13:03.200 | but to have the concentration of our banking system is in fact larger, I think the top

00:13:09.400 | five banks have over 50% of the deposits of all banks now, and it's probably 40% of what

00:13:19.000 | happens with these little banks and smaller banks, not little banks at all, smaller banks,

00:13:23.800 | they merge into a big one, and that concentration gets worse and worse, and every corporate

00:13:28.400 | merger makes the clients get bigger and bigger and demanding of more and more big banking

00:13:33.800 | services, and in the long run, we get a whole system of oligopoly, I'm troubled by the fact

00:13:40.200 | it's also happening, as I've said before, in the mutual fund industry, where the top

00:13:44.800 | five firms have almost 50% of the assets, and they're all index firms, you know, you

00:13:51.200 | like diversity in capitalism, corporate America, diversity, I'm not talking about all this

00:13:57.600 | gender stuff, just in terms of the number of participants in the system, the greater

00:14:02.000 | number of participants in the market system, the more you're likely to get efficient markets,

00:14:06.600 | and it's all dwindling and getting larger and larger, I don't know what to do about

00:14:11.400 | that, it's well known, I haven't done any research on this, but I will get into it one

00:14:14.800 | day, thanks Michael, be ready, but the number of stocks that we used to have, the Wilshire

00:14:21.000 | 5000, and it's now called the total stock market index, I guess it's Dow Jones or whoever

00:14:27.200 | does it, and it got up to 7,000 stocks in the year 2000, now it's gone, that's way

00:14:35.200 | above, it's the 5000 it originally began with, and now it's down to I think 3200, over half

00:14:41.200 | of the stocks that were in it at the market high are gone, and some of that is by merger,

00:14:47.200 | some of that is because the tech stocks came and then they went, and you know, it's interesting

00:14:52.800 | to me, it's a vital intellectual question, where did those companies go, and what happened

00:14:57.600 | to them, and to the extent they're mergers, why do we do all those mergers, and I happen

00:15:02.600 | to be a real, this is really going to surprise you, a real cynic about these corporate mergers,

00:15:08.400 | I think they're done for one of two reasons, or maybe both of them at the same time, and

00:15:13.600 | that is one, bigger corporations pay their executives bigger salaries, so the CEO wants

00:15:18.400 | to do a merger, he thinks he knows everything, the board thinks he knows everything, and

00:15:22.400 | they pay him a lot of money for doing pretty much nothing, I think, and so that's one part,

00:15:30.800 | and the other part is, it muddies the accounting waters, you do a merger, and nobody knows

00:15:36.400 | proforma, this, proforma, that, and all of a sudden the shoddy record looks like a good

00:15:41.400 | record, and in terms of earnings per share, and they're just basically not credible and

00:15:46.400 | not believable, but we take anything that is quantified, that we can, it's the perils

00:15:53.400 | of numeracy, one of the talks I gave all over again, and reminding me of a thing in Einstein's

00:16:00.400 | office, which Bill knows well, I'm sure, and that is, there's a sign, it's said to be a

00:16:05.400 | sign in Albert Einstein's office, the former office of the Princeton Institute of Advanced

00:16:10.400 | Study, saying there's some things that count that can't be counted, and there's some things

00:16:16.400 | that can be counted that don't count, and you know, and here I am, a big math guy, beta

00:16:23.400 | mogul, the data devil, and skeptical about the idea that we can quantify everything, and

00:16:31.400 | that's why I'm pleased to have gotten this article in the Financial Analytics Journal,

00:16:35.400 | where my guesses about the cost of transaction costs, about advisory costs, about cash drag,

00:16:42.400 | aren't just estimates, but it's better to have the estimates there, up or down, do what

00:16:47.400 | you will with them, anybody can change the math, and then ignore these huge costs that

00:16:52.400 | come along with the fund expense ratios, so I'll be glad to have that out of the way,

00:16:57.400 | but on banking, I had a chapter in my book called The Battle of the Soul of Capitalism,

00:17:04.400 | not a chapter, but a take out from another chapter, it's called Bring Back Glass-Steagall,

00:17:07.400 | and that's what we should have done, but we couldn't do that, so we get the Volcker Rule,

00:17:12.400 | which is, I think, 198 pages in the Glass-Steagall Act, 65 pages, because you're trying to fuss

00:17:19.400 | around the edges of the system, and it still hadn't gotten anywhere, it still hadn't been

00:17:23.400 | implemented, so you get a lot of people, banks, these get into the big issues that confront

00:17:29.400 | the American Republic today, and that is the power of money in the system, but banks are

00:17:34.400 | out there with these high-paid lobbyists fighting every comma, every paragraph, everything they

00:17:39.400 | can with all their might, and they can, of course, out-think the civil servants of the

00:17:46.400 | SEC, and so on, and it's not putting down the SEC, it's just, they've gotten into such

00:17:52.400 | a complicated mess, but you tell me that Jamie Dunn can take you through the annual report,

00:17:57.400 | or J.P. Morgan, and explain every item to you, and I'll say, "I'm not hanging by my

00:18:01.400 | thumbs in the latter."

00:18:03.400 | Yeah, that actually raises a couple of subsidiary questions, the first of which is, if you're

00:18:10.400 | a libertarian, you blame Sarbanes-Oxley for a decrease in the number of publicly traded

00:18:15.400 | companies, do you think that's a valid argument?

00:18:17.400 | I'd like to look at the data, but I doubt it very much, it's an easy out, you know,

00:18:22.400 | it's so demanding to be a public company and not be a private company.

00:18:26.400 | First place, it's much easier said than done to do that, and second, at a certain level,

00:18:31.400 | when you get to really big corporations, going private is impossible.

00:18:35.400 | I think one of the challenges to the long-term investment management business is as our investment

00:18:41.400 | universe shrinks, it's the kind of things, Bill, that very few people, but you, are even

00:18:47.400 | thinking about, and that's why we need you.

00:18:51.400 | I'm not sure who needs me these days, except my granddaughter.

00:18:58.400 | Well, that leads me to an actually very leading question, which is the quality of financial

00:19:05.400 | regulation during the most current administration.

00:19:09.400 | We had a woman who was the SEC chairman, who as far as I can see did not have great accomplishments,

00:19:15.400 | she went from one job in a quasi-private regulatory agency, in which she had a seven-figure salary,

00:19:22.400 | and now she's gone through the revolving door, into another job with an eight-figure salary,

00:19:30.400 | and one should not be surprised, or might not be surprised, if she didn't do great things.

00:19:37.400 | I'm wondering what your view of her tenure was.

00:19:40.400 | Now this is, who's tenure?

00:19:42.400 | Mary Shapiro.

00:19:45.400 | Well, first of all, I empathized with Mary Shapiro.

00:19:50.400 | She was trying her best to do the right thing, and the industry ganged up, and so it was

00:19:55.400 | irresponsible and disgraceful.

00:19:57.400 | Like in Union Station, the SEC is now right next door, they had all these signs saying,

00:20:03.400 | you know, down with asset value, floating asset value, money, money, money.

00:20:08.400 | Basically, arguing with the SEC, and with the people who are walking in and out of the

00:20:12.400 | SEC doors every day.

00:20:14.400 | You know, I don't think we need to stoop to that.

00:20:16.400 | There's a rational argumentation that we should use, and not a sensationalist orientation.

00:20:21.400 | But, you know, she was right on money market funds, she was right on a lot of things, and

00:20:25.400 | basically ended up getting very, very little done.

00:20:28.400 | Because this industry mobilizes, I mean, this is a powerful lobbying industry, and I think

00:20:34.400 | it should look to its own interests more.

00:20:38.400 | Obviously, a complete conflict of interest in the fund industry.

00:20:41.400 | It's being run, they call it the Investment Company Institute, and it's the Investment

00:20:45.400 | Managers Institute.

00:20:46.400 | That's a big difference.

00:20:48.400 | I don't see any evidence they're looking after the interests of fund shareholders.

00:20:52.400 | It's run by the managers, and the managers are paying the dues, and the managers have

00:20:57.400 | their own lobbyists.

00:20:58.400 | So, I'm not bothered by her accession.

00:21:04.400 | I should say this, I come to it from a background before she took over the chairmanship of being

00:21:10.400 | pretty skeptical of Mary Shapiro.

00:21:12.400 | And I ended up being kind of a Mary Shapiro booster.

00:21:16.400 | And maybe I'm just a sucker for, you know, someone who's trying to do the right thing

00:21:21.400 | and gets it thrown back in their face.

00:21:23.400 | I know a lot about that subject.

00:21:25.400 | Well, to shift gears ever so slightly, as simulating as this year is going to be, it

00:21:31.400 | won't be quite as interesting as Die Hard 8 was in 2008, which I think was what, two

00:21:37.400 | weeks, one week post-Lehman.

00:21:39.400 | We almost got there, though.

00:21:41.400 | And so, that's my next question, which is the view from the precipice, which we just

00:21:46.400 | stopped short of, and the view over the precipice.

00:21:49.400 | I think the long run down, which was done in the financial system with the most recent

00:21:57.400 | growth deal in Washington.

00:21:59.400 | And what could have happened?

00:22:03.400 | Well, you know, those are, I guess I was going to say, questions about my pay grade.

00:22:09.400 | But let me just give you a couple of reflections.

00:22:12.400 | I begin, which in turn had to be totally true with our idiotic statesman, listen statesman

00:22:19.400 | like elected officials.

00:22:21.400 | And that is, I begin with Churchill's statement that Americans always do the right thing,

00:22:27.400 | but only after they've tried everything else.

00:22:31.400 | And we came, I mean, I'm not sure, I didn't get a chance to read the morning papers yet,

00:22:37.400 | but we probably came within an hour to get President Obama's signature on that bill,

00:22:42.400 | an hour of the actual report.

00:22:44.400 | I think it was done before midnight, pretty much had to be.

00:22:47.400 | Maybe Congress often sets the clock back, so it makes everything that's illegal, legal.

00:22:52.400 | But it's, to me, incredible how people can get so dug in with their own personal agenda

00:23:02.400 | that they can fail to see what is obviously good for the nation.

00:23:07.400 | And they can fail to see, I mean, I don't want to get into too much politics here,

00:23:10.400 | but I might have mentioned this word before, but the president cannot be held hostage,

00:23:17.400 | cannot have hostages held and said you do this if you want to ever see your cousin again

00:23:22.400 | or your wife again.

00:23:24.400 | That's just not the right way to negotiate.

00:23:26.400 | There's a big difference between negotiating over the right things

00:23:29.400 | and negotiating in a hostage situation.

00:23:31.400 | And it's just about every government and every corporation has found out

00:23:34.400 | you just can't finally negotiate with people who are holding hostages.

00:23:38.400 | There's no final way to win, so you just say do what you will

00:23:42.400 | and then get as many bodies in there, FBI, whatever it might be,

00:23:45.400 | to try and undo the situation by intervention of some kind.

00:23:51.400 | And it's a risky thing to do.

00:23:54.400 | So that's what we're going to see, I guess, in Captain Phillips.

00:23:57.400 | I haven't seen that yet, but those kind of hostage-taking things are not the right way to do it.

00:24:03.400 | So it's time for negotiation and time not.

00:24:05.400 | And what I have been amazed at, honestly, Bill, is true to my trying to keep against all odds

00:24:13.400 | a balanced viewpoint about the political system.

00:24:16.400 | I read the Wall Street Journal as well as the New York Times,

00:24:19.400 | and the Journal has been so much more scathing than the New York Times

00:24:24.400 | about how the Republicans, basically the Journal's constituency,

00:24:28.400 | got themselves into such a loser's game, a mess,

00:24:31.400 | that it's really tough on the Republican Party.

00:24:35.400 | Everybody knows that they finally give up because they're losing in the court of public opinion.

00:24:39.400 | But that brings up the worst point that affects our, I think, single worst thing that affects our political system,

00:24:45.400 | and that is these safe boroughs, we used to call them rotten boroughs in England, like Bigville,

00:24:51.400 | in the old days, the long old days, but these safe seats that, you know,

00:24:56.400 | the more strident, the less reasonable you are, the more likely you are to be re-elected.

00:25:01.400 | And if you're even a moderately conservative person,

00:25:06.400 | you're probably going to be confronted in the next primary with someone who's just off the wall,

00:25:11.400 | on the right side of things.

00:25:13.400 | There doesn't seem to be a contravening force on the left.

00:25:15.400 | Although I think the Journal would say that the labor unions are such a force.

00:25:19.400 | I'm not sure they have that much power, but there we are, we just own them that way.

00:25:23.400 | So that's a real problem, to have these basically locked in seats,

00:25:27.400 | that care, that are so safe, that they may be around for a long time.

00:25:33.400 | I read this data the other day, and I'm not sure I'm going to get it right,

00:25:37.400 | but as everybody knows, the House of Representatives is around number 60-40 Republican.

00:25:42.400 | But the votes cast for the House of Representatives are roughly 60-40 in favor of Democrats.

00:25:48.400 | Think about that.

00:25:49.400 | So when these people say, "We're representing the people,"

00:25:52.400 | they're representing this minority of people, and not the majority of people.

00:25:57.400 | I'm reminded, if I can give you one more of the better quotes of the day, not a current one,

00:26:02.400 | but a quote that will indicate that Benjamin Franklin was not without some wisdom about the long term.

00:26:10.400 | He came out of the Constitution Convention in Independence Hall down here.

00:26:14.400 | When the deal had been signed, the Constitution had been approved by the Constitutional Convention,

00:26:19.400 | going out to the states, and a woman comes up to him and says,

00:26:24.400 | "What have you given us, Dr. Franklin?"

00:26:27.400 | And he said, "We have given you a republic, if you can keep it."

00:26:32.400 | And I think we are endangering that, and I think that's a very, very serious, if totally unquantifiable risk.

00:26:41.400 | But, to get to the second question, Jack, which is, what do you think could have happened,

00:26:48.400 | and what would have happened, do you really think, had we fallen from our treasuries?

00:26:56.400 | I think it would have resulted in such financial chaos all over the world,

00:27:01.400 | that we would have thrown ourselves into not a depression, a very deep recession.

00:27:08.400 | And there's no way to know that, thank God there's no way to know it.

00:27:12.400 | But, when you think about the dollar being the international world currency,

00:27:17.400 | basically the currency of the world right here, that would go under those circumstances, I think.

00:27:22.400 | But to think about this powerful nation, the most powerful, except from a financial standpoint, nation on earth,

00:27:29.400 | not able to pay, or not willing to pay its interest, and that gets to the interest on its debt,

00:27:34.400 | and that gets to the idiocy, the utter idiocy of a debt limit.

00:27:39.400 | Because a debt limit is basically a way of saying, we're going to spend X,

00:27:44.400 | and we're not going to charge any taxes for it, and if you end up, so you're going to borrow money,

00:27:49.400 | but we're going to tell you how much you can borrow with the mathematics of that equation,

00:27:53.400 | or establish the moment you undertake the expenditure.

00:27:56.400 | You've got to pay for it, it may be difficult to do, you've got to hire taxes,

00:28:00.400 | you've got to get rid of tax loopholes, whatever you want to say.

00:28:04.400 | And that gets me to another of my favorite, I don't know if I should be talking politics here, I know I shouldn't,

00:28:09.400 | but the idiocy, the arrogance, the disgrace of these hedge funds getting capital gains taxes,

00:28:18.400 | 100% of fees, is just so moronic, and so unfair, and it's just, I call it a national disgrace.

00:28:27.400 | Why should that be? Why should the people that have more than anybody else in America pay lower taxes?

00:28:32.400 | And that's because Senator Schumer, who happens to be a director, is head of the Senate Finance Committee,

00:28:37.400 | and he's not going to let it happen. His constituency, down there in Wall Street mostly, is not going to let it happen.

00:28:43.400 | And of all the simple reforms, and the only argument I've ever heard against it is it would affect some other things,

00:28:48.400 | I don't know how that would be, and the other one would be, it doesn't raise a lot of money.

00:28:53.400 | Well damn it, if it's wrong, it's wrong. If it raises five cents, or even to do it right, loses five cents, I couldn't care less.

00:29:01.400 | But there is such a thing as moral absolutism, and there is such a thing as right and wrong.

00:29:07.400 | And sometimes they're very difficult to see, and sometimes I think I see it a little more clearly than the fact is, I'll admit that.

00:29:15.400 | But, you know, we've just got to have more of a thought about what's good for this great nation,

00:29:22.400 | and what's going to keep us from getting in even more trouble than we're having now.

00:29:26.400 | I was intrigued by the identification of the big fund companies.

00:29:32.400 | BlackRock, Vanguard, as saying systemically important financial institutions, CIPIs.

00:29:41.400 | And, you know, I can see how AIG and Lehman did stupid stuff, and got themselves and the financial system into trouble.

00:29:50.400 | What kind of stupid stuff could Vanguard, Fidelity, and BlackRock do to get the financial system into trouble?

00:29:59.400 | Well, usually trouble comes, everybody knows, from leverage.

00:30:03.400 | You know, you've got obligations you can't meet, and interest payments due on the money you've borrowed.

00:30:10.400 | And that's what banking is all about, of course, finally.

00:30:15.400 | And you don't have those kind of issues in sci-fi. What do you call sci-fi? SIPI. Sci-fi sounds better, science fiction.

00:30:26.400 | And you don't have the borrowing issue.

00:30:30.400 | But I do think that we are, in fact, systematically important financial institutions.

00:30:36.400 | The concentration in this business has gotten bigger.

00:30:39.400 | It's gotten more narrow.

00:30:43.400 | That is to say, my firm's acquired, I must have mentioned this before, half of all the mutual fund assets.

00:30:50.400 | And I don't think that's a particularly healthy thing.

00:30:52.400 | But I can't put my finger on precisely what's wrong.

00:30:56.400 | But the things I would look first to is, supposing there is a run of redemptions.

00:31:00.400 | What you're going to say, or somebody, not you, Bill, I'm going to say, well, you know, if you get too many redemptions,

00:31:08.400 | there'll be a lot of sales, and the market will, you know, find its intersection.

00:31:14.400 | And it'll go down, and then the black will come in, and that's just life in the marketplace.

00:31:20.400 | And in some of these scares we've had in the last few years, that short-term malfunction in the marketplace,

00:31:26.400 | you know, door and well are going to be corrected pretty quickly, you know, maybe in a day.

00:31:30.400 | And investors care about that, but only very foolish investors care about that.

00:31:35.400 | You know, it's going to be all come out in the relationship of price to value, and whether there's a bubble or not.

00:31:42.400 | So, you know, it's not easy to say what the consequences of it are.

00:31:48.400 | Even as I say, absolutely, you know, if these five firms control, let me say, 20% of all the stock in America,

00:31:56.400 | and if you had another 10 firms, it's probably 50%, 10 firms controlling 50% of the stock in America.

00:32:02.400 | There's something you ought to be concerned about.

00:32:04.400 | The fact that you don't particularly know what you should be concerned about doesn't mean you should raise a little alarm to me.

00:32:10.400 | And alert everybody, await the ICI's compassionate response, stay out of our business.

00:32:17.400 | And I do particularly worry about, on the municipal bond side, and particularly for Vanguard,

00:32:25.400 | because we're the dominant force in the immunity market.

00:32:28.400 | Everybody knows it's not particularly liquid, and I might talk a little bit about this earlier.

00:32:32.400 | So, you know, maybe some kind of an idea of having a reasonable amount of reserves to meet demand,

00:32:40.400 | to meet redemptions in that business would be a good idea.

00:32:44.400 | I hope we still do, but I don't know.

00:32:46.400 | And if the concentration grows, and there's no signs of it growing, you know, at some point, it's just too much concentration.

00:32:58.400 | But we never know how much is too much.

00:33:00.400 | I mean, it's, you know, like, write down a number, and I don't think that does it.

00:33:05.400 | I think what captures it is basically a little bit like corporate America, a concentration of economic power.

00:33:13.400 | And we're systematically important, because we can tell any corporation in America,

00:33:18.400 | the mutual fund industry can, what we want them to do.

00:33:21.400 | We can tell them how much to pay their CEOs, we can tell them anything we wish to.

00:33:24.400 | And we don't do any of that, that's a whole other issue.

00:33:27.400 | But that means you're systematically important.

00:33:29.400 | It doesn't mean there's any terrible risk coming with it, although I think there is the liquidity idea of risk.

00:33:34.400 | And that's all I can honestly come up with to think about something nearby.

00:33:39.400 | But I'm glad to have the government look at it that way.

00:33:42.400 | It's 31 pages long.

00:33:44.400 | I've read it, because I read that kind of stuff.

00:33:48.400 | And I didn't see anything to really worry, but they have the same kind of numbers that I'm doing every day,

00:33:53.400 | the concentration of oil, oil resources, and things like that.

00:33:57.400 | And it's a pretty good report, they don't come out with any conclusions.

00:34:00.400 | But I think the idea that we are systematically important basically has to be tautologically correct.

00:34:07.400 | You know, if you own, as mutual funds do, about 32% of all the stock in America.

00:34:11.400 | And that in itself, not to get you into this any deeper than you want to be,

00:34:15.400 | but it's only the tip of the iceberg.

00:34:17.400 | Because when you look at these 25 largest mutual fund firms,

00:34:20.400 | every single one of them also has a pension management affiliate.

00:34:24.400 | When you take the two of them together, their pension funds and their mutual funds,

00:34:28.400 | they own, I think it's 55% of all the stock in America.

00:34:31.400 | These are powerful institutions.

00:34:33.400 | And the fact they aren't exercising that power is either A, a national disgrace,

00:34:39.400 | or B, a national asset.

00:34:42.400 | And you'll have to tell me which is which.

00:34:46.400 | Okay, well, I think what I'll next do, and perhaps close it up,

00:34:50.400 | at least in terms of the formal fires out of Chad here,

00:34:53.400 | is, unless Chad has questions for me, which is,

00:34:56.400 | end with a personal finance question.

00:35:01.400 | Which is, I don't know if Wade Fowl is in the audience?

00:35:04.400 | If he is, raise your hand.

00:35:06.400 | Wade.

00:35:07.400 | There you go, hey, Wade.

00:35:09.400 | You haven't presented your paper yet, have you?

00:35:12.400 | Okay, great.

00:35:14.400 | Well, Wade has done a very important piece of work,

00:35:18.400 | which bears on the glide path of asset allocation throughout age,

00:35:23.400 | or at least in retirement.

00:35:25.400 | Correct me if I'm wrong, Wade, but, you know, the rule of 100 serves pretty well.

00:35:30.400 | I think it's a pretty good rule.

00:35:32.400 | Starting point.

00:35:33.400 | Yeah, pretty good starting point.

00:35:35.400 | And Wade has come up with something different.

00:35:37.400 | It's a very fine analysis that shows that if you start retirement

00:35:42.400 | with a given allocation, you're actually better off if you raise that allocation

00:35:47.400 | throughout retirement as you get older.

00:35:51.400 | And I think, you know, he's done an excellent analysis.

00:35:54.400 | I think he's right.

00:35:56.400 | And I can even come up with some narrative stories that explain why he's right.

00:36:01.400 | But I'm wondering what you think of that idea.

00:36:04.400 | In other words, you should really be 80% or 90% stuck.

00:36:07.400 | [laughter]

00:36:10.400 | As Bob Dole would say, "Whatever."

00:36:13.400 | [laughter]

00:36:16.400 | There's one thing about mathematical analysis,

00:36:19.400 | which depends on a whole lot of hypotheses about future returns will be,

00:36:23.400 | all of which are uncertain.

00:36:24.400 | Even the great Vogels, that's in quotes, are uncertain.

00:36:27.400 | And you want to really be careful of extending, you know,

00:36:32.400 | your ideas into somebody's actual living platform.

00:36:35.400 | You do not want to ignore the behavioral problem.

00:36:38.400 | You would like to ignore it.

00:36:39.400 | You should ignore it.

00:36:40.400 | Investors should ignore it.

00:36:42.400 | But you're building kind of a world there where you're asking for the impossible.

00:36:47.400 | So I'm going to be interested in hearing Wade's thing.

00:36:49.400 | But before we end this, you know, I hope I can just push Bill a little bit.

00:36:54.400 | If he's up to it after getting out of the hospital, oh, my God, what a miracle.

00:36:57.400 | [laughter]

00:36:59.400 | You're making me look bad, man.

00:37:00.400 | [laughter]

00:37:03.400 | But talk a little bit about your three books, your three chapters on the investor.

00:37:08.400 | Okay, well, for those of you who haven't yet bought all three of my e-books,

00:37:14.400 | [laughter]

00:37:16.400 | I have a series which is called "Investing for Adults."

00:37:21.400 | What I say by adults, I mean people who know all the things that just about everybody

00:37:26.400 | or everybody in this audience knows about active management,

00:37:29.400 | about there's no stock-picking theory, there's no market-timing theory,

00:37:33.400 | there's no risk theory.

00:37:35.400 | And so the first book, who looked at life cycle investing,

00:37:40.400 | was somewhat congruent, actually, with the paper that Wade did as well.

00:37:43.400 | In fact, Wade helped me with it.

00:37:47.400 | And it just looks at life cycle throughout age,

00:37:51.400 | and it takes a somewhat different point of view from the rule of 100.

00:37:58.400 | I say it's a good place to start.

00:38:00.400 | But at the end of the day, I default back.

00:38:04.400 | The retirement really isn't two-bucket territory.

00:38:07.400 | It's nice to have one bucket and think of one portfolio throughout most of your life.

00:38:11.400 | But when your human capital runs out or is about to run out,

00:38:15.400 | what really matters to you most is your liability-matching portfolio.

00:38:19.400 | That is, the portfolio you need, the money you need,

00:38:22.400 | in addition to whatever pensions and Social Security you've got,

00:38:25.400 | to make sure that you're not diving the dumpster, all right?

00:38:29.400 | And maybe have a living standard which is closer to what you might be.

00:38:33.400 | And beyond that, you can invest in very, very risky assets.

00:38:37.400 | Well, if you think about what happens as your retirement progresses,

00:38:42.400 | you start out age, if you're a go-go head, 48.

00:38:45.400 | [laughter]

00:38:47.400 | And you have no human capital left

00:38:49.400 | because you're bouncing your grandkids on your knee.

00:38:52.400 | You're spending all your time in Florence.

00:38:55.400 | And so you have this liability-matching portfolio

00:38:58.400 | that's pretty large that you need.

00:38:59.400 | You probably don't have a lot of money left over from that, okay?

00:39:02.400 | Well, that's a low stock allocation.

00:39:06.400 | That's a high-bond stock allocation.

00:39:08.400 | Well, as you get advanced slowly into geezerhood,

00:39:12.400 | what happens is that you need less and less of a liability-matching portfolio.

00:39:17.400 | And if you're reasonably disciplined and you're a go-go head,

00:39:20.400 | your risk portfolio gets larger, okay?

00:39:27.400 | Now, unfortunately, in the United States,

00:39:29.400 | most people don't get anywhere near having a liability-matching portfolio.

00:39:34.400 | But then again, this is an alternative universe in this room.

00:39:38.400 | So we're not really talking about that.

00:39:41.400 | The second book really wasn't aimed at this audience.

00:39:44.400 | It was a book called Skating Where the Puck Was,

00:39:46.400 | and it's about alternatives.

00:39:48.400 | And basically, alternatives weren't a bad idea 20 to 10 years ago.

00:39:53.400 | Most ones actually did have positive alpha 15 to 10 years ago.

00:39:57.400 | They don't anymore.

00:39:58.400 | And that's simply because David Swensen went through the head of the buffet table,

00:40:05.400 | and he got the sirloin and the lobster tail,

00:40:07.400 | and the guys who came through behind him got the chopped hamburger.

00:40:16.400 | And unfortunately, David Swensen then went and tried to go through the line a second time,

00:40:20.400 | and he got mac and cheese from 2007 until 2012.

00:40:26.400 | And that's what that book is about.

00:40:28.400 | It's why alternatives in the modern era, that is, you know, the past five or ten years,

00:40:32.400 | are simply a terrible idea because there's far too many people chasing far too many alternatives,

00:40:38.400 | including one that might be important to discuss in this audience, and that's commodities.

00:40:43.400 | I have two words about commodities, which is "stay away."

00:40:47.400 | Or at least commodities futures funds.

00:40:50.400 | I'm more sympathetic towards commodities producers.

00:40:54.400 | The third book was a book called "Deep Risk."

00:41:00.400 | And "Deep Risk" is about the two different kinds of risk, which you can--

00:41:06.400 | and I don't mean to denigrate shallow risk.

00:41:09.400 | Shallow risk is, you know, temporary stock market falls,

00:41:12.400 | which can be a very high magnitude, but eventually are fairly quickly recovered.

00:41:17.400 | And I don't mean to denigrate shallow risk,

00:41:19.400 | because if you are someone with very little or no human capital, then shallow risk is really important.

00:41:25.400 | And in fact, you shouldn't even be concerned about deep risk at all.

00:41:29.400 | But if you're 23 years old and you have no investment capital,

00:41:32.400 | and you have a large amount of human capital left,

00:41:38.400 | then you should be very concerned with deep risk.

00:41:40.400 | And what are the deep risks?

00:41:41.400 | Well, I list them there.

00:41:43.400 | Inflation, deflation, confiscation, and devastation.

00:41:48.400 | All right?

00:41:49.400 | And inflation is the single most important one.

00:41:53.400 | And if you look at the long-term returns of stocks and bonds in multiple countries

00:41:57.400 | over the past century, almost a quarter,

00:42:00.400 | what you find is that inflation is a much bigger risk to bonds than to stocks.

00:42:07.400 | If you have inflation for a period of 30 or 40 or 50 years, it's a very high magnitude,

00:42:13.400 | you can actually have real stock returns, which happen in a number of countries,

00:42:17.400 | most particularly Israel and Chile.

00:42:19.400 | And even the nations that you think of as having awful inflation,

00:42:23.400 | like Argentina and Brazil, over 20 and 30 years, at least had zero real returns.

00:42:30.400 | You didn't lose real purchasing power.

00:42:32.400 | I was amazed to find that during the Weimar inflation of the 1920s, the wheelbarrow phase,

00:42:37.400 | stocks actually had a positive real return,

00:42:39.400 | because they were viewed as a real store of value.

00:42:43.400 | Bonds, on the other hand, get absolutely hammered.

00:42:46.400 | You lose all your money in bonds.

00:42:48.400 | So if you're concerned about deep risk, you really do want to invest in stocks for the long run.

00:42:53.400 | I don't view deflation and the fiat money era,

00:42:57.400 | now that we're off the gold standard, as being a serious issue,

00:43:00.400 | because it just doesn't exist anymore.

00:43:04.400 | Japan really hasn't had--people talk about Japan having deflation.

00:43:08.400 | During the past 10 or 12 years, I think they've had 2% total deflation.

00:43:15.400 | Ireland and Hong Kong had, I think, double digits for a relatively short period of time.

00:43:20.400 | That's it. Three countries out of 200 and some odd countries in the world.

00:43:24.400 | But it really had deflation.

00:43:27.400 | Confiscation, you can move abroad with that.

00:43:31.400 | You can play Gérard Depardieu and become a Russian citizen.

00:43:36.400 | When you talk about devastation in this day and age,

00:43:39.400 | you can buy an interstellar spacecraft.

00:43:44.400 | So that's what the book is really about,

00:43:47.400 | is how you think about portfolio management in terms of those risks.

00:43:52.400 | One thing I like about what Bill has done, and I thought the same thing about Peter Bernstein,

00:43:57.400 | is I am looking at myself in a kind of Jonas man, kind of a one-trick pony.

00:44:03.400 | But Peter Bernstein, to a much greater extent, Bill, has such a range of interests.

00:44:08.400 | And I love it when investment people, even self-trained investment people,

00:44:13.400 | have a lot of other interests.

00:44:15.400 | And he's written these books about the history of the world of plenty, it's called,

00:44:21.400 | something close to that, The Birth of Plenty.

00:44:26.400 | And then his newest one is about communications, is that a fair way to describe it?

00:44:33.400 | Communications technology.

00:44:34.400 | And communications technology.

00:44:36.400 | Another is about world trade, called A Splendid Exchange.

00:44:40.400 | I'm plugging you here, Bill.

00:44:41.400 | Thank you.

00:44:42.400 | All available on Amazon.

00:44:44.400 | But it's the broad-gauge view that I think finally is, in a way, a counterpoint to what I do.

00:44:53.400 | I'm very happy with what I do.

00:44:54.400 | I'm sure it's right because it's a simple man.

00:44:56.400 | But if you're going to go beyond that, listen to someone like Bill,

00:45:00.400 | who has such a broad range of experience and such a, not to embarrass him,

00:45:07.400 | but such intellectual brilliance.

00:45:10.400 | And it's a little bit like Paul Sagas, and I'll put you in his camp.

00:45:14.400 | And that is, I love to be associated with people who are hell-bound smarter than I am.

00:45:20.400 | It's amazing how much you can learn if you just take a minute to think.

00:45:24.400 | Take a minute to think of ideas in particular that are not those that you hold dear,

00:45:29.400 | but maybe even counter-opposing ideas.

00:45:31.400 | And one of the issues, and I hope that Bill can have a minute to comment on this,

00:45:35.400 | is when you get to asset allocation.

00:45:37.400 | It seems to me quite apparent, I don't know how to do it,

00:45:42.400 | but it's quite apparent the way you look at asset allocation depends on the relationship,

00:45:47.400 | oversimplified statement, but it'll make the point,

00:45:50.400 | on the relationship between bond yields and stock yields.

00:45:53.400 | And back in the Paul Volcker era, the 10-year treasury was 16%, or at least 15%,

00:46:00.400 | and it got down to 1.5%.

00:46:03.400 | So what rule might have applied when you had that kind of an option to protect your money

00:46:08.400 | in the early 1970s, when bond yields were so generous,

00:46:18.400 | and they were generous for years and years, and that's why we have a bull market in bonds,

00:46:22.400 | with the returns going down as interest rates go down.

00:46:27.400 | The returns were good for those that held it,

00:46:29.400 | and probably when you get back into the treasury, just by a principle-only treasury bond,

00:46:36.400 | there could have been no better investment than the U.S. Treasury.

00:46:41.400 | Nobody saw it at the time, but that's, I think, because they couldn't do the math,

00:46:44.400 | and I'm afraid even I didn't think about it enough at the time.

00:46:47.400 | But my question, I guess, Bill, is what do you think about, conceptually,

00:46:52.400 | the idea of taking into account, when you're talking about safety in bonds,

00:46:57.400 | and growth in stocks, if you will,

00:47:01.400 | about taking into account the yield differential that exists,

00:47:07.400 | sometimes greatly in favor of bonds,

00:47:11.400 | sometimes kind of today I would call it more or less neutral,

00:47:14.400 | maybe a little bit better in bonds, but not much,

00:47:16.400 | about taking that into account conceptually?

00:47:20.400 | And then the much more difficult question is,

00:47:23.400 | when you come to grips with it conceptually,

00:47:26.400 | assuming you think there's some reason to it,

00:47:29.400 | how the hell do you implement it, and when?

00:47:31.400 | Well, that's a very interesting question, Jack.

00:47:34.400 | I'll tell another story out of school here.

00:47:38.400 | First of all, the first part, that was a little older-dash.

00:47:41.400 | When people ask me, usually it's people who aren't from New York asking me,

00:47:46.400 | because my last name is Bernstein, I was related to Peter,

00:47:49.400 | and I always say two things, number one is I wish,

00:47:52.400 | and number two is he's who I want to be when I grow up.

00:47:57.400 | But I learned at the feet of a master, Jack.

00:48:03.400 | You taught me the three-step for estimating stock returns

00:48:07.400 | and comparing them to bond returns, and of course it matters.

00:48:12.400 | And now I'll tell my out-of-school story,

00:48:15.400 | which is I had dinner with you some years ago,

00:48:18.400 | but not too far from 2000.

00:48:22.400 | And I waited until you had drank, I think it was your dry martini,

00:48:26.400 | before I asked you this question.

00:48:29.400 | And I finished my beer, because I needed to screw up my courage,

00:48:32.400 | and I said, well, Jack, tips are now yielding 4%,

00:48:37.400 | and stocks look like they're priced to yield a real return of 2%.

00:48:44.400 | This was in the day when yields were 1% back in the early 2000s or late 1990s.

00:48:51.400 | And I said, doesn't that impact your asset allocation just a little bit?

00:48:56.400 | And you said, yeah, I'll probably own 5% less stocks.

00:49:01.400 | And of course, not too long after that, Jack,

00:49:05.400 | I think I went to my first boogleheads, and he flips up a slide,

00:49:09.400 | and he projected negative nominal returns for the next 10 years for stocks,

00:49:18.400 | and everybody guessed, because you brought in mean reversion,

00:49:21.400 | which was something that I wasn't even willing to think about.

00:49:25.400 | - Mean reversion of the P/E.

00:49:27.400 | - Yes, mean reversion of the P/E.

00:49:29.400 | So what's it look like in 2013?

00:49:32.400 | Well, you can do the math as well as I can.

00:49:35.400 | Stocks--excuse me--bonds have a zero return pretty much,

00:49:40.400 | certainly a zero real return.

00:49:42.400 | Stocks are priced to yield a positive 3.5% return, real return, real return.

00:49:48.400 | So all right, maybe you should own more stocks now.

00:49:53.400 | But then what happens, Jack, if we get mean reversion of P/Es?

00:49:58.400 | - Well, that gets to--and I talked a little bit about this maybe before you got here--

00:50:02.400 | about where the P/E is today.

00:50:04.400 | And there are so many ways of calculating, and I went through that earlier,

00:50:07.400 | and I won't take you through it again.

00:50:09.400 | But I'd say they are within the bounds of reason in terms of the future.

00:50:13.400 | I don't think--I mean, the P/Es go from--

00:50:16.400 | I mean, I'm using a range of--I think it's 20 for the reported earnings,

00:50:24.400 | past reported earnings, and about 15 for the future earnings,

00:50:29.400 | the so-called accounting-only operating earnings, the lower earnings, the higher earnings figure.

00:50:34.400 | And so let's just use 17 just for the element.

00:50:37.400 | You've got to start somewhere.

00:50:39.400 | And, you know, if you went to 20,

00:50:41.400 | that would have very little impact on your return to P/E of 20 from there.

00:50:45.400 | And if you went from 15, that would have very little positive impact.

00:50:49.400 | And not enough--since they're all guesses,

00:50:51.400 | I'd say not enough to change your course of action.

00:50:54.400 | So I don't see a lot of mean reversion there, although that's the reality.

00:50:58.400 | And I think I might have it--do I have this in John Wasik's book?

00:51:02.400 | Michael, your version of P/Es.

00:51:05.400 | It will--I think it's in--I think I put it in the former I wrote to John's book.

00:51:09.400 | And that is what we know about past experience, which is not--without utility here,

00:51:14.400 | is that if a P/E is over 20, the odds are about 85% that it will go down in the next 10 years,

00:51:20.400 | by the end of the next 10 years.

00:51:22.400 | And if the P/Es are under 12, the odds are also about 85% it will go up in the next 10 years.

00:51:27.400 | So you have a little bit of that going for you.

00:51:31.400 | A little bit of knowledge about some kind of reversion that's more likely to take place than not.

00:51:37.400 | Not mathematical purity or precision at all.

00:51:41.400 | But when you get through it all, you know, the dividend yield is pretty precise

00:51:45.400 | and it's highly unlikely to be cut again for a long time, but it could be, of course.

00:51:49.400 | Earnings growth is going to have something to do with the GDP.

00:51:52.400 | Earnings growth is slower, as everybody should know.

00:51:54.400 | But there should be earnings growth of some dimension.

00:51:57.400 | And the one thing I'd be interested in what you think about this bill is

00:52:01.400 | I assiduously calculate nominal stock returns and then take out an estimated inflation number.

00:52:11.400 | So there are two discrete numbers that lead to the real return.

00:52:17.400 | I'm very uncomfortable with numbers that don't have that kind of a split

00:52:23.400 | where they build CPI into maybe earnings growth, from nominal earnings growth to real earnings growth.

00:52:29.400 | First, I'm not sure where it all should come out of there.

00:52:31.400 | I'm not sure how to handle that.

00:52:32.400 | But I like the knowledge that I can make my own inflation adjustment looking ahead

00:52:38.400 | and not be wrapped up in somebody else's.

00:52:41.400 | So I can take each step of this way.

00:52:43.400 | And what I like about it, it's so fragile, I like one of my own ideas.

00:52:49.400 | But what I like about mine is they're very discrete.

00:52:51.400 | You cannot argue about the dividend yield.

00:52:53.400 | You can argue about the earnings growth, but only within limits.

00:52:57.400 | I mean, I think we all know it's not going to be 15%.

00:53:00.400 | And we all assume it's not going to be zero.

00:53:02.400 | So you pick your own number of earnings growth.

00:53:04.400 | That's two-thirds of the equation, a known and a highly likely.

00:53:07.400 | And the PE, when you get down there, you know the probabilities.

00:53:10.400 | So it takes a lot of the mystery out of stock returns.

00:53:15.400 | And it focuses on anything less than 10 years.

00:53:18.400 | Oh, they still ask me.

00:53:19.400 | Maria Barnaromo still says, how do you feel about today's market?

00:53:23.400 | Yeah.

00:53:24.400 | Okay, well, Mel just told me his stomach is really starting to growl.

00:53:27.400 | [Laughter]

00:53:29.400 | So I'll make this snaggy.

00:53:30.400 | You're right.

00:53:31.400 | Well, that's great food for thought.

00:53:33.400 | People probably want to put some food in their belly.

00:53:36.400 | [Laughter]

00:53:37.400 | So I hadn't figured mine was that much.

00:53:39.400 | Jack, you earlier quoted Ben Franklin.

00:53:41.400 | And Ben Franklin has another famous saying that I like to quote.

00:53:45.400 | And that's, "A penny saved is a penny earned."

00:53:48.400 | So we thought this Ben Franklin bust was appropriate

00:53:51.400 | because he saved investors trillions of pennies and billions of dollars.

00:53:55.400 | Please accept this as a reminder of the 2013 Volcanics Conference

00:53:59.400 | and a reminder of all the money we've saved investors.

00:54:02.400 | [Applause]

00:54:20.400 | Good God.

00:54:21.400 | [Laughter]

00:54:23.400 | Three hours and 45 minutes with Vogel.

00:54:25.400 | And even with the help of Bernstein to bail me out at the end.

00:54:28.400 | It was quite remarkable.

00:54:30.400 | You should know that I've received, I think, four of these.

00:54:34.400 | A long enough for these things.

00:54:36.400 | I've got Independence Hall.

00:54:37.400 | I've got the Love Statue.

00:54:39.400 | And they all sit right on my mantelpiece in my den.

00:54:44.400 | And this will go next to them.

00:54:45.400 | But something's going to have to go off it now.

00:54:47.400 | [Laughter]

00:54:48.400 | I know you said that, but we just thought this was so appropriate.

00:54:51.400 | Oh, this is perfect.

00:54:52.400 | This will be the last one.

00:54:54.400 | Oh, I don't want to hear about the last anymore.

00:54:56.400 | [Laughter]

00:54:59.400 | I don't want to hear about the last hurrah.

00:55:01.400 | I know you're out of space in your den.

00:55:05.400 | Well, thank you all very much.

00:55:07.400 | And how you can handle this much provo is beyond my comprehension.

00:55:11.400 | But you've all been very generous.

00:55:14.400 | When my wife says--she doesn't do it anymore--she says, "How's the speech go?"

00:55:20.400 | And I say, "Well, I don't really have any idea, but I do know this.

00:55:24.400 | When I laughed, they laughed.

00:55:26.400 | When I cried, they cried.

00:55:29.400 | And when I sat down, they applauded."

00:55:31.400 | [Laughter]

00:55:32.400 | Thank you all very much.

00:55:33.400 | [Applause]

00:55:35.400 | [Applause]

00:55:36.400 | [Applause]

00:55:37.400 | [Applause]

00:55:38.400 | [Applause]

00:55:39.400 | [Applause]

00:55:40.400 | [Applause]

00:55:41.400 | [Applause]

Bogleheads® Conference 2013 - John Bogle & Bill Bernstein Fireside Chat

Chapters