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- [00:00]
A
As a species, we do not do unpleasant years and we do not do long term. And my advice to the investor is try and fight those two tendencies. We have gone from a monopoly world to a brutal competitive world and we will stay there for years and there will be blood in the streets because these are aggressive, take no prisoner type companies with lots of money and they are heading right into each other's teeth. Fast forward a few years. Everybody is doing AI, aren't they? Everybody is paying for the service that they need. It is now, in that point in the future, the cost of doing business, it will not move aggregate profit margins or aggregate profits notably higher than they are typically.
- [01:01]
B
Jeremy, thank you very much for joining us today and welcome to Excess Returns.
- [01:05]
A
It's a pleasure.
- [01:07]
B
Earlier this year, in the Wall Street Journal review of your book, the book title is the Making of a Perma Bear. James Grant described you as a principled, value minded, dogmatic nonconformist. And I have a feeling that brought a smile to your face.
- [01:22]
A
It did, yeah. I like the dogmatic part. In particular, Jim Grant never, never takes any unnecessary prisoners.
- [01:32]
B
No, absolutely not. We've had you on the podcast a few times. You're exactly right. And, and that's what we're going to talk about today. Sort of the book is going to be the foundation of the discussion. We were fortunate enough to be forwarded copies of that. Thank you very much. And the title, the Making of a Perma Bear is your story. It encapsulates your beliefs on investing, the stories of success in your career, the times at GMO where there was uncertainty and difficulty. And also I think the book highlights, you know, what you think is important to successful long term investing and also in life. So we look forward to spending the next hour or so with you to kind of work through a lot of these topics and a lot of the sort of principles that you outline in the book. I'm guessing that the title, even though many people that maybe listen to you might not think it's sort of tongue in cheek, but the title, the Making of the Perma Bear was sort of a, you know, tongue in cheek, sort of joking around title in the sense because some people do kind of paint you in that corner. But the first question I want to ask you is, I mean, why do you, why do you think that that sort of people sort of paint you with that brush?
- [02:44]
A
I voted, by the way, for putting it in inverted commas and I was outvoted because I thought at least in inverted commas people could tell it was Tongue in cheese. And this way I think quite a few do not. And that's a shame really because
- [03:08]
B
the
- [03:08]
A
Perma Bear comes out every super bull market in the rest of the time. And in the bear markets no one calls me a super bear. And my counter argument of course is that it's been a very bullish 50 years. But there was a pretty decent decline in 1982. In 1982 the whole market sold at 7 times earnings. And that was my first quote ever in a relatively short lived publication called the Wall Street Letter. And in that edition of about mid June, 82, pretty close to the low, I said I thought the market was close to a unprecedented or unusual rally in both the stock and the bond market. So that was my one bullish claim. It turned within a few weeks and then of course never went anywhere near seven or eight times earnings for the rest of the our lives up till now. And the other one was reinvesting when terrified. Which was one of only two things I ever posted on our website. That was not a quarterly letter, that was just a one pager saying, dudes, get a plan together. Start to get your money back into the market. Of course you're paralyzed, everyone's paralyzed. Who understands what's going on? And the banking system came very close to the edge and everyone was suitably frightened. But the market is now cheaper than it's been in 22 years. And on our infamous seven year forecast we see double digit returns from the S and P and handsome returns from the rest of the world in equities. So get back in. You will not call the low, but that doesn't matter. It's now cheap enough to justify rolling the dice and getting there. Even a bad plan is better than no plan at all because it gets you thinking, it gets your committees listening and you start to develop a serious plan. So they're my two. I'm afraid that's all there is. That's my entire bullish output really. But they were very good timing because the second one was not a few weeks ahead like 1982. It actually was published on the day the market hit its infamous low on the S and P of 666, which is of course famously the doubles the devil's number. And now it's over 10 times that. And you can't say the period from then until now has been without its problems. So it is a fairly remarkable performance.
- [06:22]
B
In the book you talk about making the decision to be louder when you are bearish. What's behind that? I guess idea is it because to your point, the bullish calls don't come out very often because you don't see the opportunities as clear as when they are really truly opportunities or sort of. How do you think about.
- [06:40]
A
I think that's actually, if you'll forgive me, a misreading. Okay, that. What I'm trying to say anyway is that it's important when you're bearish to different differentiate between when you have really high confidence that the pain is imminent and desperate and. And when you're merely bearish. Hey, guys, you invest today, you'll probably be at least moderately disappointed with the returns you get at the end of 10 years. That's a kind of typical bearish comment. And you've got to make sure you differentiate between those ordinary bear market calls and the real McCoy. And frankly, the average reader has a bit of a problem. So if you say the market's overpriced, they'll clock you down. And apparently they'll equate that with abandoned ship. The end of the world is around the corner, then they're not really good at hearing shades and therefore you better give that up and ignore the idea of shading the opinion. Make it absolutely clear. So in the great financial crash as it built up, one of my quarterly letters said just that, that it's very important to make it clear when you're really serious. And I'm now really serious. How do I express that? And I've spent the last week thinking about it and this is it. I think at least one major bank will fail and that is in the July 07 edition before the failures started. And by the end I think they should have let Citibank go. But of course several banks basically went belly up and AIG was bailed out with government money and so on. And of course Lima and Bestows.
- [08:44]
B
It really was an amazing time how those, you know, major institutions, many of them came to their knees and went out of business. So yeah, you were right, clearly right on that call in mid 07.
- [08:57]
A
The other, I haven't made many ultimate calls, but the next one was in the middle of July of the following year, 08. And we'd encourage people who had still the itch to be bullish to own emerging markets. And they had gone up and up and up and frankly they had peaked out around the end of the year, so they were already declining a bit. But the quarterly letter that was published on the 15th of July 08, we always published on the 15th, basically said literally abandon ship. The old French expression, sauve qui Peur anyone who can save themselves, save themselves. And I even included the old nursery rhyme, don't be brave, run away, live to fight another day. In other words, this is it, guys. Sell all your emerging, everything you can possibly sell. Get the hell out. This is going to be disagreeable. And I can say with a clear conscience it was disagreeable. And the emerging market index from that day, it fell 50% in four months, which I think is the sharpest decline of a broad index ever. And we actually got to buy back our position in about October of 08 because it had gone from dangerous to very cheap. 50% decline will do that.
- [10:29]
B
One of the core, I think, concepts that you talk about in the book repeatedly is this idea of mean reversion. And this is from the book you said. Early in my career I came to the conclusion that everything important in the markets is mean reverting. And I, you know, our audience is very, we have investment professionals that listen to us, but then we have, you know, beginning investors. When you think about mean reversion. And I think this plays into, you know, being bullish or bearish on over valuations in the markets and the way that we look at, you know, future returns as well. But how do you think about mean reversion and why is it so important in your mind in the markets?
- [11:08]
A
I think the abstraction that people might get is that mean reversion is kind of shorthand for history matters. You go back into the past and you see what happened and you learn from that. You take lessons and you make investment rules and they're never going to work perfectly. But the past, if it replays somewhat, if there are recurrent patterns, then you will make money doing that. And if it's always completely new, then you will not. And one of the things we had noticed for the prior 200 years was that PEs pro price earnings ratios tended to rise and fall. And fashions between small stocks and big stocks, they tended to rise and fall over several years. The same with emerging. Emerging market equities would have eight years of massive outperformance of the S and P and then the S and p would have 12 years of massive outperformance of emerging markets and so on are a lot of cycles and what a cycle says it's mean reverting, otherwise it wouldn't cycle like that. So when emerging has an incredible run, they almost certainly end up overpriced and eventually they roll down. And history was pretty clear. Asset classes mean revert sectors within an asset, like small versus large. They mean Revert. And even companies in the end mean reverse. And then, to be more detailed, mean reversion at the corporate level. Says, if you make abnormal profits, you will receive competition. If you make obscene profits, you'll get ferocious competition. If you're having a slump and you're not making much money at all, or even losses, you will frighten away capital and you'll have no competition at all. And eventually, as the market slowly grows or rapidly grows, you will reach a period of shortage and everything will recycle and your stock will go up, your profit margins will go up. And there was a very clear history of that happening. And in recent years, one has to say that is not as clear as it used to be. The bottom 90% of the market seems to fairly clearly still mean revert. And yet then you have a novel emergence of a kind of elite, a few handfuls of stocks that seem to have gone from strength to strength. And you have to ask the question, why isn't the money flooding in to compete these ridiculous returns and drive them down? And one is the winner take all nature of software. Guys who get there first have such an advantage, it's hard to break in. The other is the attitude of the government, of the administration, to monopolies. And you can look back over this interesting different phase. And of course, this time is different. You look back to about 2000 and you say, in what way is it different? And one of the ways at the top of the list is a steady concentration in every industry. There are fewer companies and bigger companies and more dominant companies in every industry. In most of them, it's not that big a deal. In some of them, it's massive. And what did the Justice Department, et cetera, do about this? And the answer is, uniquely, in this time period, nothing at all. So companies were able to quickly develop not just domestic monopolies, but global monopolies. The MAG7 were not universally seven global monopolies, but there were several in that group that were. And there is no better way to make money than to have a near monopoly or a complete monopoly to be a price setter. So ask yourself, are the Mag 7 setting prices? And the answer is mostly yes. They fulfill the characteristic of a workable, profitable monopoly. And they've been tolerated in other eras. The government get in there and say, nah, Standard Oil is too big. We're going to break it up into nine pieces, and so on. And that's pretty effective. It's pretty effective at certainly breaking the monopoly. Then you have more competition from the pieces and the Prices tend to be lower and the competition tends to be higher. The characteristic, the unfortunate characteristic of increased monopoly is that the growth rate of the system tends to slow down. So the profit margins of the monopolist go up, the share going to workers goes down, inequality increases, but the growth rate of the GDP tends to slow down. So a lot of people think because there's so much profit being made by the top 20 firms that somehow everything in the garden is great and growth rate must be higher. No, it isn't. Growth rate in GDP is actually slower for the last 20 years than it was the prior 20 and the prior 20 to that.
- [16:57]
C
Does AI exacerbate this or make it better? I can argue AI is going to be a wind at the back of these big companies, but I also could argue it gives smaller companies a better chance to compete. Like, you know, if you think about Google having a monopoly on search, you could argue maybe they don't anymore with everything that's going on with, with AI. So does AI make the situation better? Does it make it worse?
- [17:15]
A
So first, a few things. AI is infinitely complicated. It's the first time in history that I can remember where every group disagrees. People with a modest knowledge of AI all disagree. Is it going to destroy mankind? Or is it going to make us all sit on the beach and be waited on? And then you go up to the Nobel Prize winning level and they disagree. At every level of sophistication, there is vast disagreement on how AI will work out. Second point, AI is incredibly important. It will change our lives. Now, whether it will kill us all or make us all rich is part of that guessing game. But it is obvious to everybody that it's an important idea. And there are several things to be said about AI, but the most interesting one to me is that when a new technology comes through, the early adopters often make considerably more profit than normal. Their profit margins become wider than normal. The medium adopters maybe have a slight edge. The late adopters bring the market into balance again. And if I go back and look at prior cycles, what I have to conclude is that when the smoke clears, any new technology is merely a cost of doing business. Let me focus on the asset management business, which I know a lot about. I remember not so long ago when we had to dig deep and buy our first prime computer, a minicomputer. It filled the room the size of the one I'm in. It generated enormous heat and it processed the data pretty quickly. And we had a competitive advantage for two or three years until everybody Gritted their teeth and paid up for their mini computers. And then it became a cost of doing business. Everyone in the investment management business had a compute right. I can assure you everybody was not having higher profit margins than they used to. The profit margins settled back down to normal. The return on capital which is the central driver in capitalism, how much money do you make on your investments? Has been it remarkably stable for a couple of hundred years. And after the computers had all been bought, all you got was a modest return on the cost of the computer. That was it. You had to put more assets into the game of money management. You made the same average typical return on it. And the early adopter thing was gone. Well, think of AI. The guys who adopt it professionally first have a huge advantage. But fast forward a few years. Everybody is doing AI, aren't they? Everybody is paying for the service that they need. It is now in that point in the future, the cost of doing business, it will not move aggregate profit margins or aggregate profits notably higher than they are typically. Only in the early adoption phase where we are now, does that effect occur. Once everybody has settled in, this is just another cost of doing business. It's obvious. I think it's incontrovertible, but you would never guess it from the conversations of the day. There are many other problems and possibilities with AI that we haven't talked about, but that's the one I think I understand the most.
- [21:10]
C
Do you think it makes any difference like relatively in the market? I mean you mentioned we've had these, this set of huge companies that's been dominating the market for a long time. Like do you think at all if it like benefits the average company relative to them or if it sort of reasserts their dominance over everybody? Have you thought about like how that works?
- [21:25]
A
Yeah, that's what I do. I just thinking all the time about these things. But. I don't think it will not be quick. The average company will not catch up easily or quickly. And there can be a lot of pain along the way. But this is clear if you back up five years even you see a world where the mag seven basically represents seven monopolies. Seven quasi monopolies, half monopolies, or the very worst, duopolies and oligopolies. A handful of firms dominating the industry. You've got a whiff of competition in the cloud, but you had three of them converging. But they got on very happily. They either got on the telephone to each other or more likely they just deduced that if they behaved in a discreet way the enemy would not get in a price war and they did. And so all three of them became a well behaved oligopoly and they made tons of money. That's okay. But now we are faced with an utterly different world where all seven of these guys, plus another 15 around the edges are showing their hairy chests and beating their hairy chest and saying my 120 billion this year is better than your 82. Every one of them mean to win the AI war. They realize the first people to break through into a new level of technology will become trillionaires and et cetera. Or they think so and they mean to be there first. So we have gone from a monopoly world to a brutal competitive world and we will stay there for years and there will be blood in the streets because these are aggressive, take no prisoner type companies with lots of money and they are heading right into each other's teeth and it will be exciting to watch. But this is unlike, dear viewer, this is unlike anything we have been saying for the last 20, 30 years as we watched Amazon inherit retailing and Tesla inherit EVs and et cetera, et cetera.
- [24:06]
C
Just one more thing on mean reversion before I lose that thread. How do you think your average investor should think about mean reversion with respect to valuation?
- [24:12]
A
You know, we, we.
- [24:12]
C
If you look at like the historical valuation data, you've got a period in history where it was much lower. You've got a new period and you know, whatever it is post night, post 1990, where the average is much higher.
- [24:22]
A
And then one of our guests pointed
- [24:23]
C
out recently that even inside this new period, you've got a mean that continues to rise. Like, how do you think people should think about mean reversion and where we mean revert back to and how this whole process plays out?
- [24:35]
A
Yeah, well, you know, these are each topics you could run a podcast on, but we'll go as long as you want. Take your time. I noticed that GMOs emerging market fund in the last 12 months is up 70%. And you know, this is not a normal occurrence. The S and P is not up 70% or anything. Like it's up 25. That's a big gap. And that is the spirit of mean reversion. That last January, not the January of this year, but the January of the prior year. In my podcast I said, the good news is that outside the US equities are pretty interesting, pretty cheap, and they're about as cheap relative to the US as they have ever been. They've only reached that point two or three times approximately the same level. And from that level the rest of the world outperformed the US handsomely, typically for multiple years. And happily I got that bit right. What I got wrong was I implied that the US would not be up 25%. On the other hand, I wasn't suggesting for a second that emerging and international value would be up 50 or 70. So everything was up more than one thought. But there was a massive mean reversion and from an all time low of the value of the world versus the S and P. And the world has handsomely outperformed and typically this goes on for a few years and I expect it will. So mean reversion is alive and well in certain areas, Even as the Mag 7 have made life very difficult for the study of mean reversion.
- [26:42]
C
Do you think there's a case though that the mean should rise over time? I mean, you could argue we have better companies, the mix of the market is more towards high margin companies. I mean, do you think there's kind of an in between here where we're going to get mean reversion? But maybe the mean should be rising to some extent over time.
- [26:56]
A
For a couple of hundred years the return to capital was pretty even. And is there a chronic systematic shortage of capital? I don't think so. So the reasons for moving return on capital above normal should tend to be idiosyncratic, short lived events. And when I say short lived, even the emergence of the Mag 7 will only be a blip in history. Of course. Is there anything that feels like it's permanent? Why would the required return to invest a dollar in the economy suddenly go up after 200 years of it ebbs and flows? Of course you have economic cycles, you have cyclical peaks and troughs. But is there any reason why the central tendency should go much higher? And the answer would be yes. If there's a chronic permanent shortage of capital, if there are more people bidding for capital and nobody is saving, there's not a hint of that seen through my eyes and other people's eyes, there does not seem to be a permanent chronic shortage of capital. And therefore in the long run, if capitalism is working effectively, high returns are competed down. If you get in the way and you allow monopolies to start, like Rockefeller back in the days where he arm twisted the railroads and said, I am doing so much business with you, if you don't increase the rates for my competitors, I will leave and go to another railroad. And so they did. And whether that was breaking the laws of the day or not had to be decided, and Teddy Roosevelt decided it was breaking the laws and, and slashed and burnt. So these are very important, very difficult issues to deal with. But history is pretty clear. The return on equity is fairly stable in the long run. And that if capitalism is working, there should be competition to push the return down for a while. New technology can create a monopoly feeling, but in the end, they all converge, as they appear to be about to do. They're in the early stages, are they not, of investing vast sums of money to attack the same market. This is the kind of process that ends up in the long run, creating regression to the meat. One of the topics you talk about
- [29:48]
C
in the book, which many people would argue is very valid, relevant right now, is the idea of bubbles. But before we talk about that, and we talk about that in relation to AI, I just wanted to talk about what you think a bubble is. You talk about that in the book. You say there's two conditions for a bubble to form and that they're quite simple. Like how do you define a bubble?
- [30:03]
A
A bubble occurs typically when the economic conditions are nearly perfect and there's plenty of money around. If you get those two things together, you will have market prices rise. If they stay in that condition for several years, the market will rise and rise and rise until it's in a bubble. But we asked ourselves 20 years ago, 20, 27 years ago, we asked ourselves, we better define a bubble so that we can know what we're looking at. And we defined it in nerdy statistical terms as a two sigma event. And a two sigma event in statistics is the kind of thing that happens every 44 years in a random series. So imagine yourself putting numbers down in a little green book from a roulette wheel that you're spinning. That's a random series. And a Two Sigma event is the kind that would happen every 44 years in the stock market. On the roulette wheel, it's equivalent to, let me guess, eight or nine reds in a row. So you get an arbitrary measure, two sigma, based only on the price. So we've kept it unbelievably simple. Give me the price series and we will tell you when it's two sigma. And we went through all the asset classes and we had well over 202 Sigma events. And there were a few that were paradigm shifts, which is the other group, but just a handful. And they were all commodities except one or two emerging countries. As they became developed countries, they went from non serious to serious. And so they had a Permanent move up in price earnings ratios and so on. I think India was in that place many, many decades ago. But and this is the key if you limit your two sigma events to serious developed country stock markets. Every single one of them, when we did our opening study, every single one of them always had gone back to the pre existing trend, that is to say the trend that existed prior to the bubble. By the end of the bubble, of course the trend line is a bit higher, but they more than met the standard. They went all the way back to the pre existing trend, every single one of them. I think there was something like 27 and there were no exceptions. And so we look at a two segment, we see it as a complete outlier. We have enough faith in history to think they will go back. And therefore back in the day we thought Japan was horrifyingly out of line. We actually thought owning it was fiduciary, irresponsible. And so in our foreign accounts, even though it was then 45% of the benchmark, we went to zero. And we watched it rise to over 60% of the benchmark and we watched it go from 45 times earnings to 65. 65 times earnings. Japan had never sold over 25 prior to that great bubble and it went to 65. That's the kind of outlier that makes value managers, or should make value managers wake up in the middle of the night screaming. Because that was long and brutally painful and we had to ride that out. We were out of Japanese stocks completely. We underperformed by 10 points a year for three years and came out when Japan had finished breaking far, far ahead on the round trip.
- [34:07]
C
It's funny, I think that Japan bubble is underfollowed by people. You mentioned 60% of the benchmark. That's insane. It's crazy to think about. I mean even if you look at the dot com, I mean that, that Japan bubble is many, many levels above that.
- [34:20]
A
And it's many levels, not many levels, but it's substantially ahead of today. And that's the thing, you think this market, it's broken all the rules. Nah, it's a piker compared to Japan. And then of course we had to go through the tech bubble or the Internet bubble if you prefer it. And a similar story, the market had never sold over 21 times earnings, which was the peak in 1929. It hit 21 again in 1972, the Nifty 50 era. And it hit 21 at the end of 1997. We had perfectly good competitive performance. We had managed to fake it. Even though the market was at 21 times earnings, as high as it had ever been. We were in the game, we were a player. Perhaps we were bending our rules a little bit. Who knows? With hindsight, I'm a little suspicious that we had done that well, and then breaking through 21 times, it went 23, 25, 27, 20. You must be joking. 31, 33, 35 times earnings. Nothing had been like that before. And along the way, we made a value bet. We doubled up, we tripled up, we rolled the dice, and in two and a quarter years, we lost about half our book of business, slightly over half our market share of the asset management business. Pretty quick, heartbreakingly quicker than I would have would have guessed beforehand. But it came back down, returned all our money, and then made us a ton of money beyond that. But none of the clients came back, by the way, half the clients left, not a single one came back, even though we'd made the right bets for the right reasons and we had won. And in the decline of 2000, 2001 and 2002, we made very nice money as the S and p went down 50% and the Nasdaq went down 80. We made good money, double digit money in 2000 and 2001 and half a percent in 2002, hanging up by our fingernail. But we were up over 30% by the low and the S and p was down 50, so that was okay. That took us too, through to the housing bubble, which is the only one we ever got right. We wrote a series of quarterly letters saying, starting in the spring of those seven, watch your tails, things are looking tricky. And then this is like watching a slow motion train wreck, unquote. As everything seemed to move through the paces. Market was continuing to go up, but the debt levels were continuing to look worse. The financial system was beginning to look shaky. And the more we looked into the quality of the subprime instruments, the flakier they got. And although that was not our specialty, we did understand that it was a drastic source of risk. And then we said, get out of everything really, but emerging. And then finally, slightly after the peak, we advised everyone to sell everything they possibly could, including emerging, as I said before, on July 15th. And we made a huge trade out of everything we could. In some accounts you have constraints, but we sold every emerging dollar we could before, of course, we published the letter for the rest of the world. So that's three big cycles until you get to 22 in 2021. We had every condition of a bubble in place, including my very favorite rule that I could or could not describe to you, which was flashing brightly. And that rule only occurs at the top of 1929, the nifty 50 of 72 and the tech bubble of 2000. This had only occurred three times in history and the fourth time was late 2021. And that is when the market leaders of the second to last year, where they're all up 70, 80%, the market leaders start to go down as the market, the broad market, the S and P, continues to go up. So in 1929, the S&P was up 40%. But the S and P had an index there called the low priced index, which were $5 flaky fallen angels typically. And they had been up 80% in 1928. And come January 29, they started to go down. And before the market broke in October, they were down 40%. They were actually down 40% with the S&P up over 30. Oh my. That was what I call the biggest scream from the stomach of the market in history. And nothing like that happens again until 1972, where you get a significant, but only a faint echo in comparison. The S and P goes up 17 in 1972 and the average of the S and P goes down 17, so that I can remember it forever. And nothing like that happens again until 2000, as the tech bubble begins to break. Growth stocks go down 50%. The S& P continues to go up. The balance goes up another 14%. So that you have the same level on the S and P in September 2000 that you had at the growth stock peak of March 2000. Why does that happen? I think it's because the players, you know, Mr. Prince once said, if the music's playing, I've got to keep dancing. And that is ultimately important statement of how the professional money management business works. You cannot fight a major bull market. It is ruinously unprofitable. It's not optimal behavior at all. So the big companies never fight the market and never tell you to get your ass out of the market. And they never have, they never will. If you are waiting, dear listener, to be told to abandon ship by the Goldman Sachs and the JP Morgans, you will have a long way. They have never told you, they never will tell you because it's simply bad business for them. They do very nicely being bullish all the time and trying to be a little quicker and slicker on the execution on the way up and the way down. And it works very well, thank you.
- [41:36]
C
Well, I think it'd be a terrible interview if I didn't at least ask you if that rule is triggered now. You know, we've kind of seen a revert or like the tech stocks have taken off a little bit. But last year, I believe only 2 of the mag 7 outperformed. So have we seen any signs of this market still up, the leaders going down?
- [41:51]
A
Unless I'm missing it and it's a complicated business, I would say absolutely not. As far as I can tell, junky stocks are beating safe stocks. We have an index where we go long quality and short junk and it's being bashed around the ears. Okay, but go back to 2021, and it was not being bashed around the ears. In 2021, you had a perfect example where the super blue chips were doing well, but the flakier ones had peeled off. For example, Cathie Wood's portfolio, right? She had been brilliant off the low, off the COVID low. And then starting a few months into 2021, Cathie Wood's portfolio that had been brilliant had tripled and doubled. I mean doubled and tripled. And then it started to go up, it fell off and it lost a lot of headway. And one by one, you remember the meme stocks, they were taken out and shot as the market climbed handsomely through the year. They were shooting the meme stocks and I inadvertently owned the meme stock. Quantumscape I had for a long story, I had a huge position. That was the only terms we could get the stock on 5% of the company and it was 5% or nothing. And that was far too big for the foundation that we run for the protection of the environment. So that was the only thing I owned myself. And so I owned it. And I watched it come as a SPAC at 10 in late 2020. And while the market was still roaring upwards, it came as a SPAC at 10, four times my money. Not bad. Much better than a kick in the pants. And in three months it went to 131. At 131 it was worth more than General Motors. It was a research lab that was going to develop one day, we hope, a solid state battery. But today they still don't have a commercial product on the market. But they will, I think in a year or so, maybe even in six months. In any case, they did not then. It was an idea still. And yet it sold for more than General Motors. There was never an idea. That scale in 1929, by the way, I mean that you have to admit to be worth more Than a seasoned firm selling millions and millions of cars. When you have a research lab with years to go before you have any sales, forget profits. And that was the leading. When did it peak? It peaked, sadly for me, in December 2020. It was the first meme stock to peak. And then all the other meme stocks peaked in the first half of the year and Cathie Wood's portfolio peaked about mid year and so on and so forth. It was classic. It was just like the behavior in 1929. 1972. Better than 1972. Better than everything except 1929. And we do not see that definitive behavior. And I'll tell you why it happens. I was talking about Mr. Prince. When the music's playing, we've got to keep dancing. But you don't have to keep dancing with PumaTech. PumaTech is my favorite example since it was the most advanced stock in 99 in that bubble. And mysteriously in the next few months, people made sure they recycled out of the Puma tank into the Coca Colas. So Mr. Prince was still dancing, but he was veering towards the Coca Colas. And why not? History tells you in 1929, et cetera. It is better to go over the waterfall with Coca Cola with the survivors than it is with the Puma Tech, which quickly ceased to exist. And Coca Cola of course, did not. So it's a strategy that makes sense and you can imagine how it would happen. They say, yeah, I'm optimistic and the market's been lovely, but this is ridiculous. Or it's getting ridiculous. I better make sure I play the game. But at least I will play it with survivors. So I understand the logic. I see why it only happens in extremes. And it clearly happened in 2021. And 2022 is a very nasty bear market, in case people have forgotten already. S and P down 25 growth stocks down 35. MAG7 down 40. The bond market. The worst year in the history of the bond market. And then I like to say my nice prediction, my wonderful bear market was rudely interrupted by Luminous AI introducing in. What was it? Late October, I think. Chat GPT.
- [47:09]
C
Yes, October 22nd.
- [47:11]
A
October 22nd. ChatGPT. Wow. And that. That ruined the bear market the following year, the following 10 months, all the other stocks on average were down, by the way, they continued down. They couldn't quite believe that the bear market was over. But the Mag 7 doubled and dragged the S and P with it. And then 10 months later, the rest of the stocks threw in the towel and joined in. The bull market and my belief is that we would have gone into a minor recession. Why didn't we? Because they stepped up the capex for AI to such a huge degree that if you back it out of that time period, it appears to account for all of the GDP growth. So we would have approached a zero growing gdp. As Keynes explained, Animal spirits is very important. As the market goes down and the growth rate of the economy goes down, Animal spirits sometimes can get very pessimistic. They affect the investment rate and you slide into a recession. My guess. How do you prove it? My guess is that in 2023 we would have moved into a recession and the market would have gone down another 25% and AI headed it off. So now we're in terra incognito. We've never been here before where a major event, AI with massive capex, unprecedented in any era, even including railroads as a percentage of gdp. We have a bubble forming out of a bubble that was only halfway completed, only halfway deflated, and then resuscitated by this magnificently complex and important business and AI.
- [49:13]
B
One of the things you had mentioned was in the late 90s, early 2000s, that was a pretty, you know, dark time for GMO as you were losing clients and underperforming just because everything was going parabolic. You obviously were positioned great when that party came to a standstill or came to an end. But I'm curious, and it's a. The question is rooted in investor behavior. Because what I was thinking was even if those clients, which you said, I guess none of them came back, but even if they would have come back and said, you know, what, you know, Jeremy and gmo, we want to put money with you and, you know, would you have even sort of taken them? If that's a, a fair or right question and really what it gets at,
- [49:58]
C
what, what I'm, what I'm trying to
- [49:59]
B
get at is like the investor behavior aspect and the importance of believing in a strategy affirm and being able to see through those times and get the most out of a strategy. So there's a couple different questions wrapped up in there, but yeah, I'm interested in your thoughts.
- [50:19]
A
I would very happily accepted anyone who came back. Most of the people we got, and let me point out that we had 30 billion going into the tech bubble and the market roared upwards and we roared downwards to 20 billion. So a typically successful firm starting at 30 billion would have gone to 50 or 60 and we went to 20 and then on the way down, you know, they went from 50 to 35 or 30 and we went from 20 to 22. But then the third phase, starting at the bottom of the market in 2002, we went from 22 to 165 in four years. All new business, all thinking. GMO is our kind of guy. They're tough, they stood their position, they got it right. And very few of them really aware that had they been exposed to the stress of badly underperforming in a bull market, they too might have found that the committee was advising them to fire us. Committees, after all, are made up of illustrious, important members of the college, famous alumni who are in hedge funds and private equity and therefore, of course, know everything about investments. And these are powerful guys and they tend to be much more short term than some of us. And they lean on the hired guns. The hired guns weren't too bad. In 99, 2000, they would call up on a Friday evening and say, oh my God, Jeremy, that last meeting was terrible. They're beating me up. Give me some ammunition for the meeting next week. And I tell them the best data we had. And we spent a lot of time in 99 reviewing the data and improving it. So we'd hand over impeccable data about mean reversion and he'd go there and he'd call back a week later and say, ah, thank heavens they bought it for the time being. And then a couple of months later, he'd call back and say, or a quarter later and say, oh, this was even worse this quarter, and I think it's going to be either your job or mine. And then a couple of weeks later, I'm sorry, Jeremy, it's you. And we'd be shocked, but they kind of believed, a lot of them believed that we lived in a mean, reverting world and that these stocks were dangerously overpriced and they were being forced by their committees to fire the value managers and hire yet another growth manager. In a couple of cases, we managed the whole account, and in both cases, funnily enough, there was one important member of the committee common to both of them, and they were going to shoot us. And I made the most passionate plea of my investment career, probably. And I said that firing a value manager under these conditions and hiring another growth manager was on the very border of fiduciary. First Feinterbuilding. And I knew I'd get fired. So, you know, I was thinking, well, I've got nothing to lose. At least I can say what I honestly believe. But it turned out there were enough nervous nellies on the committee that they persuaded the boss to go with shooting half of us, so they shot half of us. And they did indeed put the rest in another growth manager. This was fairly near the peak. And in 21 months, their half was half of our half. They had wiped out a quarter of their endowment in 21 marks. That's a tough world we live in.
- [54:33]
B
Well, I guess that comment on the fiduciary aspect was more. More right than wrong, but, yeah, interesting. Thank you for sharing, sharing that history with us. We have. And, Jeremy, there's a lot, you know, we really touched on, you know, a few aspects of the book and we have a lot more to ask you. So maybe this conversation can continue at another day in the future, if you're so kind to come back and join us at some point down the road possibly. But I wanted to ask you two kind of standard closing questions here. Well, one is not a standard closing question. One is more about how you ended the book. And this is talking about the purpose of, I guess, in your life and in your career and. And for people that don't know, you know, you run, you know, a number of philanthropic efforts on a number of different things. So this idea of purpose, you know, it's not just talking about it, it's actually putting your money that you've earned and your resources behind some of these things. So just, I thought we could at least on this point, you know, share with us and our audience how you think about sort of the purpose in your life that you would like to impart on others.
- [55:50]
A
Yeah, well, I have come to believe that purpose is pretty darn important, that as you get older, you don't want to be sitting around thinking, what a useless life. What was it all about? In the end, it's about kind of doing your best or trying to improve the system in some way that you can. And so my recommendation to anyone who's kind of young and graduating and so on is to make sure that your career is likely to be useful. Be an engineer, be a scientist, be in the health business, be anywhere where you know that what you're doing is. Is useful. Start a new company. I think venture capitalism is the very, very best part of modern capitalism. I think capitalism is a bit fat and happy and too monopolistic. But I do think that the venture capital world generates very important new ideas. If you look at the Mag 7, ask yourself this, how many of them came out of the venture capital business 50 years ago, 30 years ago, 25 years ago? You know, GMO was started a month or two after Apple and Microsoft, it's stunning. And they're the old fogies. The other guys are all younger than we are. As corporations, it's a really good idea to have a target and keep going. And it's particularly important when you've retired. Otherwise you sit around playing golf and wondering what it's all about. And there are so many really important risks. Risks that could bring culture, civilization, safety, growth to a screeching end in the not too distant future unless we address them. There's the chemicals that we swim through every day, and we eat the food we eat covered in toxic chemicals. The fertility rate of our species is going to hell in a handbasket. This is all a matter of public record. And our sperm count is down to less than 30% of what it must have been in the hunter gatherer days, and down well over half since 1972 when the academics took a brilliant survey of the topic. So we are busy going out of business as a species. The trouble with capitalism, it's killing off its own market by resolutely defending their right to produce toxins. And they were thinking of going to the Supreme Court to make sure that fossil fuel companies and chemical companies could not be sued for the damage they create. So, fine, go ahead. But at least toxicity is regional. If they want to behave pretty well in the eu, they live longer and healthier. If you want to behave badly in the US, the reverse. And we're the only country. Fifteen years ago, our life expectancy was long and our healthy years have done even worse. The gap between us and Sweden has gone from two years to six years in the last 40. And as I said in the book, I think, or in a quarterly letter, my estate would be willing to bet you a considerable amount of money to come back in 50 years. That gap will be eight years or more. Let me give you one example. In cosmetic, there are 10,000 chemicals. The EU has banned 1500. If they banned carefully the worst ones, that's a pretty good dent in the danger of cosmetics. Canada has banned about 550 and the US has banned 12. And you know, as a Brit, my tendency is to say, fine, you guys want to kill yourselves, go ahead. But it seems like a bad idea, doesn't it? And then we have climate change. If unaddressed, that will make life very unpleasant. The last two years, by the way, for the first time, is about a half a percent of global gdp preventing climate disasters, fixing them, et cetera. Half a percent of gdp that is going to get steadily worse. And everyone in the World realizes this is a serious topic now, except the us Not a good place to be. So these are really serious topics and there are plenty of others. Even worrying about AI and trying to decode some of the problems would be pretty worthwhile. But many and most jobs, in fact, are just making a living. And I recognize someone has to do them. But if you have a choice, pick something useful.
- [61:03]
B
The last question that we always like to ask all of our guests is based on your experience in the market. If you could teach one lesson to your average investor, what would that be?
- [61:13]
A
The really impressive thing about Homo sapiens is it doesn't like to deal with long term and it doesn't like pessimism. I suspect that we're optimistic because it helps you to survive. If you look at the millions of years as we developed, I think pessimism is probably not very helpful and that the willingness to see the bright side and keep on driving through any dangers that came along was helpful. Who needed the long term? For 99.9% of our history as a species, who needed to worry about the long term? Eventually, no doubt painfully, we learned to try and save enough for the winter to stash away enough potatoes or whatever, roots, berries, and that was it. So as a species, we do not do unpleasant years and we do not do long term. And my advice to the investor is try and fight those two tendencies. Try and be realistic, right? Rather than systematically looking for the good news and try and focus on say, a five year horizon. What is going on? So since the war broke out with Iran, the S and p is up 5%. Oh, I get it. That war must be good for us, right? Somehow, somewhere, I'll tell you, it's very, very good for the profits of US oil companies. Terrific. Not very good for the people who buy their product, but terrific for the oil company. But can't you tell, dear listener, that since the war this has not been very good for the world, for Europe, for anybody who needs oil. The only two who look even semi reasonable are Russia are good allies here and the us. The US is oil and gas neutral. We don't need to import oil and gas. All that's happened in the US is as the prices went up, the oil companies made the money, the people buying at the pump lost equal enough setting amount, but together we did okay. In Europe, everyone is bleeding. In the Far east, in China, Japan, they're all bleeding. But Russia is making money and the US is merely shipping money from the poor to the rich. So try and overcome these two tendencies and you will be one of the better investors.
- [63:55]
B
Thank you, Jeremy.
- [63:56]
A
You're welcome.
- [63:57]
B
Thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform on YouTube. You can also follow all the podcasts in the Excess Returns network@excessreturnspod.com if you have any feedback or questions, you can contact us@xsreturnspodmail.com no information on this podcast
- [64:17]
C
should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.