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The Colossal Mistake | Richard Bernstein on the Risks of Tariffs and Passive Investing
00:55:20
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- [00:00]
Richard Bernstein
Certainly I'm not going to be too far away. The biggest tax on the consumer, certainly that we've seen in our professional careers. 2024's stock market was the most narrow stock market we had seen since the Great Depression. If you're investing in an index fund or you're investing in a growth index fund, I think you're making a colossal mistake. My joke used to be we were seeing unprecedented use of the word unprecedented. Now we're seeing unprecedented use of the word uncertainty. If you were another country and you didn't like the tariff that was being placed on you, the biggest threat you could offer the United States back is not I'm going to tariff you, it's that I'm going to puke your Treasuries.
- [00:43]
Matt Zigler
You're watching Excess Returns. I'm Matt Zigler, co hosting today with me, Justin Carboneau. And of course, our esteemed guest CEO and chief investment Officer of Richard Bernstein Advisors. It's Richard Bernstein himself. Welcome to the show, Richard.
- [00:58]
Richard Bernstein
Thank you. Thanks for the invitation.
- [01:00]
Matt Zigler
So, gotta be honest, I'm a little uncomfortable with this. I remember 2008 sometime. I was in Merrill. You were in Merrill, too, in a prominent role. And you were telling me about how you really should be avoiding those financial stocks. The market could hit 666 if things go awry. And that was like a year in the future. And I remember you saying that, and I remember registering my head. I was new in the business at the time when. But I have never forgotten neither that call nor just what it felt like in that environment. Do you see anything today that rhymes with the financial crisis in any way, shape or form? I need to say ask this for myself if nothing else.
- [01:38]
Richard Bernstein
Yeah, I think I. Matt, I think this is. This is obviously a very different construction. Right. In 2008, it was centered, as the name would imply, the global financial crisis. It was centered on the financial sector. And the financial sector, especially the major banks around the world, are obviously key to the economy, right? Capital formation, savings, lending, all these things very key to the economy. And also it also affected housing. And housing is a very high multiplier industry. So that was the construction end. Today the construction's a little bit different. I'm not sure I can say it's better or worse yet, to be honest. But this is really what we're feeling right now is probably the biggest tax maybe in history in the United States history. I'm not sure about that. But it's certainly. I'm not going to be too far away. The biggest Tax on the consumer, certainly that we've seen in our professional careers. And given that the United States is, you know, 70%, 65% consumer oriented economy having that kind of tax on the bulk of the economy, I think that's what we're feeling right now in the volatility of the markets.
- [02:55]
Matt Zigler
You also, something I learned just, you know, following your work all those years ago was what you called style investing and thinking about sectors and just this approach to how these things stack up and then tacking it back to broad market indices, which is insanely useful for any active manager. I, I'm curious what you're seeing kind of like you saw in underweighting financials back then. Are there any sectors right now we should be thinking about?
- [03:20]
Richard Bernstein
Yeah. So, Matt, one of the things that I think investors always have to remember, it's fun to be a momentum investor. I would actually call that more trading than investing, but it's always fun to do that. But the problem is with momentum investing, it's sort of like Wile E. Coyote, right? You just keep running and running and all of a sudden there's nothing there. And then who. And then you get a little puff of smoke at the, at the bottom of the canyon. That's what momentum investing is all about, is that you kind of just, you know, you're the first lemming going over the cliff type thing. And, and that's when you're a momentum investor. Buying things is not where success comes from. It's actually knowing when to sell. And, and I think momentum investors always forget that. It's always, you know, what am I going to buy? What am I going to buy? It's so, it's so exciting. And they forget that that's not really the key to, to momentum investing. And so what we all know that the market got very, very narrow. There's no value added in my saying that. Everybody knows that with the magnificent seven or the, you know, top 10 or whatever phrase you want to use. But I don't think investors realized what a pessimistic view of the future that was to have such incredibly narrow leadership. Now what do I mean by that? So Goldman Sachs giving credit where credit's due. Goldman Sachs pointed out that 2024 stock market was the most narrow stock market we had seen since the Great Depression. Now in the Great Depression, it makes sense to see a narrow market, right? Because companies are trying, forget growth, companies are trying to stay alive. And the companies that can grow are like a handful. And so you had very narrow leadership during the Great Depression makes perfect economic sense. Now we could argue all day long how strong or weak the economy was in 2023 and 2024, but unless I missed it, we didn't have a depression. So it was very hard to argue that this was really a fundamentally driven market that we saw. And our argument was that people were missing all these other growth opportunities that were going on around the world, not just the United States. And I think so. So where am I going with this relative to your question? What I'm saying is that I think right now that if you're investing in an index fund or you're investing in a growth index fund, I think you're making a colossal mistake because those index funds are dominated by those seven or ten names. And those seven or ten names may not do very well because there's tons of growth opportunities all around the world, a much broader universe. And the market will eventually understand that and rotate towards that broader universe. So I think the unfortunate reality right now is that growth investing, the way it has been designed or defined rather in, in recent periods is very, very, very dominated by those seven or 10 or 20 companies. And so I think that right now, if you're an investor, not a day trader, but if you're an investor, there are a bazillion reasons to err on the side of value over growth.
- [06:25]
Matt Zigler
So important follow up question. If momentum investors are Wile E. Coyote. Who's Roadrunner?
- [06:32]
Richard Bernstein
Who's Roadrunner? I'm, I'm not sure. I haven't, I haven't thought about that one out. I can, I can, you know, I'm ready for the Tortoise and Hare type thing, but I wasn't ready for, for Roadrunner.
- [06:42]
Matt Zigler
I want to know who's, who's painting the, the fake tunnel. We can at least figure that out.
- [06:47]
Richard Bernstein
Exactly. I'm not sure who that is. And if I get an idea is running through my head, but I'm not sure I want to share with everybody.
- [06:54]
Matt Zigler
Well, I'll give you a much easier question to answer. If we're not going to say who's painting tunnels on walls. Let's talk about tariffs and let's just talk about how do we even start to think about these, how do we start to think about their impact and forget unknown tariffs? Like if we start to think about them as a construct, how can we put something to work here?
- [07:12]
Richard Bernstein
So, Matt, the idea of the re industrialization of America is a very worthy goal. In fact, we've, we started writing about this. I think, you know, we, the first Time I seriously wrote about this was in an op ed in the financial times in 2011. So that's now what, 14 years ago? Right. This is a real theme that we've been investing for, for more than a decade. And, and we think it's, it's a necessary theme. It's not just a nice theme. It's a necessary theme for the United States to regain some element of our economic independence. We're not going back to the 50s and 60s. I think that's a pipe dream to think that we're going to be the manufacturing powerhouse. That's ridiculous. I think that's really a silly idea. But on the margin, can we regain some element of manufacturing independence? Yes, and we should be doing that. And so I think the goal is a very worthy goal. Personal opinion here for a second. I think the way we are going about this with tariffs is about the most ham handed way we could possibly have designed a way to achieve this goal. You know, the reality is, is that tariffs are near term. Capital spending, as we all know, is a long term phenomenon. You don't just buy new equipment, you don't build a new factory in a quarter. This takes years. So we've got this mismatch of, of pain versus reward. You know, there's, there's plenty of, of better ways to achieve this goal without hurting the US consumer and placing this massive tax on the US consumer. So the goal I think is very worthy. I don't think anybody should argue against the goal. I realize politicians are going to say, oh, you know, right and left, all this kind of. I don't think there's any reason to argue against the goal. But I do think that the policies that we're, the policy path that we're following right now is really not a very wise one. I think that's why the markets are reacting the way they are inside of.
- [09:01]
Matt Zigler
The market reaction, which is the injection of this type of uncertainty. What about inflation? Tariffs and inflation? How should we process that?
- [09:10]
Richard Bernstein
Well, I mean, I've been unequivocal on this point. I think that tariffs, deglobalization, first of all, just the process of deglobalization is inherently inflationary. And the reason why was that globalization, whether you like it or not, I mean, I'm not passing judgment on that one. But globalization was inherently disinflationary because all globalization did was increase competition. And everybody that's listening to this podcast knows that when you increase competition, you put downward pressure on prices. That is not PhD type stuff. Right? Well, what deglobalization does is it starts reducing competition. And we all know when you reduce competition, you get upward pressure on prices. And therefore deglobalization is inherently inflationary. It's a very simple construct. So on top of that, we now have tariffs. Tariffs exacerbate that inherently inflationary force. Why? Because the United States does not have the excess capacity to provide goods to substitute for the tariff goods. So here's a way to think about it. Here's the example I give everybody. Matt, is anything in. And Justin, too, is anything you guys are wearing right now made in the United States? No. No. There's no way that anything you're wearing is made in the United States. In the last 30 years, the United States has lost, depending on how you measure it, up to 90% of our textile manufacturing capacity. So if the administration puts a 15 or 20 or 25% or 125% tariff on clothes, we have a very simple choice as consumers. We can run around naked, or we can pay 10 or 15 or 125% more for clothes because there's no alternative. There is nothing else we can do. And so that's why tariffs are inherently inflationary on top of the secular deglobalization, which is inflationary, too. Now, one, one thing just to add to that real quick, when I say that it's inherently inflationary, people go, you know, this is a hair and fire environment, right? So everybody goes, oh, oh what? You know, do you mean like 8%, 10%? How much inflation is going to be there? Well, remember, the Fed is still using this 2% inflation goal. And, and that seems incredibly antiquated to us at RBA. And so maybe instead of 2%, the Fed should be using 3 to 4, something like that. I think that's a. That's a reasonable secular outlook for inflation.
- [11:38]
Matt Zigler
Totally makes sense. And I just want to point out, I think Wile E. Coyote and Road Runner both ran around naked, so they.
- [11:43]
Richard Bernstein
Might have been on the stage. They actually did. Yeah.
- [11:45]
Matt Zigler
Yeah, I don't think. Maybe a necktie or something somewhere. One more thing on tariffs, the negotiating strategy for tariffs. Is there. Is there a smarter way to roll out a policy like this, understanding we're reversing some of the globalization trend? This is always going to be a messy process. Other ways to do this.
- [12:06]
Richard Bernstein
Yeah, I think, look, the argument that I made, you know, a decade ago was that, you know, this is, and forgive me on this one, I'm going to get a little kind of professorial. There's two. Two classic Inputs of production, capital and labor. The United States cannot compete on labor. Right. We're not going to put children in the mines. We're not going to, you know, child labor is not going to happen here in the United States. You know, that's just not going to happen. So we can't compete on the cost of labor. So what we have to do is compete on the cost of capital and specifically the after tax cost of capital. And what I tried to outline in my earlier reports and commentaries was that the United States, we should treat the United States as a giant enterprise zone, right? So that we reward good behavior. But there's no government expenditure, there's no damage to the economy. Nothing changes unless corporations do good things and we reward them for their good things. You'd say, well, why don't you just cut corporate taxes? That's part of the problem as to where we are today. So not picking on Apple as any one company, but I think it's one that everybody knows Apple got a corporate tax cut and then they built plants in China. That doesn't work. That defeats the purpose. Why would the United States finance, effectively finance China's expansion? That's ridiculous. So what we should have done was said, Apple, if you build a plant here in the United States, it will be, I don't know, tax advantaged forever. You know, I mean, make up whatever numbers you want to make up here. But as opposed to just saying, here's money, go do what you think is right. What we should have said was we want you to do this. If you don't want to do it, you don't have to do it. But if you do it, there's going to be a huge incentive to do it that doesn't blow out the budget. We don't run a bigger budget deficit. Nothing like that happens. And the return on investment becomes very measurable. Rich.
- [14:04]
Justin Carboneau
I know from following you all these years you have a humility when it comes to forecasting. But with that being said, I feel like you're probably one of the more accurate people that I've listened to over the years. But I wanted to get your take on kind of forecasting in this type of environment where you have these massive changes happening rapidly. It's kind of one decision maker supposedly making the decisions. You know, you can't really rely on the economic data that you would usually look at. So just, you know, generally what's your take on that? And if you want to tie in. You wrote a piece for the Financial Times. The title of that was Certainty is Now a scarcity in the market. So that I think plays into this.
- [14:46]
Richard Bernstein
Exactly. So. So Justin, first of all, thank you for the, for saying what you said. You're grossly overstating my ability to forecast. But that's fine. I'll take it for this situation. I'm happy to accept that. But, but yeah, I think the point that I tried to make in that, in that opinion piece was the uncertainty is growing. And you know, it used to be my joke, used to be we were seeing unprecedented use of the word unprecedented. Now we're seeing unprecedented use of the word uncertainty. Right. And, and what a change in six months for that. And so the range of outcomes, this uncertainty that we're all faced with now, the market is dealing with that in terms of just increasing the risk premium. If you have a riskier asset, say a junk bond relative to a Treasury bond, junk bonds carry higher yields because they are riskier. The uncertainty is greater. You know, is the company going to go bankrupt? Will they make their payments? Will they go up in credit quality? And maybe that could happen, but the range of outcomes for a junk bond is greater than the range of outcomes for Treasury. And so with that uncertainty comes a higher yield. Well, in the United States, as we have become more uncertain, what you found is that the market has begun to reprice the risk premium on U.S. assets. It's a very simple story. And so you're seeing that in that we've knocked off about five or six multiple points off the S&P's valuation, despite the fact that earnings have actually been reasonably healthy. Right. That's not what should happen in this environment. That's the repricing of US Assets. People have been shocked that treasury bonds aren't rallying like crazy into and interest rates aren't falling like crazy into this, into this volatility that we're seeing. It's the repricing of US Assets, it all kind of works its way together. And so if that's true, and if we're right in that assumption that we're in a uncertain environment where risk premium are being reevaluated to your point, what you said before, certainty becomes the scarcity in the marketplace. And so in our portfolios, what we're trying to do is we're trying to increase the certainty. What does that mean? We are looking for higher quality companies, not technology companies, because that's obviously been very, very speculative, but higher quality balance sheets that are non tech. We are looking at dividends more and more. Right. Because of the certainty to the cash flow that you, you get as an investor. And we're discounting these lofty growth stories where the range of outcomes is now spreading exponentially. Right. You have no idea what's going to happen over the next three, five, ten years. And, and so even in, in, in our fixed income portfolios, we've been reducing what little credit quality we had. We were already underweight credit, but we've been reducing credit quality even more now in that respect. And people are wondering like, why is gold performing well? Well, there's a fantastic correlation between gold and the small business service, the NFIB Small Business Survey. They have a component that's called the uncertainty index. And there's a tremendous correlation between gold and the uncertainty index. So of course we have, we have had and continue to have gold in our portfolios as well. So the way to think about it is if certainty is, is, is the scarcity, you want to buy that, that certain that scarcity. And that's basically what we're trying to do.
- [18:17]
Justin Carboneau
So two things, earnings and stock picking. So do you, I don't know at a firm level if you forecast s and P500 earnings, but I know you guys look at individual company earnings. So the first question is, is, you know, what type of effect do you think this tariffs are going to have on earnings? And then B, it would seem to me like this would be a good environment for roll up your sleeves sort of due diligence on individual companies and like active stock selection. Because I feel like there's certain companies that are going to be affected more or less to your point about the certainty thing. So just on those two, those two.
- [19:00]
Richard Bernstein
Sure, sure. So in terms of the second one, first, we don't really spend a lot of time on individual stocks or more of a macro firm. But there's from a macro perspective, the spreads, the valuation spreads are obviously widening and widening pretty dramatically, but they're not enough yet to say like, wow, this is, this is the time to go, go buy, you know, individual companies. There's a normal process, that normal process is underway. It has not yet hit an extreme. I know that's disappointing to a lot of people given the level of volatility, but it hasn't yet hit that kind of extreme yet. But we're working our way there we are. There's definitely some effects that are going on. And then, forgive me, now I'm going to show my age. What was the first part of your question?
- [19:46]
Justin Carboneau
Oh, it was the earnings forward. Earnings.
- [19:50]
Richard Bernstein
Oh, earnings. Okay, so let's, let's talk about Earnings pre tariff, pre, pre, you know, Liberation day, all this kind of stuff. Before all that even occurred, our forecast was that the profit cycle was going to peak out roughly about mid year, roughly about, let's say somewhere between June and September, let's say the summer to, to be, you know, imprecise, somewhere around the summer that the profit cycle in the United States was going to peak out. That was before, I think now it's a, it's obviously a boatload more nebulous. Very difficult to figure out whether this is, you know, how quickly and dramatically this is going to occur because there's no certainty. Again, you know, things are changing right and left and very capriciously, but it certainly is not going to make the profit cycle stronger, let's put it that way. So I think in terms of, you know, the normal story for us would have been that, that as we move through the year, this year, and we wrote about this at the beginning of the year, we expected our portfolios to move from something more cyclical to something more quality and defensive oriented. I think that process is speeding up a little bit.
- [21:02]
Justin Carboneau
You had mentioned before that one of the goals of the tariffs is to bring manufacturing back to America. But I think that, you know, what's confused the market here is it seems like there's a number of maybe other goals and it seems with the tariffs and it seems like one of those is to bring the 10 year down. So you know, it used to be the belief that Trump focused on the stock market. Now it's like the ten year yield. So can you just talk about why that would be important to them and maybe the impact of if that's true, switching from, you know, focusing on the stock market to the bond market.
- [21:37]
Richard Bernstein
So it's important to the administration of lower long term interest rates because of the effect that that has on very high multiplier industries like housing. Right. I mean that was one of the problems we talked about before in 2008 that housing got hit and housing is about the biggest high multiplier industry. What do I mean by high multiplier? I mean that if you think about this, when you build a house, you employ people, you're using a lot of building materials, there's lots of stuff that goes in there. Person or family moves into the house, you're buying all new furnishings, you're, you're, you know, all this kind of stuff. And, and so, you know, there's a lot of spending that ripples through the economy. In an economist sense, it's called a multiplier effect. And housing is about as high multiplier as you can get in the economy. And we all know that housing is very sensitive to mortgage rates and mortgage rates are very sensitive to the 10 year, to the 10 year note. So if, if 10 year, if 10 year yields start going up and going up dramatically, that's going to have an impact on the mortgage market. Mortgage markets therefore going to impact the housing market. You start increasing your risk of recession. And, and that's. So that's number one. Number two is the administration's concerned because, you know, one of the things that we do export, export and quotes is not something we really export is Treasuries. And everybody around the world owns Treasuries. And so if you wanted, if you were another country and you didn't like the tariff that was being placed on you, the biggest threat you could offer the United States back is not I'm going to tariff you, it's that I'm going to puke your Treasuries. That's the biggest risk that's out there. And so when they started seeing rates going up, they started worrying that foreign buyers were selling Treasuries. And if that happens, then we kind of lose control of our own economy to some extent. And so there's a fine line here. I would dispute the notion that the trade hand we have been dealt is quite as strong as the administration is making it out to be. I really don't think we have a very strong hand here.
- [23:53]
Justin Carboneau
What do you think about the level of debt that we have as a country? I think we're roughly, I think our debt to GDP ratio, and correct me if I'm wrong here, is around 120%. Something like that.
- [24:03]
Richard Bernstein
Yeah, yeah, yeah, yeah.
- [24:04]
Justin Carboneau
Does that, is that something that we should be concerned about or is there a tipping point somewhere? What is your feeling on that?
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Richard Bernstein
So we should all be tremendously concerned about that. There is nothing good to say about debt to GDP and the debt levels in the United States. I'm amazed that people somehow try to twist this into something that's positive. I can't figure that one out. There's nothing, I mean, think about this. If it was your own personal finances and you were levered up the schnoz, you know, would that be good? Would that, would we all say that's a smart thing to do? Probably not. If we had a company that was levered up the schnoz, would they, we say that's a, that's good for the company. No, we, we wouldn't do that, and we've learned in the past that when hedge funds or Korean companies, if you want to go back to the 1980, 1990s, you know, levered themselves excessively, it led to tremendous volatility in their earnings streams and everything else. So, so I don't think there's any good to be say about this. However, I'm not sure. People kind of have this notion that there's going to be a day of reckoning, right? We're going to wake up tomorrow, we're going to be an emerging market and nobody's going to want to own our assets and it's going to be this sudden thing, like all of a sudden the lights are turned on. And, and I love, I love when people say that one because it's like, you know, we're so smart and the markets are stupid. I mean that's, that's a huge statement to make, right? We're all smarter than the market. The markets don't realize this. The markets realize it, I can assure you. And the second thing is that, that it's not like we're going to wake up and there's going to be a day of reckoning. Rather it's a slow bleed. And that slow bleed has been going on for really 10 or 15 years already. What do I mean by that? So you might remember that in I think it was 2011, the spring of 2011, U.S. treasuries got downgraded for the first time from AAA. Okay, now let's again go back, take a step back. If I had a corporate bond and it was downgraded from AAA to double A, would it trade similarly to other AAA rated bonds? No, it would not. It would start trading like double A rated bonds and there would be a little risk premium attached to that yield. Now if going from AA to aaa, that might be small, but still it would not trade with AAA anymore. Right. Okay. So the US debt gets downgraded in 2011. Prior to that downgrade, US treasuries trade pretty much in tandem with other AAA rated sovereign debt around the world. Sometimes we yield a little more, sometimes they do. We do, they do. Back and forth, back and forth, back and forth. Depending on what was going on around the world. Then we get downgraded and I'm going to exaggerate here, but almost to the day that U.S. debt gets downgraded, U.S. treasuries have sold at a risk premium yield relative to other AAA rated sovereign debt. And that spread has just continued to grow through time. It's come down a Little bit in the last several years. But it's still, I mean the chart relative to history is something to see. It's like you can tell exactly when we were downgrading. Now why is that important? It's important because we know that everything in the, all debt in the United States basically trades off to 10 year. We know that mortgages do, we knew the corporate loans do, you know, all this kind of stuff. And municipal bonds, everything trades off that. So what's happened is because the United States has already been penalized with this risk premium, that penalty has translated through to all debt in the United States. And so it's not like we're going to wake up and be penalized. We've already been penalized with higher interest costs for being a riskier country. Why hasn't anybody noticed that? Because the absolute rate of interest was so low nobody cared. They missed the point that it should have been lower. Right. But we were being penalized. And so part of our lack of competitiveness is already being felt in that spread that's hindering our ability to raise capital at a cheaper price relative to other nations.
- [28:02]
Justin Carboneau
I have two questions about the Fed and the first one is more about, I guess narrative. It seemed like, and this is true, I think in the markets in general that, you know, maybe like a year ago all that anyone was talking about was the Federal Reserve. And you get these times in the market where I think investors become laser focused on something. Now the Fed is obviously important and I get why, but I'm just wondering, like how, how do you, or how should an investor. Would it be true to say that if you're hearing something too much, it's like it, it might not matter as much as you think. And I'm thinking about the Business Week, you know, cover story of, you know, Warren Buffett, you know, not. And then all of a sudden Buffett goes on a great 10 or 20 year run. Just, it's like some perspective on like narratives in the market and how, you know, you, when you see something, what gets you either concerned or what, what gets you look. Wanting to look deeper.
- [29:04]
Richard Bernstein
Right.
- [29:04]
Justin Carboneau
Is there a question in that?
- [29:05]
Richard Bernstein
Yeah, no, I, I get it, I get it. So first, let me, let me preface this by saying I don't envy the Fed. I'm about to be very critical of them. But I think it's real easy to be an armchair Fed watcher than it is to be the Fed itself. And, and I, I admire them for their, for their guts and gumption, even though I don't agree With a lot of the things they do. You know, it's two kind of two separate issues there. So I don't want anybody to think that this is that, you know, they have an easy job. They certainly don't. That being said, a couple of things. I used to teach in the grad school at nyu, and one of the things we used to talk a lot about was leading, lagging, and coincident indicators. So a leading indicator is one that actually leads gdp. A coincident indicator moves in tandem with gdp, and a lagging indicator moves after gdp. And so what we do, what I always used to try to point out to the students, was that investors, for some reason, have an amazing fascination with lagging indicators. I just don't get this. I mean, it's one of the things that, that when we go out as a firm and we market to people, we talk about the importance of leading indicators and we follow them, blah, blah, blah, blah, blah. And. But everybody talks about lagging indicators. So what are kind of lagging indicators? Well, the CPI is a lagging indicator. The unemployment rate is a lagging. Think how much attention those two get. And they're lagging indicators. What's another lagging indicator? The Fed. The Fed is a lagging indicator. And Janet Yellen used to talk about this. She used to say, we're going to become data dependent. Now, I always love that phrase, because what were they before? Were they just winging it? And all of a sudden this is something new and now they're data dependent? You know, no, they were always data dependent. But what the, what that statement really means is that they were going to get the data, they were going to analyze the data, and then they were going to keyword, react to the data. That's the definition of a lagging indicator. So whereas Wall street always treats the Fed as being the initiator of something, at our firm, we've always treated them as the reactor, not the initiator. And and so I think that's very important for investors to understand that, you know, maybe if you're a hedge fund and you're day trading, I get the Fed announcement's gonna be very important. I understand that. But from an investment point of view and a portfolio construction point of view, you cannot treat the Fed as a leading indicator. They're very much a lagging indicator. Second thing is, I think the Fed right now is kind of caught between a rock and a hard place. And that's what I was saying before. This is a tough job because the Fed was spoiled for many, many years. By that deglobalization, secular disinflation, deflationary force that was put on the United States. So we all thought that like a lot of the Fed chairmen were, were fantastic. It was, they couldn't go wrong because even if they completely messed up, you saw this massive disinflationary force keeping inflation under check. Well, as def this as deglobalization takes effect, the Fed's job gets harder now because now the secular trend isn't disinflation. The secular trend is inflation. So they can't play the hero anymore. In other words, they can't. You know, the whole notion of the Greenspan put and all this kind of stuff the Fed put that people like to talk about how when the market goes down, the Fed saves the day. The Fed can't really do that now because inflation expectations are rising. You know, secular inflation may be rising. That, that handcuffs them a little bit. So they're caught between a rock and a hard place in that the economy might be weakening because of. Might weaken. Rather not be weakening, but weakened because of tariffs. We may hurt the consumer on that. But at the same time inflation expectations are going up. Which do they choose? Now they have to make a choice. Do they want to fuel inflation and maybe save the consumer or do they want to fight inflation and maybe cause a recession? Now they got it. Now they're going to have to earn their keep. It's a much different world to be a Fed chair than it was 10 or 15 or 20 or 25 years ago.
- [33:12]
Matt Zigler
If Rich Bernstein was Fed chair, what would the Bernstein put be?
- [33:16]
Richard Bernstein
Rich Bernstein is Fed chair number one. I can assure you that's not happening. One, I probably wouldn't do it and two, I certainly don't have the political connections to make that happen. So, so let's, let's. For what? But what would I do in this environment? Look, I think not being cruel, I'm not trying to be cruel. Through time, historically, people have hated central bankers. And the reason people hate central bankers is they're tight wads. And they're tight wads because the most critical thing in an economy is to not allow inflation to creep into the economy. It's really not the job of the Fed to save the day. That's the job of the fiscal side of the equation to have appropriate policies in place to alleviate pain during a recession. That's not really the Fed's, the Fed's point of view. Now if the banking system gets in trouble, then yes, the Fed should be, should be easing and Making sure there's adequate liquidity in the system. But if it's just unemployment going up and you know, there's inflation going up, I think they have to err on the side of inflation. You can tell from that comment that my central bank hero was Paul Volcker. Right. Because I think he set us on a path for long term disinflation. And I think that's what a central banker should really try to do through time is kind of be a tightwad. Your role is not to be generous.
- [34:39]
Matt Zigler
We'll accept that as your formal submission for throwing your hat in the ring for that.
- [34:43]
Richard Bernstein
Wrong.
- [34:44]
Matt Zigler
You had this great piece on your site and we want to ask some questions. The first one, and this goes right back to the leading lagging coincident question. Is a recession looming? Is that what's up next for the United States?
- [34:57]
Richard Bernstein
So a couple of things on that. Number one, throughout my entire career, the consensus economic forecast has never, never correctly forecasted recession. Recessions are always for the consensus. Recessions are always a surprise. And so the way I would think about that is how many people forecasted the 2008 financial crisis and the recession like nobody. One of my colleagues did and he was like Persona non grata on the street. It's usually a surprise. So if you couldn't forecast 2008, which was like the mother of all recessions in our lifetimes, I don't think we should expect the consensus to correctly forecast even a mild recession when and if it happens. So the fact that the consensus is rolled towards this recession, inevitable recession forecast, there's probably good news, to be honest. That being said, and I think it's hard not to feel like if there's not going to be a recession, the growth is going to be slower than people think. Right. I, I just don't understand that, that if tariffs are put in place, it is. And well, maybe let me rephrase this. We are seeing if, if everything goes according to plan, we will see the most restrictive fiscal policy in our lifetimes by an order of magnitude. I can't even imagine. You've got doge and all the cutbacks on fiscal spending. At the same time, you're raising tariffs, which is a tax on the consumer, to do both at the same time. Seems as I used the word I used before, very ham handed. Right. I get the point about cutting and shrinking the size of government. I get that. I can't imagine anybody would argue against it. We could argue whether it's the right programs or the wrong programs. That's a whole different story over beers. But I. Who doesn't think that there's got to be some waste in Washington D.C. of course there has to be. How could there's waste in my little company? Right. I mean there, there has to be waste in a big enterprise like that. But to do both in the magnitude they're being done at the same time is an amazing contractionary fiscal policy. And you know, I don't, I don't see how that speeds up growth. That's kind of the way to think about it. And you know, as we get towards mid year, as I said before, we're going to have another one on top of that and that is corporate profits. Growth is going to start rolling over. So, you know, is there going to be a recession? I don't really know. But the probability has to be going up or at least if not a recession, the growth is going to be for many quarters weaker than people think.
- [37:30]
Matt Zigler
And that shows up in the market multiples and everything else, right?
- [37:33]
Richard Bernstein
Absolutely.
- [37:34]
Matt Zigler
That's unsettling.
- [37:34]
Richard Bernstein
Absolutely. Okay. Yep.
- [37:36]
Matt Zigler
All right. Well, if, you know, Elon's out of work anytime soon and he shows up at RVA looking for a job to help you crack down on those costs, we pray for you.
- [37:45]
Richard Bernstein
I'm not sure that's going to happen.
- [37:47]
Matt Zigler
Well, let's turn our eyes overseas because I think this is one of the other big tariff takeaways right now. Are non US Stocks finally attractive enough to warrant some investor flows?
- [37:57]
Richard Bernstein
Yeah, so it's a really interesting question because one of the things I try to get our investors to understand is that we at rba, we don't think like economists, we think like investors. And everybody goes like, what does that mean? Isn't it one and the same? No, it's not. So an economist would say, what's the difference between the US Economy and the European economy? And then you hear all the stories about slow growth and everything else that's going on in Europe and all these kind of things. At rba, we ask the question, what's the difference between the US Stock market and. And the European stock market? That's a slightly different question. Subtle but slightly different question. And the answer to that is that Europe doesn't have a big tech sector. And so if you think about what's been driving the US Market for the last two, three, four years, five years, it's really been tech. It hasn't been the US Economy. It's been tech and tech stocks that have been driving the US Stock market. And so we just simply said, look, if you look at the world ex tech, whether you're looking at Europe, you're looking at emerging markets, you're looking at the equal weighted S and P. Right. You look at all these other ways that people look at the world, they're all valued very similarly. And, and, and their performance has actually been very similar. So, and this may be the. If in many people's minds, if technology falls out of bed and if it becomes, if it falls out of favor and goes into, say, let's end some kind of secular doldrum, which I kind of think could happen, might these other Rectors of the US economy, other sectors of the global economy perform better and therefore you'd want to be diversified around the world? I mean, the simplest way to look at it is to simply say we've got seven or 10 companies and then we've got everything else in the world. So if you're going to say everything else in the world, wouldn't that include non us? My answer would be yes, it would include non us.
- [39:57]
Matt Zigler
Well, speaking of seven things and then everything else in the world, you shared this chart which was Basically the top 10 wealth management stocks and their one year beta relative to the S, S and P. And I don't know if it's your word or Professor Damadiron's word, but diversification turning into diversification comes to mind.
- [40:17]
Richard Bernstein
Right, exactly. So let me just correct one thing. You said there, that that chart of the, of the beta is the 10 largest stocks in private client portfolios, the most widely held stocks in private client portfolios. That's what's really there. And, and the interesting thing is if you go back to the beginning of the bull market in 2009, the secular bull market, which by definition is the period where there's the most opportunity, the beta was 0.75. Right. So a beta of one, if just in case people aren't familiar, beta of one would say you're taking equal risk to the market, 0.75, you're taking considerably less risk than the market. But at the beginning of the bull market, you should be taking like boatloads of risk. But no, everybody was under their desk in the fetal position. Fine, okay, we started writing about that, I don't know, let's say a year, two years ago when the beta hit 1.25 and we said, whoa, you know, 0.75, 1.25, they're taking as much risk risk now as they were not taking risk before. This is kind of interesting. And the 1.25 went to 1.4. And the 1.4 went to a totally mind boggling 1.7. Right. And, and I, I, I, I will, you know, people are familiar. I will guarantee you can't use that word, but I'm going to use that word. I will guarantee you, you will not find a pension, endowment and foundation in the world that runs an equity beta of 1.7 that is just a massive amount of equity risk in a portfolio. But that's what private client investors were doing, right? They were so certain that this is, that this was a sure thing. And so, you know, now I'm gonna, I'm gonna quote the renowned philosopher Mike Tyson and say, you know, everybody's got a plan until they get punched in the mouth. That 1.7 said that everybody had a plan. They thought it was easy, right? I can trade, I know what I'm doing. And then they just got punched in the mouth. And, you know, what's the, what are the things you're supposed to do to build wealth? Or one of them is diversification. But people were saying to me, a number of people said this, the exact word to me isn't diversification. Now, diversification, that is just a lead weight on performance. And why would anybody diversify? Well, that's that 1.7 beta talking to all of us and telling us that it's easy. And, and, but I think right now diversification is not only a risk reduction tool, which is how it's usually thought of, but because of the extraordinarily narrow market, it actually opens the portfolio to incredible opportunities. Right? There's more than seven growth stories around the world. So just by diversifying, you open up the portfolio to all this, all these opportunities out there. And that's what we've been trying to do is just take that attitude.
- [42:55]
Matt Zigler
Well, speaking of opportunities, and this is a weird one because everybody with the DCF loves to throw this one under the bus, but it's also, it's also kind of ripping lately. And I want to invoke one other Mike Tyson quote because he is the ultimate poet philosopher. For times like this. Fear is like fire. If you learn to control it, it can cook for you, it can heat your house. And if you can't control it, it'll burn everything around you and destroy you. Which I think is the bull case for gold. Siblione.
- [43:20]
Richard Bernstein
Yeah, that's great. I love that. You know, like, who would think that we'd end up quoting Mike Tyson on the document?
- [43:25]
Matt Zigler
Who would think we would? If you're quoting Mike Tyson, who would think we would.
- [43:29]
Richard Bernstein
Right. So. So gold. Gold's an interesting asset class. Okay. And. And I want to set kind of my personal opinion here first. At rba, we're not gold bugs. Right? I'm not advocating anybody buy gold and bury coins in their backyard. You know, all these kind of extreme things. I think that's really extreme, and I don't think that's the right thing to do. But the reality is that gold has been and apparently continues to be a good hedge against uncertainty. That uncertainty can arise from inflation, it can arise from geopolitics, it can arise from the combination of the two, which is kind of what we're seeing right now. And as I said before, there's a great correlation between the Small Business Uncertainty Index and gold. It really is pretty good to hedge against uncertainty. And so in our portfolios, we pretty consistently. I don't want to say like all the time, because I might be overstating it, but we pretty consistently have a little bit of gold in our portfolios to work it to work as a ballast against volatility. And I'll be damned if it's not working again, doing exactly what it's supposed to do. So, you know, you're going to get people that are talking about, are we in a new bull market on gold? Is it time to buy gold? It's like, also exciting. And now we're going to shift from the mag 7 to gold. And I think that's the wrong attitude to take here. I think the right attitude is to say, look, gold's a good balance against volatility. If you're freaked out about volatility, maybe you want to carry a little bit of gold in your portfolio to mute that through time. And that's all that we do. So, yeah, I think we're in a good environment for gold. I don't think it's an unusual environment for gold. I think we're seeing extremes of uncertainty and you're seeing gold appreciate pretty dramatically, which seems to make perfect sense to me.
- [45:12]
Justin Carboneau
Do you find yourself fielding questions about crypto and your thoughts on that and how that could fit into a portfolio?
- [45:19]
Richard Bernstein
Oh, Justin, you just opened the floodgate. I won't go on and tell you because we'll be here for another hour. If I tell you my whole story about crypto, I think, and I'm going to alienate probably a good portion of the people watching this. I think crypto is the first true global financial bubble that we have seen. I think that most financial bubbles have been regional, like US Tech, you know, if you want to go back. Dutch tulips, right. They were very localized. Crypto is now a global phenomenon, and I think it is highly speculative. Why do I say that? The number one driver of crypto prices, Bitcoin. Let's just use Bitcoin for a second. The number one driver of bitcoin prices is financial conditions. In other words, when there's a lot of liquidity, it goes up. When there's not, it goes down. That's a perfect sign of speculation. Now, we could argue whether it's a bubble or not. That's another story. But it's certainly a highly speculative asset and there's nothing fundamental driving it. The second thing I will point out is that I think that crypto advocates don't understand money and banking. I think there is an incredible naivete. If I can say that without sounding the, without sounding too aloof about this, I think there's incredible naivete about how money and banking works and what would happen if crypto really does become a true currency. So, you know, do away with the dollar and we're all, we're all using Bitcoin. There will be Bitcoin banks, there will be bitcoin lending. Money in banking doesn't go away. It's existed no matter what the currency has been. And there's a certain naivete about the scarcity of bitcoin that revolves around that, that lack of understanding of, of how money and banking actually works. And, and so I think the valuations are overstated by, as could be, could be more than a factor of 10. That's why. So the easy way to think about that is, and, and that's just based on historical money multipliers. What normally goes on in a normal economy and, and how much money is created, you know, relative to that. Normal money multipliers would say that, that, that if you think of bitcoin, it's not trading there anymore. But if it was a hundred thousand, the, the, if you're really an optimist about this, it should be 10,000. And that's, that's an optimistic valuation. If you believe that this is going to happen because decentralized finance would argue the money multiplier should be even higher. Second thing I would point out is that there's a whole arsenal of people that believe that decentralized finance is fantastic. I would encourage them to understand why we have centralized finance, that the history of decentralized finance is pretty bad. This is not. There's nothing unique. Nobody's come up with this smart idea out of Nowhere. This has been tried many times in history and it consistently fails and fails big time, which is why you have central banks to prevent that from happening. So, as you can tell, I'm not the biggest fan of cryptocurrencies.
- [48:36]
Matt Zigler
We'll get those laser eyes in the COVID right, Justin?
- [48:39]
Justin Carboneau
Oh, no.
- [48:39]
Matt Zigler
Seth diamond hands.
- [48:41]
Richard Bernstein
Yeah.
- [48:42]
Justin Carboneau
One of the things that we've talked a lot about, specifically with Mike Green from Simplify, is the rise of passive investing and how that has influence on the largest stocks in the market. Do you have any thoughts and opinions on that?
- [48:58]
Richard Bernstein
So, I, I, I, a couple of things. Number one, Jack Bogle was one of my heroes when I was like, in business school, and I was fortunate enough to meet him a couple of times during early parts of my career. And, and I have an amazing amount of respect. I mean, I think he was one of the, there aren't as many as people think, but he was really one of the, one of the forefathers of modern investing. There's no, there's no doubt about that. And, and however, one of the things in one of the books I wrote, one of the things I pointed out was that Jack would never tell you. He would say, go buy an index. What he would never tell you is what index to buy and when. And that's actually a pretty critical question because, you know, if you had bought NASDAQ at the peak of the bubble, it took you 14 years to break even. But if you had bought an emerging market index fund, you would have been fantastic. You would have had a great old, great old time, or you bought the Energy Spider, you would have had a grand old time for that decade. But if you bought an S and P index fund, you had negative returns for a decade. So to say I'm just going to hold an index fund, it doesn't quite always work that way. And right now, when we've got such domination of such a narrow market, buying an index fund basically gets you exposure to these tremendously overvalued stocks and doesn't get you exposure to everything else. So I, I think one wants to be a little careful about that. I've always taken issue with the notion that index funds drive narrow markets. I don't think that's actually right because if you're buying an index fund, the index fund buys everything in proportion. It's not like they're buying just the Mag 7 and therefore the Mag 7 are going up relative to everything else. If you're buying an index fund, it should be neutral relative to everything's out there. And now one could argue that the less liquid companies don't know. You know, there's all kinds of ways you can argue against that. But I don't think in a grand scheme of things that's what's actually going on. I think it is much more that that people really took a speculative liking to a very narrow universe of companies. And, and so I, I'm not against index. I think right now is a very bad time to hold like an S and P index fund or a growth index fund. I said that before. But you know, if you're talking about something like an equal weighted or you're talking about emerging markets, you're talking about Europe, you're talking about acqui x u s, there's plenty of of index like products that you could invest in and probably get pretty good returns.
- [51:27]
Justin Carboneau
So we have two standard closing questions. I can either ask you both of them or I can ask you one with the promise that you'll come back again in the future where we can ask you the other one.
- [51:42]
Richard Bernstein
I'm your guest, so you can set the table however you'd like.
- [51:45]
Justin Carboneau
All right, so I'll do the one and hold the other one out for hopefully another future conversation because this has been great. So based on your experience in the markets, if you could teach one lesson to your average investor, what would that be?
- [51:57]
Richard Bernstein
Oh, one lesson. Okay, so here's what I tell everybody. And I wrote a book about this 20 years ago or something. It was called Navigate. Imagine this. This was 25 years ago. I wrote a book that was called Navigate the Noise. Get the subtitle. Investing in the New Age of Media and hype. That was 25 years ago. Okay, so more, more appropriate today than it was 25 years ago. And what the book basically argued is that building wealth is not difficult. It's actually very easy. So why don't people do it? And the answer is that there's always a siren song of something new, better, sexier, something. And to continue on the Greek mythology there. And then people go and they crash on the rocks, right? And so why don't we know that certain things are critical? Like we know that diversification helps you build wealth. People don't want to do it because now there's the Mag seven Something New, Better. You know, we know that compounding dividends is a fantastic way to build wealth through time. People don't do it because who wants dividends? So boring, right? Why do we want dividends? You know, things like that. So I think, you know, there's, there are I, my, my advice to individual investors has always been to keep to the straight and narrow. Right? If you want to have a little, a little puddle of money over here, that's your more speculative play money, that's fine. I get that. I mean, we all do that. That's fine. I have mine. I'm not going to share with you the stuff that I blow up in like everybody else, but that's fine. Right? But the bulk of your wealth building should stick to the straight and narrow and, you know, just keep it simple, think about the rules. And, and I just think people don't do that. They always think there's a get rich quick. And I, there's never a get rich quick. Just doesn't work.
- [53:52]
Matt Zigler
I mean, that's sage like advice. And I just have to say some of the great expressions now that I'm taking home while I wait for you to come back to answer the other closing question. The unprecedentedly ham handed market. I think that's a good, that's a good feel on this one. I love this expression of how you fight tariffs as you puke your treasuries. That's evocative. I'm going to start using levered up the schnoz more often.
- [54:16]
Richard Bernstein
Yeah, that's a good one.
- [54:17]
Matt Zigler
I think levered up the schnoz really captures something almost Shakespearean. And I, I don't know, I didn't realize it now, like the armchair fed quarterback or whatever. Like the armchair Fed chair is a word that we should start using far more often as people are critical, you.
- [54:33]
Richard Bernstein
Know, I mean, look, I, I know in my heart that I could be quarterback of the New York jets, right? And I know exactly what to do in every down and everything. But somehow the jets haven't called me yet. Maybe they should, actually, now that I.
- [54:45]
Matt Zigler
Think about it, you know, I mean, some of that spare capacity around rva, you could just throw that in, fit it on the cz.
- [54:51]
Richard Bernstein
I'm ready.
- [54:52]
Matt Zigler
Well, Rich Bernstein, thank you so much for joining us today. We'll put links to all the places to find you in the comments and we'll see you real soon.
- [54:59]
Richard Bernstein
Thanks guys. Much appreciated. Thanks so much for tuning in to this episode. If you found this discussion interesting and valuable, Please subscribe on YouTube or your favorite podcast platform. Leave a review or a comment. We appreciate it.
- [55:11]
Justin Carboneau
No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be.
- [55:17]
Richard Bernstein
Holdings of the participants or their clients.