Bogleheads® on Investing Podcast 013 – Dr. Bill Bernstein, host Rick Ferri (audio only)

00:00:00.000 | (upbeat music)

00:00:02.580 | - Welcome to Bogleheads on Investing, podcast number 13.

00:00:14.520 | Today we have a special guest, Dr. Bill Bernstein.

00:00:19.200 | Dr. Bernstein is a neurologist, financial historian,

00:00:24.200 | author, advisor, and overall, really smart guy.

00:00:28.960 | (upbeat music)

00:00:31.540 | Welcome to Bogleheads on Investing, podcast number 13.

00:00:41.960 | My name is Rick Ferry, and I'm the host of this podcast.

00:00:45.940 | This episode, along with all episodes,

00:00:48.520 | are brought to you by the John C. Bogle

00:00:51.480 | Center for Financial Literacy, a 501(c)(3) corporation.

00:00:57.240 | Today, my special guest is Dr. William Bernstein,

00:01:01.180 | a favorite of the Boglehead community.

00:01:04.140 | Dr. Bernstein is a neurologist, financial historian,

00:01:09.140 | author, advisor, and a walking encyclopedia.

00:01:14.460 | Jack Bogle used to refer to Bill Bernstein

00:01:17.560 | as the smartest guy in the room.

00:01:19.940 | I always joke that when I have lunch with Bill,

00:01:22.480 | the three of us have a great conversation.

00:01:24.920 | So, with no further ado, it is my great pleasure

00:01:28.960 | to have on the Bogleheads on Investing podcast,

00:01:32.280 | Dr. Bill Bernstein.

00:01:33.720 | Welcome, Dr. Bernstein.

00:01:36.000 | - Hey, glad to talk to you, Rick.

00:01:37.360 | And by the way, my first name is not doctor.

00:01:40.300 | - It isn't?

00:01:41.140 | But everybody refers to you as doctor.

00:01:43.180 | (laughing)

00:01:44.040 | - It gives me the creepy crawlies.

00:01:45.440 | (laughing)

00:01:46.780 | I get PTSD, and I pretend I've got a white coat on, you know?

00:01:50.120 | (laughing)

00:01:51.480 | - You know, I work with a lot of doctors,

00:01:54.320 | and a lot of them are a lot less formal

00:01:57.240 | about being called doctor than it was, say, 25 years ago.

00:02:00.680 | Do you find that?

00:02:01.960 | - Yeah, I think so.

00:02:03.280 | There's no question.

00:02:04.360 | I mean, I think that physicians these days

00:02:05.960 | are a whole lot more emotionally mature,

00:02:08.580 | at least young physicians are,

00:02:09.720 | than they were 30 and 40 years ago.

00:02:12.180 | - Just for the funny, any time I even put in an email,

00:02:15.000 | you know, Dr. Smith or Dr. Jones, male or female,

00:02:17.800 | they'll always come back and say, no, no, no, no, no.

00:02:20.320 | You know, call me by my first name.

00:02:21.620 | So, I've just stopped doing the doctor thing.

00:02:24.100 | They don't seem to mind, but when I was young,

00:02:26.040 | you called a doctor, doctor.

00:02:27.680 | So, Bill, Bill, how are you?

00:02:30.280 | (laughing)

00:02:31.720 | - I'm fine, Rick, and how about you?

00:02:33.520 | - I'm doing well.

00:02:34.480 | So, speaking of doctors,

00:02:36.640 | but you were a neurologist at one time, is that correct?

00:02:39.720 | Did I say that correctly?

00:02:40.560 | - Correct.

00:02:41.680 | For 25, yes.

00:02:43.200 | - 25 years, and did you do operations?

00:02:46.160 | Like, I'm just curious, did you go deep into pain,

00:02:48.400 | or what did you do?

00:02:49.240 | - No, no, no, no.

00:02:50.060 | There's a difference between a neurologist

00:02:50.960 | and a neurosurgeon.

00:02:52.160 | A neurosurgeon is the guy or gal who operates,

00:02:57.120 | and neurologists are medical doctors.

00:02:59.440 | We work a lot with neurosurgeons,

00:03:00.960 | and they work a lot with us,

00:03:03.000 | but we don't operate.

00:03:04.480 | And it loses me the opportunity to tell a really good joke,

00:03:08.240 | which is that people look at me and say,

00:03:11.000 | how hard was it to learn finance at your age?

00:03:14.120 | And I like to tell them that, well, yeah,

00:03:16.200 | finance is hard, but it's not brain surgery.

00:03:18.960 | (laughing)

00:03:21.160 | - Yeah, at one point, you decided enough

00:03:23.160 | of all of the noise on Wall Street,

00:03:25.360 | and you were gonna go out and investigate this on your own,

00:03:27.720 | because you had come to the realization

00:03:29.960 | that what was going on out there on Wall Street

00:03:32.360 | was not working, at least not for you.

00:03:35.100 | And you started going down the path of learning on your own,

00:03:38.600 | which a lot of physicians are now,

00:03:40.680 | which I find great, by the way.

00:03:41.920 | A lot of people are self-learning like you did.

00:03:45.860 | But you just kept on going after you went down that path,

00:03:49.560 | and you got so into it

00:03:50.720 | that you decided to start writing books,

00:03:52.400 | and you actually opened up an investment company.

00:03:54.840 | Can you elaborate on that?

00:03:57.480 | - Well, sure.

00:03:58.400 | I mean, I live in a country

00:04:00.120 | that doesn't have a functioning social welfare system,

00:04:02.600 | so I had to basically save and invest on my own.

00:04:07.080 | And I had scientific training,

00:04:09.160 | and I approached investing the way I thought

00:04:11.360 | that any scientist would,

00:04:12.840 | which is you read the basic tests,

00:04:15.060 | the peer-reviewed literature,

00:04:17.460 | you collect data, you built models.

00:04:20.640 | And I went and did all those things,

00:04:22.280 | and by the time I'd finished doing this in the early 1990s,

00:04:26.120 | I realized that I had something

00:04:27.880 | that was useful to other small investors.

00:04:31.240 | And so I wrote my first book,

00:04:33.000 | "The Intelligent Asset Allocator,"

00:04:34.520 | as basically an online book in 1995,

00:04:39.320 | and I give credit to Frank Armstrong

00:04:41.560 | for telling me that I should do that.

00:04:44.100 | And the rest just followed from that.

00:04:47.740 | You can't write about finance without two things happening.

00:04:52.020 | Number one is people ask you to start managing money,

00:04:55.260 | and number two, and more subtly,

00:04:57.620 | you come to the realization

00:04:59.580 | that you can't write about finance

00:05:00.920 | without writing about the history of finance

00:05:04.140 | and the history of economics.

00:05:05.900 | And so that opened up yet another career,

00:05:08.380 | which is writing books about economic growth and trade

00:05:12.340 | and things like that.

00:05:14.660 | - Yeah, and I want to go down that path a little bit

00:05:16.180 | because I want to eventually talk about Brexit

00:05:20.700 | and trade deals that are going on with China

00:05:24.780 | and how all that affects us.

00:05:26.120 | But so from your lens, having written,

00:05:29.060 | is it four history books now or economic history?

00:05:33.220 | - Yeah, yeah, I'm working on my fourth.

00:05:35.860 | I've written three so far,

00:05:37.340 | and there's a fourth that'll be coming out

00:05:40.260 | in about a year's time from now.

00:05:42.700 | - So Bill, the first economic history book you wrote

00:05:45.180 | was "The Birth of Plenty."

00:05:47.420 | Just briefly what you learned in that book

00:05:50.020 | and then how that led to the next book.

00:05:52.620 | - It's a long, shaggy dog story,

00:05:54.340 | but one of the reasons why I became interested

00:05:56.540 | not only in economic history but also in finance itself

00:05:59.760 | is because I knew 35 years ago

00:06:02.580 | that the most successful economies

00:06:04.100 | and the world's most successful securities markets

00:06:08.020 | existed in countries that spoke English.

00:06:10.540 | All of the daughter countries,

00:06:12.220 | great daughter countries of England,

00:06:14.300 | the United States, Canada, New Zealand,

00:06:16.380 | Australia, South Africa, all had very successful economies

00:06:20.460 | and all had securities markets with higher returns.

00:06:24.140 | Very few other countries matched that.

00:06:26.300 | Sweden, Switzerland came fairly close.

00:06:30.620 | And I wondered why that was.

00:06:33.380 | And it turns out it's nothing to do

00:06:35.260 | with the English language,

00:06:36.580 | but what it does have everything to do with

00:06:38.220 | is English common law.

00:06:40.220 | And I quickly came to the realization

00:06:43.300 | that it was English institutions

00:06:45.340 | and particularly the common rule of law

00:06:48.340 | and equality under the law

00:06:50.100 | that were behind the prosperity.

00:06:52.060 | And of course, that's not an original line.

00:06:54.060 | To me, Doug North got a Nobel Prize

00:06:56.940 | for realizing that 30 years ago.

00:06:59.260 | That's how I came to write "Birth of Plenty,"

00:07:01.980 | which was a modestly successful book.

00:07:05.140 | And as I had just finished that book,

00:07:08.940 | I get this phone call from a man

00:07:12.100 | by the name of Brando Skyhorse,

00:07:16.020 | who it turned out was an acquisitions editor

00:07:18.380 | for Grove Atlantic Press.

00:07:21.020 | And he said, "I'd like you to write a book

00:07:24.100 | "about economic history of trade,

00:07:27.060 | "the economic history of trade."

00:07:28.420 | And so I said, "Well, in the first place,

00:07:30.300 | "I don't know anything about it.

00:07:32.380 | "In the second place, I'm not interested in it.

00:07:35.060 | "And in the third place, you've got the wrong Bernstein,

00:07:38.140 | "the person you wanted was, of course,

00:07:39.820 | "Peter Bernstein." - Peter Bernstein,

00:07:40.980 | of course. (laughs)

00:07:41.820 | - Yeah, and there was this awkward silence

00:07:44.420 | at the end of the line, and he said,

00:07:46.460 | "Well, we had lunch with him last week,

00:07:49.380 | "and we did offer him the project."

00:07:52.060 | And he said that he was busy.

00:07:53.660 | He was writing his history of the Erie Canal at the time.

00:07:57.860 | And Peter said, "But there's this other Bernstein

00:08:00.780 | "you ought to read."

00:08:02.980 | So I said, "I don't know.

00:08:04.620 | "There's other things I wanna write."

00:08:06.100 | And I went out into the family room

00:08:09.300 | where my wife was finishing her coffee

00:08:11.500 | and "The New York Times" crossword puzzle.

00:08:14.220 | And she puts down her coffee,

00:08:15.820 | and she puts down "The New York Times" crossword puzzle,

00:08:18.980 | and she says, "You know who Grove Atlantic Press is?"

00:08:22.380 | And I said, "No."

00:08:23.860 | And she said, "Well, you've heard of the Atlantic Monthly?"

00:08:26.860 | And I said, "Yes, I know the Atlantic Monthly."

00:08:29.020 | And she said, "And you know what Grove Press is?"

00:08:31.860 | And I said, "Well, yeah, you know Doris Lessing,

00:08:33.540 | "and P.J. O'Rourke, and Henry Miller,

00:08:35.260 | "and people like that."

00:08:36.660 | And she said, "Write."

00:08:37.820 | She said, "If you value your career

00:08:40.980 | "as a nonfiction writer,

00:08:42.340 | "you will write whatever it is they want you to write."

00:08:45.660 | - Okay.

00:08:46.500 | - So that's how I came to write "Splendid Exchange,"

00:08:50.540 | which succeeded beyond my wildest dreams.

00:08:54.100 | It was very well received.

00:08:56.700 | And I mean, one occasionally gets bad reviews

00:09:00.740 | on places like Amazon,

00:09:02.620 | but the major media reviews that I got

00:09:05.340 | were uniformly positive.

00:09:09.260 | And it's also been the source of any number

00:09:11.460 | of really interesting speaking gigs over the past 10 years.

00:09:14.980 | - Bill, from the perspective of trade,

00:09:17.060 | we're in a interesting situation in history right now

00:09:20.500 | where we're beginning to see trade wars

00:09:23.860 | that one could argue we are starting,

00:09:27.740 | not only between us and China,

00:09:30.300 | but there might be issues with Brexit,

00:09:34.500 | for example, between the UK and continental Europe

00:09:38.820 | and Ireland.

00:09:40.500 | We see trade wars, if you will,

00:09:42.180 | and trade problems potentially increasing in the future.

00:09:45.300 | Based on your work and your knowledge of it,

00:09:49.580 | where do you see these things going?

00:09:52.660 | - Well, not in a good place.

00:09:55.380 | To say that trade wars are easy to win

00:09:58.780 | is akin to wearing a bright neon sign on your forehead

00:10:02.540 | that says, "I don't know the first thing about history."

00:10:05.780 | We had trade wars in the 1930s,

00:10:08.420 | and not only were they disastrous

00:10:10.460 | from a geopolitical point of view,

00:10:12.100 | but they were disastrous

00:10:13.060 | from a military point of view as well.

00:10:15.420 | You can make a very good case that the Smoot-Hawley Tariff

00:10:18.340 | and the other tariffs that gave a rise to in retaliation

00:10:25.100 | were a direct cause of World War II.

00:10:28.940 | And it's not an accident that the people

00:10:31.540 | who set up what became the World Trade Organization

00:10:36.420 | were people in the State Department who swore,

00:10:38.340 | "Never again, we're never going to have this again.

00:10:40.820 | We want an international order

00:10:42.620 | that prevents the geopolitical catastrophe

00:10:44.980 | you get from trade wars."

00:10:47.340 | It does appear highly likely

00:10:49.660 | that Britain will go crashing out of the EU.

00:10:54.540 | And if that happens,

00:10:56.220 | it will not be an entirely negative event

00:11:00.180 | for the following reason,

00:11:02.100 | which is it will prove to be a relatively cheap object lesson

00:11:06.900 | about what happens when you follow protectionism

00:11:10.780 | to its final conclusion.

00:11:14.180 | If you think you can destroy the international trade order

00:11:18.380 | and thumb your nose at it,

00:11:19.780 | or an organization like the EU and get away with it,

00:11:23.180 | you're going to be sadly mistaken.

00:11:26.140 | You know, I always thought it was useful

00:11:28.100 | to have a couple of communist regimes around,

00:11:30.380 | like North Korea and Cuba,

00:11:33.100 | as object lessons to the rest of the world,

00:11:36.820 | in terms of the risks and the costs

00:11:40.740 | of a truly communist form of government.

00:11:43.780 | - Well, that's an interesting perspective, Bill.

00:11:45.260 | So basically, there's a lot more to trade wars

00:11:49.100 | than just trade.

00:11:50.900 | There's a very predictable sequence of events

00:11:54.220 | that occurs when you start a trade war.

00:11:57.260 | In the first place, you're shooting yourself in the foot

00:11:59.700 | because it's a tax on your consumers.

00:12:02.300 | To anyone who doubts that,

00:12:03.300 | I suggest you go out

00:12:04.220 | and try and buy a washing machine right now.

00:12:06.260 | So that's the first thing that happens.

00:12:07.620 | Secondly, it damages your own domestic corporations

00:12:11.300 | who need foreign inputs

00:12:13.060 | because they're going to be spending a lot more.

00:12:15.420 | The third thing that happens

00:12:17.460 | is that you get retaliatory tariffs.

00:12:20.820 | And then the fourth things that happens

00:12:22.380 | is you get shooting wars.

00:12:23.820 | And history is rife with trade wars

00:12:27.260 | that evolved into shooting wars.

00:12:28.500 | I mean, the Dutch and the British fought four of them

00:12:31.980 | a couple of centuries ago,

00:12:33.460 | just over the issue of trade.

00:12:34.780 | Why did the Japanese attack Pearl Harbor?

00:12:36.660 | Well, they attacked Pearl Harbor

00:12:37.780 | because we embargoed their oil.

00:12:39.980 | You're playing with fire.

00:12:42.900 | It's a stupid thing to do.

00:12:44.980 | - Well, let's move on to the masters of the word.

00:12:48.340 | And I recall, I read the book before you published it.

00:12:52.340 | Thank you for letting me do that.

00:12:53.460 | And I thought it was a fascinating book.

00:12:55.780 | - Well, it sank like a stone.

00:12:57.500 | I had a good time writing it.

00:12:59.260 | And what I learned about it is that,

00:13:01.180 | writing a long form history book

00:13:02.980 | is really about the process.

00:13:04.820 | And if you don't enjoy the process,

00:13:06.620 | you shouldn't be writing the book.

00:13:08.340 | And it would have been nice

00:13:09.260 | if I had gotten the frosting on the cake

00:13:11.060 | of a successful book.

00:13:12.740 | But at the end, I learned an awful lot.

00:13:16.460 | And the reason why it sank was simply

00:13:21.100 | because media academics,

00:13:23.660 | who are the people who are gonna be reviewing the book,

00:13:25.940 | didn't like it because I didn't pay proper homage

00:13:30.060 | to McLuhan and Kittler and Derrida and people like that,

00:13:34.660 | who I didn't find terribly relevant to my story.

00:13:37.740 | So it was a lesson in a number of regards.

00:13:40.700 | - So just to regress a little bit,

00:13:42.540 | that the book was about the history, if you will,

00:13:44.780 | of communication and how that affects society.

00:13:48.900 | - Yeah, the basic thesis of the book

00:13:52.060 | was that access to communication technology

00:13:55.060 | is what determines politics.

00:13:57.060 | So for example, in the ancient world,

00:14:00.300 | very few people knew how to read and write.

00:14:03.220 | Not only did they not have the time to do it,

00:14:05.340 | but the writing systems that were in place

00:14:07.580 | were extremely complex and took a long period of time.

00:14:12.020 | So no one could afford the time to learn them.

00:14:14.420 | So if you were a scribe, if you could read and write,

00:14:16.820 | which had to have been less than 1% of the population,

00:14:20.500 | you were the combination of a software engineer

00:14:23.620 | and a venture capitalist and an investment banker,

00:14:26.300 | all rolled up into one.

00:14:27.860 | You were the person who could basically

00:14:30.060 | give everybody else their orders.

00:14:32.980 | And that changes around 600 or 700 BC

00:14:37.700 | when the Greeks inherit the Phoenician writing system,

00:14:41.140 | which doesn't have vowels, and they put vowels into it.

00:14:44.820 | And all of a sudden,

00:14:46.220 | with the presence of vowels and consonants,

00:14:48.740 | a clever five-year-old can learn how to read.

00:14:52.220 | And at the time of, say, Pericles,

00:14:55.540 | probably 50% of Greek citizens,

00:14:59.140 | who were all, of course, all men, could read and write.

00:15:02.900 | Well, it's not an accident

00:15:04.140 | that democracy develops in ancient Greece.

00:15:07.060 | And you can jump a couple of millennia ahead of that,

00:15:11.460 | and you could look at Nazi Germany

00:15:13.900 | and see that their degree of control over the population

00:15:18.340 | basically stemmed from the fact that they controlled

00:15:20.860 | the leading-edge communications technology of the era,

00:15:23.780 | which was, of course, radio.

00:15:25.740 | You know, Bret Stephens wrote a very fine column about that

00:15:28.940 | in "The New York Times" last week.

00:15:30.500 | It's not an accident that totalitarianism

00:15:33.540 | has its high watermark in the '30s and '40s

00:15:36.540 | with the rise of radio.

00:15:38.060 | - But radio was just a one-way communication.

00:15:40.060 | It went out, but it didn't come back.

00:15:41.900 | - Exactly.

00:15:42.740 | If you wanted to say something back to the radio,

00:15:44.220 | you were out of luck.

00:15:45.900 | - So then it entered the internet,

00:15:47.300 | and suddenly now it goes both ways and things change again.

00:15:51.260 | - Exactly, exactly.

00:15:52.420 | Now, the question is,

00:15:53.860 | the other really interesting story was, you know,

00:15:57.220 | were some of the things

00:15:58.060 | that people don't talk about very much

00:15:59.220 | that contributed to the fall of communism.

00:16:01.340 | Obviously, it was a miserable economic system,

00:16:03.380 | and that didn't help.

00:16:04.700 | But the Russians, the Soviets,

00:16:07.020 | weren't nearly as smart as the Germans

00:16:08.820 | because the Germans made radios

00:16:10.340 | that made it almost impossible

00:16:11.820 | to receive foreign broadcasts, okay?

00:16:14.380 | The Russians built these very sophisticated

00:16:16.500 | shortwave receivers that could get, you know,

00:16:20.180 | Voice of America, Radio Liberty, the BBC.

00:16:22.940 | And when you read people like Lech Walesa

00:16:25.980 | and Václav Havel, the first thing they tell you

00:16:29.100 | is that it wasn't for Radio Liberty and Radio Free Europe,

00:16:32.860 | which, of course, were CIA plants.

00:16:35.140 | They wouldn't have gotten anywhere.

00:16:37.140 | - And so here we have a situation

00:16:39.180 | where instant news everywhere all around the world.

00:16:42.580 | You know, if a one-tier gas canister gets shot in Hong Kong,

00:16:47.060 | the whole world knows about it within 10 seconds.

00:16:49.980 | How is that changing things?

00:16:52.700 | - Well, it makes the cost

00:16:54.140 | of totalitarian suppression much higher.

00:16:57.220 | The Hutus in Rwanda, you know, 25 years ago,

00:17:01.940 | could use the radio to direct their genocide,

00:17:05.420 | and the people on the other side

00:17:07.140 | didn't have any way of publicizing what was happening.

00:17:10.420 | Well, if they tried that today,

00:17:12.580 | there would be cell phone videos

00:17:15.140 | that would be flooding the internet,

00:17:16.900 | and people would have intervened a whole lot faster.

00:17:20.100 | I think, you know, the one thing you can,

00:17:21.660 | you know, you can talk about

00:17:22.660 | the negative effects of social media,

00:17:24.860 | but one thing I'm quite certain of,

00:17:26.340 | which is that the internet and cell phones

00:17:28.820 | have made genocide a whole lot harder.

00:17:31.940 | - Let me ask about what you're working on now.

00:17:33.420 | I know you're working on another book.

00:17:36.180 | - (laughs) Well, yeah.

00:17:38.540 | I'm working on a modern version of a book

00:17:40.700 | that I'm sure you've read too,

00:17:42.260 | which is 178 years old,

00:17:44.660 | called "Memoirs of Extraordinary Copter Delusions

00:17:47.220 | "and the Madness of Crowds" by Charles Mackay,

00:17:50.420 | who was a Scotsman.

00:17:51.780 | And the book is famous, as we both know in finance,

00:17:55.220 | because it described the three great bubbles

00:17:58.060 | of the 17th and 18th century,

00:17:59.940 | the tulip mania, which Mackay got completely wrong,

00:18:03.340 | and the South Sea and Mississippi Company bubbles,

00:18:06.300 | which he did a fairly good job with,

00:18:09.460 | or at least a fair job with.

00:18:11.100 | And I can remember reading that book in the 1990s,

00:18:15.100 | and thinking to myself, my God, this is fascinating,

00:18:19.460 | but I'm never gonna see anything like this, of course.

00:18:22.660 | And then all of a sudden, right in front of my eyes,

00:18:24.940 | I saw the same kind of behavior

00:18:27.860 | as Mackay observed with tech stocks

00:18:31.060 | and the popular mania that surrounded them,

00:18:33.420 | and it saved me a lot of money.

00:18:36.300 | And I'm certainly not the only person

00:18:40.580 | who had that experience,

00:18:41.660 | or by many decades was the first person

00:18:44.420 | to have that experience,

00:18:45.260 | because the book has been in print ever since 1841,

00:18:48.860 | and the 1932 edition, the forward to it,

00:18:52.500 | was written by Bernard Baruch,

00:18:54.940 | who had his bacon saved in 1907 by it.

00:18:58.140 | So that's the first thing that impressed me about it.

00:19:01.180 | And then the other thing that really impelled me

00:19:04.900 | to write the book was the rise of the Islamic State

00:19:07.860 | in the Middle East,

00:19:09.220 | and how the Islamic State and their predecessor,

00:19:12.260 | ISIS or ISIL, or however you wanna refer to it,

00:19:16.540 | and how they were able to attract people

00:19:18.380 | from tens of thousands of people from around the world,

00:19:20.860 | some of them from very comfortable Western societies,

00:19:23.940 | to hell on earth, and to fight and to die there.

00:19:28.940 | And of course, Mackay wrote about religious manias too.

00:19:32.860 | And so I had to write a book

00:19:34.940 | that married the two of those together,

00:19:37.180 | because they were both popular manias,

00:19:38.540 | both financial manias and religious manias

00:19:40.980 | propagate by the same social mechanisms.

00:19:43.420 | So I wanted to write about that,

00:19:44.780 | and that's what I'm finishing up on.

00:19:46.580 | - And is Bitcoin and cyber currency part of that?

00:19:50.860 | I had to ask.

00:19:52.620 | - It gets about two sentences or three sentences.

00:19:55.700 | It's just, it's quite frankly,

00:19:58.860 | it's not big enough to make it into my book.

00:20:00.940 | It still makes headlines,

00:20:02.860 | but you don't very often meet people

00:20:05.180 | who will talk your heads off about it at a cocktail party,

00:20:09.140 | which is typically what happens during a mania of any sort.

00:20:12.660 | - Back in the 1990s, people were experts.

00:20:15.460 | You go to your local barber to get a haircut,

00:20:17.340 | and they were experts on tech stocks.

00:20:19.940 | I don't think you have that with cyber currency.

00:20:22.420 | I don't think anybody claims to be an expert.

00:20:24.180 | I think they all know what they're doing is speculation.

00:20:27.060 | - Although the really interesting thing

00:20:28.940 | is that it seems that every other Uber driver

00:20:31.140 | that I encounter wants to talk

00:20:33.140 | about the inverting yield curve.

00:20:35.300 | - That's true.

00:20:36.140 | And negative interest rates

00:20:39.620 | get to be a big thing right now as well.

00:20:41.380 | A lot of people tend to want to talk

00:20:42.780 | about negative interest rates,

00:20:43.900 | which, you know, speaking of that,

00:20:46.500 | let's get into this a little bit.

00:20:49.660 | Negative interest rates are a new phenomenon.

00:20:53.140 | I mean, as far back as what I can tell, right?

00:20:55.860 | Years going back.

00:20:56.820 | I mean, interest rates may have been low

00:20:58.380 | because inflation was low,

00:21:00.020 | but where do negative interest rates get countries

00:21:03.220 | like Germany and Japan, Switzerland?

00:21:07.220 | I mean, where does that all go?

00:21:09.780 | - Well, I tend to look at negative interest rates

00:21:12.740 | more as a symptom than as a root cause of anything.

00:21:18.820 | It's obviously not good for fixed income investors,

00:21:21.740 | but what it's a manifestation of

00:21:23.900 | is several different things all coming together

00:21:27.220 | into a perfect storm.

00:21:28.860 | Thing number one is something that I like to write about,

00:21:31.740 | which is that, you know, societies get wealthier,

00:21:34.860 | the rate of return falls.

00:21:36.540 | And that's true of both stocks and bonds.

00:21:40.580 | Inequality comes into it as well.

00:21:43.700 | You know, you have more and more capital

00:21:47.020 | getting hidden away into people's accounts,

00:21:50.580 | and it's not getting spent.

00:21:51.980 | You know, people don't have money to spend

00:21:53.540 | on rents and houses and food the way they should,

00:21:56.940 | and certainly on their children's vacation,

00:21:58.500 | because, you know, almost all of the increased income

00:22:01.620 | is going to the 1%.

00:22:02.460 | And what do the 1% do with their money?

00:22:04.220 | Well, they put it away into stocks and bonds.

00:22:06.540 | That's the first thing that's happening.

00:22:07.820 | The second thing is we've got a tepid economy,

00:22:10.580 | and so the demand side for capital is down,

00:22:13.340 | so the rate falls because of that.

00:22:15.220 | And then finally, you've got central banks

00:22:16.900 | getting into the act and buying up fixed income assets

00:22:19.940 | onto their balance sheets.

00:22:21.300 | So all three of those things

00:22:23.060 | are causing the reduction in interest rates.

00:22:27.060 | I'm not sure there's anything to do about it,

00:22:29.300 | but it's just a fact of life.

00:22:31.380 | The one thing that it does do

00:22:32.420 | is it makes people enthusiastic about long bonds,

00:22:35.980 | because that's an asset class that's done very well

00:22:38.660 | with the fall in interest rates.

00:22:40.460 | You know, I think that T-bill rates

00:22:42.300 | are certainly not as low as they've ever been.

00:22:44.020 | They were actually, depending on how you measure it,

00:22:46.700 | negative during the Great Depression very early on.

00:22:49.500 | But, you know, a long-term, a 30-year Treasury bond

00:22:52.980 | is yielding, what, 2.3% or 2.4%.

00:22:56.260 | That's historically anomalous.

00:22:58.380 | And so it makes people very excited about long bonds,

00:23:01.580 | and particularly about leveraged bonds in a portfolio,

00:23:03.980 | because they've done so well.

00:23:05.900 | You know, they're an excellent way

00:23:07.420 | to chase prior performance.

00:23:09.780 | - Larry Summers wrote something recently

00:23:12.220 | talking about negative interest rates,

00:23:14.540 | and he said something that caught my ear.

00:23:17.700 | Basically, he said, if you have very low interest rates,

00:23:21.660 | it keeps a lot of companies around

00:23:24.940 | that have no business being around,

00:23:27.340 | that they should go under.

00:23:29.740 | And because they're not going under,

00:23:32.420 | the system is going to become clogged

00:23:34.940 | with a lot of deadweight companies

00:23:37.900 | that should have gone bankrupt,

00:23:39.180 | but won't go bankrupt because interest rates are low.

00:23:42.780 | - Well, yeah.

00:23:43.620 | I mean, the Austrians, the Austrians,

00:23:44.980 | that was something that the Austrians liked to write about.

00:23:46.900 | You know, Schumpeter certainly wrote about that,

00:23:49.540 | and I'm pretty sure that Hayek wrote about it too,

00:23:54.100 | which is the danger of low interest rates is not inflation.

00:23:58.620 | Okay, in other words, you can get inflation

00:24:01.140 | if you lower interest rates,

00:24:02.140 | because people start spending.

00:24:03.900 | But if you're, you know, beyond the zero lower bound,

00:24:07.340 | then simply what happens is

00:24:10.620 | that you get asset class bubbles.

00:24:12.620 | And so a lot of companies wind up getting capital

00:24:15.340 | or keeping their capital that, as Larry Summers says,

00:24:17.660 | have no business being around.

00:24:19.140 | - Yeah, one of the things I've noticed

00:24:21.540 | is that the tax cuts that corporations got,

00:24:25.300 | the money, the extra capital that they had that came in,

00:24:29.540 | there wasn't really any big spike in capital spending

00:24:33.100 | with that money, but what there was was buybacks.

00:24:37.420 | There were dividend increases,

00:24:39.820 | but, you know, the idea of giving companies the tax cut

00:24:44.820 | was they would come back and spend more money,

00:24:49.860 | invest more money for the future.

00:24:51.340 | That doesn't seem to be what they're doing.

00:24:54.460 | - Yeah, we're in a capitalist fool's paradise,

00:24:58.060 | and I'm not talking about that politically.

00:25:00.340 | What I mean by, as a capitalist,

00:25:02.340 | is anybody who has capital.

00:25:03.700 | That's you and me.

00:25:04.620 | And we're in a fool's paradise

00:25:07.180 | because we've got these bloated portfolios

00:25:09.820 | that are inflated by low interest rates,

00:25:13.820 | and we feel rich.

00:25:17.140 | It seems that we're rich,

00:25:18.540 | but in fact, the earning power of what we own,

00:25:21.660 | and certainly the dividend stream from what we own

00:25:26.380 | and the interest stream from what we own

00:25:28.220 | is not all that impressive.

00:25:30.620 | If you have to live on your income now, you're in trouble.

00:25:33.900 | - Yeah, which gets us to where do you put your money?

00:25:36.540 | You know, with the potential

00:25:39.180 | for even lower interest rates in the US.

00:25:42.820 | Now, I know that that's not a popular opinion

00:25:47.300 | about where interest rates are going,

00:25:49.420 | but we have 1.4% on the 10-year,

00:25:52.860 | and I think the probability of the 10-year

00:25:55.580 | dropping below 1% is as high as the probability

00:25:59.900 | of it going over 3%.

00:26:01.660 | So, I mean, we could have even lower interest rates

00:26:04.420 | going forward.

00:26:05.340 | You know, we have earnings that are slowing.

00:26:08.740 | Dividends increases,

00:26:11.060 | which are better than what they were in the past,

00:26:13.420 | but they're slowing too.

00:26:15.260 | We have, you know, no more tax cut on the corporate side.

00:26:18.660 | We already had that.

00:26:19.900 | Buybacks are beginning to slow.

00:26:23.220 | Where do you put your money, Bill?

00:26:25.460 | (Bill laughing)

00:26:26.860 | - I put my money where I've always put it,

00:26:28.460 | which is in a prudent mixed portfolio.

00:26:31.340 | I don't know where else to put it.

00:26:33.740 | I'm not gonna put it under the mattress.

00:26:34.980 | I'm not gonna buy, you know, a ton or two of gold.

00:26:38.740 | You keep, I've always, you know,

00:26:40.980 | I've always kept my fixed income durations fairly low

00:26:45.980 | so that if things spike up,

00:26:47.100 | I don't lose too much money there.

00:26:49.820 | And, you know, you have to own some equities.

00:26:52.700 | Equities abroad are not badly priced.

00:26:55.220 | European, Japanese equities are at least reasonably priced.

00:26:58.980 | Emerging markets equities

00:27:00.140 | are even more than reasonably priced.

00:27:02.900 | You know, on the other hand,

00:27:03.900 | I'm going to be spending in dollars,

00:27:05.420 | so I'm not gonna be investing, you know,

00:27:07.380 | much more than 40% of my money abroad.

00:27:10.140 | - Anytime I put something on the Bogle heads

00:27:13.580 | about expected returns from equities

00:27:15.900 | or fixed income going forward,

00:27:17.340 | I always get a lot of pushback.

00:27:18.740 | Oh, you don't know what they're going to be.

00:27:20.780 | You know, nobody knows what the returns are going to be.

00:27:23.660 | But in order to invest your money,

00:27:25.820 | in order to come up with an asset allocation

00:27:28.340 | and some sort of an investment plan,

00:27:31.220 | you need to have estimates of return for equities

00:27:35.620 | and estimates of return for fixed income

00:27:38.540 | and estimates of return for cash.

00:27:40.660 | And I know I have my estimates, which I use.

00:27:44.020 | What are your estimates?

00:27:46.580 | - I think that right now,

00:27:51.420 | bonds, notes, anything, you know,

00:27:53.220 | beyond the couple of months

00:27:54.540 | probably has a negative expected real rate of return.

00:27:57.620 | You know, it can't be any other way.

00:27:58.980 | I mean, if you've got, you know,

00:28:00.260 | if you think that inflation over the next 10 years

00:28:03.060 | is going to be less than 1.1%,

00:28:04.580 | you know, I've got a bridge that I want to sell you.

00:28:09.020 | I think U.S. stocks have probably an expected-

00:28:11.420 | - I may want to buy that bridge, by the way,

00:28:13.060 | if it's paying tolls to get across.

00:28:15.420 | I might be interested, so let me know afterwards.

00:28:17.580 | - Okay, I'll name the bridge after we're off the call.

00:28:21.060 | And, you know, I think that cash probably has a yield,

00:28:24.380 | which is not too much less than inflation,

00:28:26.700 | so not too much less than zero.

00:28:30.100 | And then finally, U.S. stocks may be about 3% real

00:28:33.620 | and foreign stocks may be 4% real

00:28:35.940 | and emerging markets may be a little bit more than that.

00:28:38.900 | - You know, in the U.S.,

00:28:40.620 | my view of a rate of return on equities,

00:28:45.060 | and I'll use nominal instead of real,

00:28:48.580 | is about 6% on equity and 2.5% on bonds.

00:28:53.580 | If you're looking at corporate bonds,

00:28:56.300 | maybe you'll get three because you have 2% inflation.

00:29:01.100 | I know you might be looking at lower than that,

00:29:02.740 | but if you use 2% inflation,

00:29:05.020 | 2% real GDP per capita growth, if we get it,

00:29:10.020 | and then 2% dividend yield, you put it all together,

00:29:13.700 | you just zero out any P/E multiple expansion

00:29:17.420 | and you get about a 6% return on equity.

00:29:19.540 | So that's how I get to 6% on equity in the long-term.

00:29:24.020 | And then the 2.5% on bonds

00:29:25.580 | is simply whatever the 10-year treasury bond is now

00:29:28.260 | plus a 10-year corporate combined together,

00:29:30.620 | you know, 50/50, you know,

00:29:32.020 | looking forward over the next 10 years,

00:29:33.620 | it's a pretty good predictor of what that return will be.

00:29:36.500 | I mean, am I far off?

00:29:38.580 | - No, no, you're not.

00:29:39.780 | And the trick is, no matter what estimate you give

00:29:42.220 | or I give, especially for stocks,

00:29:44.700 | you have to take it with a grain of salt.

00:29:46.860 | I mean, someone took me to task

00:29:48.620 | in the questions portion of your post.

00:29:52.260 | You know, what they wanted to ask me was,

00:29:53.660 | how did I get stocks so wrong over the past 10 years?

00:29:57.180 | Because 10 years ago, I mean, it was 19 years ago.

00:29:59.540 | Yeah, it was 19 years ago.

00:30:00.500 | I predicted like 2.5% for stocks

00:30:03.820 | and they were actually 7%.

00:30:07.740 | Well, you know, over 19,

00:30:10.100 | if the standard deviation of stocks is 16% a year,

00:30:15.140 | to make life easy over 16 years,

00:30:17.540 | then the standard error is going to be 4%.

00:30:21.700 | So I was a little more than one standard error off, okay?

00:30:25.340 | - But you're a doctor.

00:30:28.660 | - Yeah, well, there's still, you know,

00:30:30.260 | but I still have to obey the laws of statistics.

00:30:32.940 | (laughing)

00:30:34.180 | So, I mean, even over 30 years,

00:30:35.660 | I can give you a 30-year estimate,

00:30:37.460 | but even over 30 years,

00:30:39.340 | I mean, the square root of 30 is like five and a half.

00:30:42.100 | So one standard deviation on that estimate is 3%,

00:30:45.300 | two standard deviations is 6%.

00:30:47.740 | So if I say a real return of 3%,

00:30:49.980 | well, it could be 9% or it could be minus 3%.

00:30:54.140 | - So getting back to what you said

00:30:55.660 | about the Boglehead question,

00:30:57.740 | we can go there now because we had a number of questions

00:31:02.020 | from the Boglehead's forum.

00:31:04.500 | A lot of them are investing questions.

00:31:06.500 | So we can get more into the nitty gritty of each asset class

00:31:09.620 | and factor investing and tips and so forth.

00:31:14.140 | Let me go ahead and go to the Boglehead forum,

00:31:19.140 | and because I always post on the Boglehead forum,

00:31:22.460 | bogleheads.org, who my guest is,

00:31:25.500 | and then I ask the forum members who are registered

00:31:28.940 | to ask intelligent questions

00:31:31.900 | that are not related to them personally that I can ask.

00:31:35.700 | So here we go with the first question.

00:31:38.820 | So Bill, I had a number of Bogleheads asking about factors

00:31:43.820 | like value, momentum, quality,

00:31:47.900 | and you've written a lot about this

00:31:51.060 | in some very prestigious academic journals

00:31:55.340 | about factor investing.

00:31:57.420 | You're well-known to have yourself

00:32:00.540 | in your client portfolios use factor type funds,

00:32:05.060 | but factors have not done well in the last, say, 10 years.

00:32:10.060 | And first of all, could you comment on that

00:32:12.860 | and then comment if you can,

00:32:15.460 | if you have any thoughts about the valuation

00:32:17.220 | of various factors going forward?

00:32:19.500 | - I knew I was going to be asked this.

00:32:22.220 | I went and did what any person does in that position,

00:32:25.620 | which is you go and you look at the Ken French website

00:32:29.300 | and you download some data and you massage it.

00:32:31.980 | The primary way you look at how-

00:32:34.420 | - No, I never do that.

00:32:36.660 | I can't believe you would accuse us

00:32:39.380 | of doing things like that.

00:32:40.740 | - (laughs) Well, it just shows how warped I am.

00:32:43.900 | And what you do, the simplest database you can look at

00:32:46.820 | is just the global database of U.S. stocks.

00:32:49.740 | And you sort purely by price to book,

00:32:52.540 | which is historically the way they've looked at value

00:32:56.140 | versus growth, or obviously other ways,

00:32:58.660 | as you well know, to do it.

00:33:00.860 | They do a 30, 40, 30 sort.

00:33:03.420 | So they look at the 30%

00:33:06.820 | that are the cheapest by price to book,

00:33:09.020 | the 30% of the most expensive,

00:33:10.740 | and then there's 40% in the middle.

00:33:12.940 | So if you look at the price to book ratio,

00:33:15.740 | or actually the inverse of that,

00:33:17.380 | the book to market ratio of the cheapest stocks

00:33:22.020 | versus the expensive stocks,

00:33:24.540 | it's always going to be much greater than one, okay?

00:33:26.580 | Because that's how you're defining it, all right?

00:33:29.260 | And it turns out that the average value

00:33:33.380 | over the past 50 years is about 4.8, okay?

00:33:36.500 | That ratio is 4.8.

00:33:37.820 | So in other words, the cheapest 30%

00:33:40.220 | have a book to market value

00:33:43.020 | that is about 4.8 times the most expensive stocks,

00:33:46.180 | which is about what you'd expect, okay?

00:33:48.420 | And it turns out that when you look at what happens

00:33:51.140 | to that ratio over time,

00:33:53.180 | it corresponds precisely to how value has done

00:33:58.660 | versus the market or value has done relative to growth,

00:34:01.780 | however you want to look at it.

00:34:04.020 | So for example, if you look at the period

00:34:06.940 | from say 1995 to 2000,

00:34:11.940 | which was a terrible period for value,

00:34:14.660 | you find that ratio rising from about four

00:34:18.500 | to about almost 10, okay?

00:34:20.940 | Which was historically unprecedented.

00:34:22.980 | That was the height of the bubble

00:34:25.020 | in growth stocks around 2000 or so.

00:34:27.660 | And then if you look at what happened to that ratio

00:34:31.260 | over the next 10 years or so,

00:34:33.340 | you find that it went from 10 all the way down

00:34:35.820 | to about 3.8, okay?

00:34:38.540 | And those were salad days for value stocks.

00:34:41.860 | You know, it was shooting fish in a barrel.

00:34:44.180 | Everybody got excited about value stocks

00:34:46.060 | because they beat growth box stocks by several percent

00:34:48.500 | per year.

00:34:49.340 | Well, what has now happened since about 2011 or so

00:34:53.460 | is that ratio has gone up from about, I don't know,

00:34:56.220 | to 3.6 or 3.8, all the way up to almost six, okay?

00:35:00.860 | So what has happened to the value premium?

00:35:02.980 | It's done very poorly, all right?

00:35:04.980 | Well, it turns out that the current value,

00:35:07.500 | about six, is more than a bit above its historical average,

00:35:11.500 | which is another way of saying that value stocks

00:35:13.540 | are now cheaper, all right?

00:35:16.020 | And I think that people are getting very discouraged

00:35:19.820 | with value investing, and that's a good sign

00:35:23.500 | because that corresponds to John Templeton's point

00:35:26.100 | of maximum pessimism.

00:35:27.540 | Yes, but only when the blood is dry.

00:35:30.620 | Exactly, exactly.

00:35:32.140 | And I think the blood is drying, but it's not dry yet.

00:35:35.740 | But you said something, I don't know what it was,

00:35:38.660 | five or six years ago, and we were having

00:35:40.540 | the same conversation about value.

00:35:42.700 | And it was too easy back then.

00:35:46.420 | And you say we need blood in the street

00:35:48.660 | in order for the true value investors to earn a return.

00:35:54.620 | I was talking with Wesley Gray, I had him on as a guest,

00:35:57.500 | and he's a quant from the University of Chicago,

00:36:00.660 | Alpha Architect is his company.

00:36:03.460 | And I had him on as a guest, and he was saying,

00:36:06.260 | the people who make money in value

00:36:10.180 | earn their value premium.

00:36:13.660 | What we have now is basically a cult of value renters,

00:36:18.340 | where we had a lot of people come in and buy value stocks

00:36:20.980 | using these newfangled ETFs.

00:36:22.660 | And there was a whole lot of value investing

00:36:26.460 | for the wrong reasons, because they were trend followers,

00:36:29.900 | getting value premiums down to this 3.8, like you said,

00:36:34.300 | a lot of money going into it at the wrong time.

00:36:36.340 | But now it's come back the other way.

00:36:38.420 | There's blood in the street, a lot of blood in the street.

00:36:41.660 | I don't know if the blood is dry yet,

00:36:43.100 | or maybe there's gonna be more blood.

00:36:44.940 | But to me, I agree with you that we're getting to a point

00:36:48.260 | where, gee, it's almost safe to invest in value again.

00:36:52.060 | - Yeah, I mean, I don't know if we're at that point,

00:36:54.380 | but you never know when you're at that point.

00:36:56.180 | And the smart thing you do is you stay true

00:36:59.900 | to your discipline.

00:37:01.340 | It was J.P. Morgan who very famously said

00:37:03.700 | that a bear market is when stocks are returned

00:37:07.300 | to their rightful owners.

00:37:08.660 | - Exactly, yeah, there you go.

00:37:10.980 | - And I think the same thing is true of the value premium.

00:37:15.980 | What we've had over the past five to six years

00:37:19.740 | is a lot of dentists getting sold by their broker

00:37:23.740 | on factor investing in smart data.

00:37:25.940 | And you need to wash those people out

00:37:29.540 | in order to earn the value premium.

00:37:32.500 | - How come you always pick on dentists?

00:37:33.860 | 'Cause I remember every joke that you make.

00:37:35.260 | Instead of picking on doctors, you pick on dentists.

00:37:37.780 | Instead of picking on surgeons, you pick on dentists.

00:37:40.660 | Is that something that in your other occupation,

00:37:45.180 | some rivalry between dentists and medical doctors?

00:37:50.100 | - Yeah, it may be.

00:37:52.500 | In medical specialty, in medical training,

00:37:55.860 | you refer to purely procedural specialists as dentists.

00:37:59.780 | It's not a compliment.

00:38:00.940 | - I remember you had a joke about the Luby's,

00:38:04.860 | two dentists sitting together at Luby's

00:38:06.740 | talking about stocks and the market will never be,

00:38:09.220 | or index funds will never take over the whole market

00:38:13.660 | if there are two dentists sitting together

00:38:15.380 | having lunch at Luby's trading stocks

00:38:17.340 | or something like that.

00:38:19.180 | - Very, very, very close.

00:38:20.340 | You got the vowels and the consonants right.

00:38:25.340 | What I believe I said was two dentists

00:38:26.820 | having lunch in Lubyck.

00:38:28.020 | - Oh, Lubyck, oh, okay, okay.

00:38:30.820 | - Yes.

00:38:31.660 | - Anyway, so we can go on to another question

00:38:36.340 | that the Bogleheads have.

00:38:37.860 | One of the Bogleheads asks how you feel

00:38:40.860 | about international REITs and international bonds.

00:38:45.740 | There's always a lot of controversy

00:38:47.380 | about those two asset classes.

00:38:50.180 | How do you feel about that?

00:38:52.140 | - Well, as far as international bonds go,

00:38:55.180 | I just don't like them.

00:38:56.380 | Even forgetting about the fact that most of them

00:38:59.460 | have negative yields right now.

00:39:01.220 | And the reason is you have a choice

00:39:03.260 | when you're owning international bonds.

00:39:04.860 | You can either not hedge them,

00:39:06.700 | in which case you've got a relatively safe bond,

00:39:09.580 | a sovereign bond, but it's got overlaid on top of it

00:39:13.620 | industrial grade currency risk.

00:39:15.420 | So that's not a bright idea.

00:39:17.060 | Or you could hedge it back to the US dollar.

00:39:19.540 | And then what you wind up when you do that

00:39:21.180 | is just a very expensive domestic bond.

00:39:24.300 | So neither of those two things make sense.

00:39:26.980 | Now, a long time ago, I did occasionally invest

00:39:30.780 | in foreign denominated bonds that were not hedged.

00:39:35.740 | And I did that whenever I went to Europe

00:39:38.740 | and I thought that it was cheap.

00:39:40.140 | Okay, so if you were lucky enough to visit Europe,

00:39:43.260 | let's say in the early to mid 80s,

00:39:47.980 | when you had a 10 franc dollar or a British pound

00:39:52.540 | that was trading fairly close to par,

00:39:56.340 | back in the day when the pound was actually worth something.

00:39:59.260 | And when those currencies had fat yields attached to them,

00:40:02.860 | yeah, that was an opportunistic play,

00:40:05.660 | but I haven't seen anything attractive in that regard

00:40:08.860 | over the past 20 years for the simple reason

00:40:11.780 | that foreign currencies have been fairly expensive

00:40:14.380 | in general over the past 20 years.

00:40:16.100 | And now, with the interest rates,

00:40:18.100 | I wouldn't do it at any currency valuation

00:40:20.700 | because of the low interest rates.

00:40:21.980 | So that's international bonds.

00:40:23.660 | International REITs, yeah, I think it's a good way

00:40:25.740 | of diversifying a REIT portfolio

00:40:27.660 | and diversifying in general.

00:40:30.660 | They're also trading at relatively attractive valuations

00:40:34.560 | relative to US REITs.

00:40:36.700 | Now, that's not exactly REITs.

00:40:37.900 | It's real estate where there are management companies

00:40:40.260 | and there are development companies and so forth.

00:40:42.460 | - Right.

00:40:43.740 | - Okay, one of the Bogleheads asks

00:40:46.340 | about the duration of your bonds.

00:40:50.700 | Should they continue to hold only short-duration bonds

00:40:55.700 | as they are getting near retirement?

00:40:59.100 | And here's the line that I think is funny.

00:41:02.660 | That's a no-brainer in today's interest rate environment.

00:41:09.020 | I remember you and I having a conversation

00:41:10.580 | about this 10 years ago.

00:41:11.700 | We were on a Bogleheads panel together

00:41:13.220 | and we were talking about bonds.

00:41:14.500 | Somebody asked, "Where should you have

00:41:16.300 | "the duration of your bond portfolio?"

00:41:18.620 | And I think you said 10 years ago,

00:41:20.200 | "It's a no-brainer, have them in short-term."

00:41:22.740 | And I disagreed with you on that.

00:41:24.760 | I said, "Well, I don't know, but I'm just gonna,

00:41:27.840 | "if your liabilities are intermediate-term,

00:41:29.920 | "you should probably have intermediate-term bonds."

00:41:32.440 | So I'm gonna go back to you now.

00:41:33.500 | Is it a no-brainer to have short-term bonds

00:41:37.080 | in your portfolio?

00:41:39.000 | - Well, I can't be right about everything.

00:41:41.040 | (laughing)

00:41:43.420 | And I was certainly wrong about that,

00:41:46.700 | but I think as a general rule,

00:41:48.560 | you wanna take your risk in stocks and not in bonds.

00:41:53.560 | And I think that going out into intermediate-term bonds

00:41:59.740 | is too much of a risk if rates spike up.

00:42:02.580 | And let's face it, there's not a lot of juice left

00:42:04.780 | in that play.

00:42:06.420 | - And there's huge complexity right now in bonds.

00:42:08.780 | I mean, just one little move up in interest rates

00:42:11.780 | on intermediate-term, and you're gonna have some,

00:42:15.300 | I mean, the duration have expanded

00:42:17.060 | on a five-year or a 10-year treasury bond.

00:42:19.220 | Duration, because interest rates are low,

00:42:22.140 | duration is a factor of the bond maturity date,

00:42:25.080 | the coupon payment, and where interest rates currently are.

00:42:29.180 | So if interest rates are 5% or 6%,

00:42:33.900 | and you had a jump of 1%,

00:42:35.540 | it wouldn't hurt the bond portfolio

00:42:37.820 | as much as it does now,

00:42:39.180 | where interest rates are less than 1 1/2.

00:42:42.260 | - Yeah, exactly.

00:42:43.100 | And I would say, when it comes to bond duration,

00:42:45.420 | I would say two things.

00:42:47.340 | And I would put two and two together and make four.

00:42:50.540 | The one thing that I would say is that

00:42:54.580 | your bonds are what allow you to sleep at night, okay?

00:42:58.220 | When everything else is going down the you-know-what,

00:43:03.220 | you wanna have something that you can look at and say,

00:43:05.220 | yes, that pays for next week's groceries

00:43:07.540 | or next month's rent or mortgage payment.

00:43:11.940 | And your bonds allow you to do that.

00:43:13.800 | So you don't wanna take that much risk with your bonds.

00:43:17.620 | The second thing I would add on to that

00:43:19.620 | is to realize that between 1940 and 1980,

00:43:22.820 | the real return of long-term U.S. treasuries,

00:43:26.660 | and that includes reinvested interest, was -60%, all right?

00:43:33.500 | And you don't want that happening to the safe assets,

00:43:36.900 | the things that are allowing you to sleep at night.

00:43:38.940 | - I have friends who are in Europe

00:43:40.500 | who are investment advisors,

00:43:42.420 | and they're dealing with negative interest rates.

00:43:46.060 | And what you said about being able to sleep at night

00:43:50.060 | by having bonds,

00:43:51.540 | that we're actually getting on the other side of that curve

00:43:54.700 | over in Europe,

00:43:56.300 | where people now are actually not sleeping at night

00:43:59.960 | because of their bond holdings and negative interest rates.

00:44:03.020 | So it's, even if they're short terms,

00:44:05.420 | this is an interesting phenomenon that's taking place

00:44:08.380 | in the global financial markets

00:44:10.460 | that has never taken place before.

00:44:12.740 | And this is where I think we're in a new area.

00:44:17.740 | If we get into negative interest rates

00:44:19.780 | like the rest of the world,

00:44:21.300 | people are not going to be looking at bonds

00:44:23.440 | as though they were sleep at night type investment.

00:44:28.140 | Do you agree?

00:44:30.100 | - Yeah, now, again, I'm putting myself, let's say,

00:44:33.700 | in the position of a Northern European person

00:44:37.620 | who is spending local currency.

00:44:39.700 | If I see negative interest rates, okay,

00:44:44.700 | I'm also seeing something else,

00:44:45.960 | which is that because of the European Union

00:44:48.740 | and because of increased immigration,

00:44:51.540 | most of the things you want to do in Europe

00:44:53.220 | have actually not gone up in price

00:44:55.200 | and may have fallen in price.

00:44:57.060 | Every time I go to Europe these days,

00:44:58.540 | I'm amazed at how reasonable it is.

00:45:00.900 | And so the one exception to that, of course,

00:45:03.780 | is if you have to buy a house or an apartment, all right?

00:45:06.660 | But I'm assuming you already own a house and an apartment

00:45:09.180 | and all you have to do is meet your living expenses

00:45:11.140 | and you want a fixed income substitute.

00:45:13.320 | Well, that's the point where I trot on down to the bank

00:45:15.500 | and I rent a great big fat safety deposit box

00:45:18.420 | and I put my cash in it, okay?

00:45:20.260 | And then I'm not getting negative interest rates.

00:45:22.540 | - So one of the Bogleheads comes back and he asks,

00:45:25.540 | under what circumstances would you recommend

00:45:28.860 | going longer term on bonds?

00:45:31.260 | What would have to happen for you to go longer term?

00:45:34.300 | - Oh, I'd want to see a great big steep yield curve.

00:45:39.500 | I want to be rewarded for going long

00:45:41.100 | and I want to be rewarded a lot.

00:45:43.500 | - As we continue with our fixed income discussion,

00:45:46.580 | how do you feel about municipal bonds?

00:45:50.220 | A lot of people are talking about these embedded liabilities

00:45:53.340 | and the quality of municipal bonds going down,

00:45:55.820 | bankruptcies and so forth.

00:45:57.340 | Where do you stand on municipal bonds?

00:46:00.180 | - Well, the thing that's always said about municipal bonds

00:46:03.500 | is that during the Great Depression,

00:46:06.620 | very few of them went bankrupt,

00:46:08.540 | very few municipalities went bankrupt because they can tax.

00:46:12.820 | But during the 1930s, as the question points out,

00:46:17.060 | municipalities didn't have these absolutely massive

00:46:20.900 | pension obligations that threatened to bankrupt them.

00:46:24.420 | I think that high quality municipal bonds

00:46:27.020 | are certainly not that risky in the aggregate.

00:46:31.420 | You know, if you own, say one of the Vanguard

00:46:33.500 | municipal bond funds that are so inexpensive

00:46:36.420 | that they can get the same yield as other funds do,

00:46:38.940 | but at much higher quality,

00:46:41.060 | I think that you shouldn't necessarily avoid them.

00:46:44.960 | But I think that less than half of your bond portfolio

00:46:47.600 | should be in munis.

00:46:48.860 | And less than half of your munis should be, obviously,

00:46:51.300 | in a single-state munis.

00:46:52.940 | As attractive as that may be,

00:46:54.180 | if you're in California or New York,

00:46:56.200 | you're taking too much concentrated risk

00:46:57.940 | by owning all of your munis in one state.

00:47:01.780 | - One other item that you've talked about in the past

00:47:04.260 | is owning commodity-producing assets,

00:47:07.860 | like gold miners and such.

00:47:10.820 | Is that still on your radar screen,

00:47:12.620 | to buy things like the gold miners,

00:47:16.620 | and not buying gold, but commodity producers

00:47:20.140 | as a diversification hedge?

00:47:22.340 | - Yes, absolutely.

00:47:23.780 | And in fact, when you look at the data

00:47:26.380 | on how commodities producers do

00:47:29.860 | during hyperinflationary periods,

00:47:32.660 | they do extremely well.

00:47:33.860 | Now, realize always that there are three things

00:47:37.100 | you have to understand about stocks and inflation.

00:47:39.740 | Number one is that in the short term,

00:47:42.020 | when you see unexpected inflation,

00:47:43.740 | stocks do take a hit, okay?

00:47:45.940 | But in the much longer term,

00:47:47.640 | stocks are a claim on real assets.

00:47:50.940 | They make products that get priced in real terms.

00:47:53.660 | They own assets that get priced in real terms,

00:47:57.620 | in real terms.

00:47:58.700 | And when you look at how well stocks

00:48:01.040 | have done internationally

00:48:02.140 | during periods of hyperinflation,

00:48:04.140 | on average, they do very well.

00:48:06.780 | I mean, the worst, well, not the worst,

00:48:08.820 | but the most famous example of hyperinflation

00:48:11.220 | was the Weimar hyperinflation

00:48:12.740 | between roughly 1920 and the end,

00:48:15.500 | the beginning of 1920 and the end of 1923.

00:48:18.620 | And when you look at German stock returns

00:48:20.500 | during that period,

00:48:21.620 | they had a positive real rate of return, all right?

00:48:24.460 | And that's true, been true of any number of countries.

00:48:29.020 | I mean, Israel and Chile, for example,

00:48:32.140 | during the '80s and '70s, '80s and '90s

00:48:34.820 | had extremely high inflation,

00:48:36.580 | but the real rate of return on their equities

00:48:39.540 | was equal to that of the United States.

00:48:44.780 | So that's the first thing.

00:48:46.060 | And then the second thing is that

00:48:48.460 | the stocks that do particularly well

00:48:50.260 | are two kinds of stocks.

00:48:51.460 | One is value stocks do well with inflation

00:48:53.980 | because their liabilities get inflated away

00:48:56.780 | and flow to their bottom line

00:48:58.020 | because value stocks tend to be more leveraged

00:49:01.860 | or indebted than growth stocks are.

00:49:05.580 | But more importantly,

00:49:07.540 | commodities producers also do extremely well.

00:49:12.380 | They don't all do well,

00:49:13.860 | but a few of them do well enough that they save your bacon.

00:49:16.300 | So if you invest, for example, in base metals equities

00:49:19.420 | and oil stocks and gold stocks,

00:49:23.260 | one of those three is going to do well enough

00:49:25.140 | that your bacon is going to get saved.

00:49:26.860 | Now, how much of your portfolio

00:49:28.060 | do you devote to that sort of thing?

00:49:29.860 | Not very much, just enough to take the pain,

00:49:31.780 | you know, take the edge off of the pain.

00:49:34.060 | You know, if you have a horrible financial crisis

00:49:37.740 | and gold stocks do well,

00:49:40.180 | instead of your portfolio losing 30%,

00:49:42.140 | maybe it only loses 25%.

00:49:44.100 | - Isn't there a lot of overlap between value investing

00:49:46.900 | and commodities like oil producers and such?

00:49:50.500 | They tend to show up in a lot of value indexes.

00:49:53.140 | - That's true, gold stocks don't though.

00:49:55.300 | - Bill, you've always been a wonderful guest

00:49:57.580 | at the Bogleheads conferences.

00:50:00.340 | When you go, you generously give your time

00:50:02.980 | to answering questions.

00:50:05.100 | And if I could just get you to comment

00:50:07.940 | about the Bogleheads

00:50:08.860 | and where do you see everything going

00:50:11.420 | now that Jack, unfortunately, has passed away?

00:50:14.380 | - Well, you know, let me make a general statement

00:50:16.540 | about the Bogleheads,

00:50:17.580 | which is that you will not encounter a group

00:50:20.420 | of even, you know, small investors

00:50:23.540 | or institutional investors who are more sophisticated,

00:50:27.060 | you know, who understand stochastics,

00:50:28.740 | who understand portfolio theory,

00:50:30.620 | who understand efficient markets,

00:50:32.460 | and, you know, who are smart enough

00:50:34.700 | not to be distracted by the news.

00:50:37.460 | It's almost an alternative universe.

00:50:39.940 | It's almost like you're on a different investment planet

00:50:42.580 | and it's a very nice place to be.

00:50:45.220 | The conference this year filled up very slightly slower

00:50:50.580 | instead of filling up inside of six hours.

00:50:53.060 | It sold out inside of like less than a day, I think.

00:50:56.340 | Maybe even better.

00:50:57.940 | So I think it's going to do just fine.

00:51:00.100 | I think that, you know, we're all going to miss Jack,

00:51:03.300 | but obviously there's a lot, you know,

00:51:04.980 | there are a lot more reasons why people come

00:51:06.420 | to the Bogleheads than to hear Jack talk.

00:51:09.060 | He's as great as his talks were.

00:51:10.860 | - You know, we continue to march.

00:51:12.180 | We have to continue to spread the word.

00:51:15.140 | We had the person who was holding the flame

00:51:18.300 | and now here we are, if you don't mind me dating myself,

00:51:20.740 | we, with our Bick Lighters, have to follow.

00:51:23.460 | That's what it's all about.

00:51:25.580 | - I thought you were going to say Zippo Lighters,

00:51:27.380 | but all right.

00:51:28.220 | (laughs)

00:51:29.980 | - That's a Bick, I'm in a Bick Lighter, if I recall.

00:51:34.740 | But I know what, yeah, Zippo is a little bit,

00:51:37.860 | it actually predates me.

00:51:39.140 | There, it shows the age between you and I.

00:51:40.900 | So there you go.

00:51:41.740 | (laughs)

00:51:43.540 | Listen, Bill, thank you so much for being our guest

00:51:45.700 | on the Bogleheads.

00:51:46.980 | Great to have you.

00:51:47.820 | And I'm really looking forward to seeing you

00:51:49.380 | at the Bogleheads reunion.

00:51:51.420 | And thanks for being on the show.

00:51:54.060 | - Okay, it was my pleasure.

00:51:54.940 | And I look forward to seeing you as well.

00:51:56.900 | You take it easy.

00:51:57.740 | - This concludes the 13th episode

00:52:01.300 | of Bogleheads on investing.

00:52:03.220 | I'm your host, Rick Ferry.

00:52:05.500 | Join us each month to hear a new special guest.

00:52:08.820 | In the meantime, visit bogleheads.org

00:52:12.220 | and the Bogleheads wiki.

00:52:13.980 | Participate in the forum and help others find the forum.

00:52:18.220 | Thanks for listening.

00:52:19.660 | (upbeat music)

00:52:22.240 | (upbeat music)

00:52:24.820 | (upbeat music)

00:52:27.400 | (upbeat music)

Bogleheads® on Investing Podcast 013 – Dr. Bill Bernstein, host Rick Ferri (audio only)

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