B (3:53)

Divergence, then that takes place. And I want to call in your profit cycle framework.

A (3:57)

Yep.

B (3:57)

Where the Mag 7 is not the market. And a lot of people seem to be forgetting that when they throw out the valuation multiples and the profit cycle of the index. And what you're pointing out is this opportunity set that exists when you take a more holistic view. Could you explain the profit cycle way of thinking as you approach it and then how it applies to right now?

A (4:16)

Sure. So this goes back, Matt, probably, I don't know, 30 plus years. And we were, when the group was at Merrill lynch and what we began to study was what drives rotations of growth and value or large and small or things like that. You know, the way people like to segment the market. And we all know that there's these segments. But what we tried to do is figure out what were the, what was the economic environment that caused Rotations doesn't just happen. It's not animal spirits. There has to be an economic justification for why you'd see the rotation. And what we came up with was that it wasn't really economic cycles that drive these rotations, but rather profit cycles. In other words, think about, instead of the growth rate in the economy, think about the growth rate in corporate profits. And, and you might say, well, what's the difference? The difference between the economic cycle and the profit cycle, Number one, profit cycles tend to boom and bust. Fortunately, the overall economy does not do that. We shall be happy about that. And number number two is that profit cycles have a shorter periodicity, a shorter time span. You can get many profit cycles within one economic cycle. And then the other thing, why does this, why is there this relationship? Well, it's because people forget that the stock market isn't a horse race. The stock market is an exchange of corporate ownership. And as a corporate owner, what you care about is the profitability of the company that you own. So profits have a closer relationship to stocks than do the overall economy. I mean, GDP can influence a company's profits, but it's not a company's profits. And people forget that. They tend to think of the stock market as a horse race.

B (5:57)

Where does that put us right now? I know in our last conversation you said the profit cycle could be close to peaking within the next year or so. Give me the Mall of America map. Where am I now? Am I somewhere else?

A (6:11)

So the profit cycle did peak. You know, we, I don't want to make it sound like we get everything right. The profit cycle has been slowing. It hasn't slowed as much as we originally thought. And part of that is because of the, the tariffs and the Liberation Day effect on corporate profits and everything else. So what happened was we had a situation where people thought that the end was near because of Liberation Day and the profits were going to implode. They didn't implode. So we had this kind of equal and opposite reaction where people all of a sudden became very bullish about profits. And so that period kind of threw off our analysis. You know, I don't want to say it was an eight standard deviation event, but certainly wasn't normal. But now what you're starting to see is the profit cycle starting to decelerate again. So it's kind of like we had this hiccup that kind of threw, really threw our analysis off by quite a bit. But now we're going back to the fundamentals.

B (7:10)

It was a very strange thing to watch because the tariff announcement really impacted expectations.

A (7:16)

Mm.

B (7:16)

As the, as the expectations moved in one direction and they moved back, where do you think we are? I'm not asking you to predict what the next thing out of the White House on tariffs is going to be, but where does that put us on the expectations that we should be watching for any. Any large change in the underlying data?

A (7:32)

So I think, Matt, I think if there's one thing that people should be watching very, very closely, it is inflation and pricing data. The consensus is clear right now that inflation is not a problem. Even if you listen to the Fed, you'll hear the Fed say, you know, well, inflation's not our big concern. It's the employment picture. And so I think if there's one thing that people aren't looking at enough, it is inflation, pricing power, things like that. I think that what happened and the reason you're starting to get this consensus that inflation is not an issue is that everybody, including ourselves. I'm not trying to say that we didn't fall into this trap too. We certainly did. Everybody thought that Liberation Day and tariffs, that corporations would immediately pass them on and that that would reflect in inflationary inflation statistics. And what ended up happening was that they tried to eat the tariffs and they squeezed margins. And that's one of the reasons you're starting to see a little bit of weakness in the employment sector is because margins have been under. Under pressure. The data has been starting to. Well, the data was. We don't really kind of get data anymore, but the data was sort of saying that companies were getting tired of squeezing margins and that they were starting to pass it on at a greater rate. So we'll see. I mean, the jury is out, but I think if there's a surprise that people should be thinking about it is it is pricing and pricing power and the notion that, you know, inflation is nothing to worry about.

C (9:12)

One of the things that we all do as investors is kind of think back to the last battle or last experience, a time similar to maybe what we're seeing today. And so what I wanted to ask you was, and investors like you, you know, you went through the tech, the, the early, late 90s, early 2000s tech boom and bust. So what are the. What would you say are the similarities and what are the differences between that market and this market today?

A (9:40)

Right. So. So the similarities, I think, are. Are. Can be summed up in, in the statement that people have a very tough time understanding the difference between an economic story and an investment story. I think that's Kind of critical. And both, during both periods, people made a tremendous, people became very confused. They thought the economic story translated automatically into an investment story. And so the story back then, the story today, back then it was will the Internet change the economy? Today it's will AI change the economy? And the answer in both cases was of course, yes, of course. Technology always changes the economy. That's nothing new. I'm sure. Last time I was here I probably said something effective. My favorite technological innovation of all time was the light bulb, right? Because we don't even think of it as being a technological innovation, but it was a massive productivity enhancing technology at the time because it turned the economy into a 24 hour economy, right? And here we are, you know, 100, 100, whatever, how many years later, and we don't even think of it as being a technology anymore. But it was a massive productivity enhancing technology. So technology always, always changes the economy. But as an investor, that's not what you should care about. You should really care about the notion about whether a sector or whether an innovation is being over capitalized. In other words, it's too much money chasing it. My attitude has always been long term investment stories are always predicated on the investor trying. Or you should as an investor predicate your investment based on whether you're the one banker in a town with a thousand borrowers, right? In other words, it's a provider of scarce capital. Think of it the other way. There's a thousand banks and one borrower, the borrower makes out like a bandit, essentially gets free money and the investment returns are terrible. You want to be the provider of scarce capital, which means by definition your returns will be higher. You know, I, for many years I've used the analysis which, the analogy rather which some people don't like. It's as an investor, you want to think like a loan shark. You want to look for people who need money really, really badly and then charge them an exorbitant rate. And I think that's the model of long term investing. Now, of course, we don't have to talk about collecting and breaking kneecaps and everything else that's, I don't think, germane to what we all do for a living. But the attitude of looking for people that need money better very badly. So the question back then was, were Internet stocks starved for capital? Of course the answer was no. And today you'd say, are AI stocks starved for capital? And the answer of course is no. There's no way they're being flooded with capital. And I think that is, that's a huge similarity and argues that the investment returns related to AI investments today that you're making today will probably be disappointing through time. You know, are there differences? I don't think there are as many differences as people think. People say to me, oh, well, this is large companies. It's not pets.com. well, has anybody noticed that there's a lot of small companies. They're just not public. They're all in the venture capital space. But all these kind of cockamamie small companies do exist. They're just not in the public domain. They're in the venture capital space. People say, well, this is. They're all large companies. There were a lot of large companies that got caught up in the, in the tech bubble back when, you know, I mean, IBM is now, is not exactly a small company. Hewlett Packard was not a small company. Cisco was not a small company. That Cisco not sy. SEO for those who might.

C (13:15)

Not the food company.

A (13:16)

Not the food company, exactly. And, and so there were a lot of big companies that got caught up in that. I mean, Lucent. I don't even think Lucent exists anymore. Maybe it does, but I'm not sure it does. But anyhow, so, so I think there's a lot of similarities. I think this is bigger though, getting back to what we were just talking about a few minutes ago and that the speculation is across asset classes. This is much bigger than what we saw back then overall, in terms of the financial sector, what would you say.

C (13:47)

What would you look for, for cracks in the sort of cracks starting to form, like for instance. And this is like in my head, like right now, companies are being rewarded for these big capital investments. I think Amazon AI just today like ink some sort of deal or something. So Amazon is offer either yesterday or today up on the news. But you know, would, would it be something like when these announcements are made, the market reacts ne negatively and so the market's sort of sniffing out that there could be problems. I mean, what would, what would you be looking for?

A (14:20)

So I, I think there's several ways that this can start to unravel. Number one is, is what I said before, just the realization that there are many more growth stories than people think. Right. Ultimately, investors will become comparison shoppers. I don't know what the valuation has to be on, say the AI stocks before people start looking for cheaper growth, but that would be one way. Right? I mean, this is no different than any other product market. If things get too expensive, you look for substitutes. That's. That's just an economic principle and that occurs in all markets, whether it's a stock market or, or you know, cars or houses or whatever. No matter what that is, that will eventually happen. I don't know what the valuation is, I'll admit in terms of would force that issue, but that's number one. Number two is that this is really very much a momentum market. And the problem with momentum markets is they can turn and the enthusiasm to let everybody up can quickly become panic that causes everybody to go down. Now I'm not good at predicting that either, but we have to realize that, you know, enthusiasm, you know, the, you know, everybody kind of running for the running into something, everybody can run out of something at the same time, you know, that's not unusual. And that happens as well. I think fundamentally what there's two things that I think are being ignored right now, ignored, maybe too strong a word, but people are discounting. Number one is that these major companies are dramatically changing their balance sheets. These are not the same companies they were even three years or five years ago. They used to be very asset light companies that had tremendous free cash flow. They turning themselves into asset heavy companies with other capex loading up on debt in various forms on balance sheet, off balance sheet and they're completely changing their balance sheets. And so when you start adding to fix costs, which is essentially what they're doing, you increase your cyclicality and you hurt your free cash flow. I there's not a lot of people talking about, there are people talking about, but it's not the mainstream. So I think people are ignoring that. And then if you agree with me, not everybody does of course, but if you agree with me that there's a speculative element going on here, I would go back to the fundamental assessment that maybe the Fed can't cut rates as much as people think maybe liquidity will start drying up. And given that liquidity is sort of the lifeblood of speculation, that wouldn't be good either. So I don't know whether it's one of these things or all of these things. I really don't know Justin. I'm not that smart, but those would be the kind of things I'd be looking for.

C (17:01)

By the way, your comment on Lucid just reminded me, I don't know if you guys saw this, but AOL just like the other day got bought by some Italian company. So there's these AOL still floating around there being purchased.

A (17:13)

You know, it's interesting, pretty funny, I didn't even know they were still around. Yeah, that's that's pretty good.

C (17:18)

I wanted to ask you, we, we've been talking about the Cape ratio lately because the Cape is very high versus historically. Actually just today Spencer Jacob from Wall Street Journal wrote a whole piece citing that, you know, some of research affiliates expected returns based on the Cape. But what, where I want to go is do you think there's anything to be said for it being higher than its long term average in like the market in the last 25 years? Like it's maintained this above average level? And is there, do you think there are things driving that that maybe investors have missed a little here?

A (17:57)

So a couple of things. Number one is, you know, valuation. The Cape has been high for quite a long time. I mean, I remember in 2009 when the bull market was starting, a lot of people argued that the s and P500 cape, or the US cape was so high that, you know, you were doomed. And here we are 15 later, as the market seems to have done. Okay. And I think what, what one of the drive, I'm trying to think what the right way to say this is that valuation obviously is not, does not exist in, in a vacuum. It's dependent on interest rates, it's dependent on, on inflation, is dependent on all kinds of different things. And so I think one wants to be a little bit careful at any point in time just saying something's overvalued or undervalued relative history, without examining all these other factors as well. That, that's sort of my, my preamble here. That being said, I think right now we're in a situation where interest rates are not going to bail out the Cape. I don't think that's going to happen. That's a big change from where we were 15 years ago. And if that's the case, if that's the case, what it suggests is what I said before about long term investment returns potentially being lower than people expect. Right. If you, if you buy something that's expensive, the hurdle is higher for you to make money than if you're buying something that's cheap. Right? If you can buy a Maserati for the price of a Volkswagen, you're probably going to do okay. But if you buy Volkswagen for the price of Maserati, you're probably not. And that's what this gets to. I think everybody understands that, that analogy. This is, you know, the Cape is kind of telling you are things expensive or cheap, then interest rates and inflation will tell you could they get more expensive or less expensive? Or is it really, you Know, are really looking at a Maserati. I think right now we're kind of looking at, we're paying a little bit too much for the Maseratis. The, that's sort of my story.

B (19:53)

That's not a sub commentary on the Italian company buying aol.

A (19:56)

Right. Just to clarify. No, no, I'm not that smart. You're, I'm not that quick, I should say. Yeah.

C (20:03)

What do you, how, how do you, how are you looking at AI in terms of its impact on margins and maybe specifically like the non AI related companies, like the companies that are, you know, you know, industrials and things like that that start to use AI. Could you see, sort of see that helping on the margin side of things?

A (20:23)

So Justin, that's a, that's a very important question because one of the big stories right now is all about margins and everything else. And I think we, we posted on our Twitter feed a really good interview with the CEO of Ford. Okay. I'm not endorsing the stock or anything else just in case many lawyers. What I'm not, you know, we hold it in some portfolios, you know, all the, all the appropriate footnotes. But it was, what he basically said was that, you know, the AI guys are complaining that they can't hire enough people. Isn't that what AI was supposed to take care of was the shortage of labor? And he says, and he further said that what's interesting is that everybody's saying how AI is going to change our business and nobody's kind of talking to us, telling us how it's actually going to change our business. And so he said this doesn't, it doesn't make a lot of sense. So I think that's, I think it was a very interesting interview about how the non tech world is trying to deal with, with AI. Right. And, and one may agree with this with the, the CEO or not, that's not my point. Which is an interesting interview, very different type of interview, but there's no doubt the technology. Again, let's take away from AI, just talk about technology. Technology always improves margins. It always does. We. Oh, technology always makes you more efficient. Right? I mean, you know, we're, it's been a long time since we used an abacus, you know, and, and technology has helped us in our mathematical formulations and, and that, that enhances margins for a while, but then what happens is it spreads through the economy and everybody starts using, starts getting rid of their abacus and starts using a computer or something else and then the competitive edge goes away and the margins. Everybody starts squeezing their margins, and it's a question of productivity. So I think, you know, from an economic perspective, does technology help productivity? I've always been a skeptic on that. And I think the reason why I'm a skeptic is because everybody copies it, and then you don't get the productivity, you know, in terms of corporate profits, you don't get the productivity that people expect.

C (22:39)

Do you think there's a chance likelihood that value stocks, cheap stocks, could sort of see another. Maybe not a comparable run to what they had between 2000 and 2007, but that was a great period to be a value investor because value stocks had been left behind in the late 90s. So coming out of this on the backside, is that a possible scenario, do you think?

A (23:04)

Oh, I think it's more than possible. I would argue it's reasonably to highly likely that we will have a big shift in value. And I think recently, let's say the past couple of years, I've been asked more than any time in my entire career, is value investing dead? And I love that question. I love that question because in every economic decision we make, we do a cost benefit analysis, right? The clothes you wear, the, the apartment you rent, or the house you, you buy, the car you drive, the restaurants you go to, the, the shampoo you use. Well, funny for me to talk about shampoo, but I get that. But, but, but. Anyhow, you know, every time there's a cost benefit analysis that you make in that, in that assessment, whether you want to buy it or not, and that cost benefit analysis is called value and growth. That's exactly it. What's the benefit? To me, that's the growth. What's the cost? That's the value. And in every economic decision we make, we do that. When it comes to the stock market, all of a sudden, nope. Value investing's dim. And I don't believe that for a second, right? It just shows how unusual a period is that people don't care about valuation, right? It's like, I don't care that Volkswagens are selling for Maserati prices. I'm going to buy four Volkswagens, right? That's kind of what. That's in English. That's kind of the way people are acting. And that makes no sense. So I think the natural reaction is going to be that people all of a sudden say, oh, wait a minute, man, what am I? I bought four Volkswagens for a Maserati price. That makes no sense. I'm going to become a real consumer and I'm going to look and make sure that I'm getting my money's worth. Well how do you do that? You become value investor and value starts outperforming growth in particular in our portfolios. The way that's reflected is two ways. One is we have a huge concentration in dividend paying stocks right now. Sort of a bird in the hand is worth two in the bush type thing. And the second is in non US high quality companies. If you could buy the Maserati for the price of a Volkswagen or you could buy the Manolo Blahniks for the price of Steve Maddens, I think everybody watching this would say sure, I'll do that Rich, I don't know how you can do that, but I'll take two, please. And non US quality is growing, has projected growth rates that are faster than that of the MAG 7, 10 times the dividend yield and 30 to 50% off in terms of valuation. So I think those, that's the way it's expressed in our portfolios right now.

B (25:40)

I'm going to come running back into the loving arms of International for questions in a second. But first on that value growth point, is there a connection between the value growth argument, the way you presented it and the way I don't want to say markets read this, but kind of some confusion between the economic cycle and the profit cycle. Is that related to value and growth in any way?

A (26:01)

A little bit. Well, the profit cycle historically has been the main driver of value and growth. Certainly when that doesn't work, the only time that hasn't worked historically, I shouldn't say the only time, the vast majority of times that that has not worked historically has been during bubble periods. And that's why they're kind of bubbles, is because fundamentals don't really matter. But yes, traditionally when profit cycles accelerate, value outperforms growth. And the reason why is growth is everywhere. It becomes abundant and investors become comparative shoppers, right? And they say, well if everything's growing, why would I pay a high price for growth? But when profit cycles decelerate, growth tends to outperform value because growth itself starts becoming scarce. And so what happens is investors bid up the price of that scarce resource and it becomes, you know, it becomes survival of the fittest. You tend to get narrow leadership during profits decelerations. You tend to get very high valuations on the companies that can still grow. Here's the way to think about it. If we, my joke used to be if we had a depression we would probably have the magnificent three. Like there'd be only three companies that could grow in a depression. That's what was so weird about the Magnificent Seven is that there was thought to be seven companies, but there was no scarcity of growth. That's to us, that was one of the keys. That if it wasn't a bubble, and it isn't a bubble, I should say it's certainly a very speculative period.

B (27:23)

In that depression, your standup career will just explode. I can tell.

A (27:28)

Stand up career. Probably be on a sidewalk wearing a barrel. Isn't that like the standard thing from the Depression? They have the people or sandwich boards or whatever it is. There you go.

B (27:37)

Wear a barrel. Sell some leftover abacuses. Abaci. I don't know what the plural is.

A (27:42)

Right, exactly.

B (27:44)

All right, I want to talk about this international thing because I think this is, this is another one of those examples. A lot of people seem to think they can just own the U.S. right now. They seem to be saying that there was a blip in European defense contractor spending and stuff like that, but it's just a blip. You're telling me that international is actually a pretty attractive story still.

A (28:04)

Yeah. So a couple of things. One is, I probably mentioned this last time because I bring this up a lot when we, we started RBA in 2009 and one of the reasons we started RBA at that time was we legit thought we were entering one of the biggest bull markets of our careers. And we just said, you're going to start a firm, that's probably a good time to start a firm. Right. Nothing smarter than that. But that wasn't consensus. The consensus at the time was that if you wanted growth, whatever that was, if you wanted growth, you had to buy emerging markets. That, that was the story. The US was a terrible economy that was going down the drain. Remember, this is right after the, the, the global financial crisis. That, that we were terrible. Why would we ever invest here? We're going down the drain. Terrible, terrible economy. You know, we're on our way to becoming an emerging market. Okay. Stock markets outperformed for 15 years. What do you hear today? US exceptionalism. Right. That was. I, my argument is that was the correct thing to argue 15 years ago when nobody. There was going to be a period of US Exceptionalism. And I think in terms of investing there was maybe not in terms of economic activity or manufacturing, but in terms of the stock market. It clearly was. So here we are today and Everybody's talking about U.S. exceptionalism at a point in time where the U.S. you know, the indices not Necessarily the broad market, but the indices seem pretty overcapitalized and the opportunities outside the United States are growing. Now why do I say they're growing? The story for non US markets especially let's say Europe as an example, was that they were cheap. Well, they've been cheap forever in a day. Right. And, and you know, valuation alone is not a great way to, for long term investing, it's wonderful. Short shortage or investing, it clearly doesn't work. The difference. If you go back to what I said before about non US high quality, the difference now is there's actually a growth story. Non US quality is forecast to grow faster than the MAG7. Right. That wasn't true a year ago or two years ago or five years ago, but that is true today. So not only do we have cheap, but now we've got a little bit of a growth story going with it. And so I think that makes it pretty interesting.

B (30:21)

I want you to look and I want you to. This, this idea that I learned from you was really thinking at the, below the index level, at the sector level and where there's growth and for what reasons? Both in the profit cycle and then with an economic tailwind or headwind. What when we get outside of the U.S. where are the most promising areas for this growth beyond just the quality label?

A (30:44)

Yeah, well that's for us. That's really where we are right now. We're in these high quality stocks and I think to some extent that takes away a little bit of the risk out of the story. Look, if the European economy and the Asian economy explode on the upside and profits growth is up 50, 60%, I'm exaggerating of course, but let's say big numbers. Non US high quality is going to underperform. Non US low quality. Right. When, when profit cycles explode the upside, you want all the junk you can get in your portfolio. That's what history suggests because they're, they have the greatest financial leverage, they have the greatest operating leverage to the cycle. And so as the cycle moves up, all the, the junky stuff works really, really well. And, and I'll be the first to tell you that our, our non US quality bet will underperform other non US stocks. If that were actually happening, why are we in quality? Because we take away a little of the risk that you have to have a profit cycle accelerating in Europe or in Asia. It's kind of, it's kind of a chicken's way. I mean if I can, I'll say that's a chicken's way to play Non us. Right. If we really wanted to go in full bore, we would not be playing quality. Right. And I think the questions, the, the, the, the uncertainty that underlies your question is exactly why we're in these quality companies as opposed to the junkie companies outside the United States.

B (32:16)

One sector. I'm completely putting you on the spot for this. So answer this in whatever way you can. The European financials, they're another place that everybody's just loved to hate and love to say, hey, look what a percentage of the index these things are. And they're terrible. And all they do is lose money. Do we believe at that level we're seeing like fundamental changes in what can grow? We have a healthier financial sector over there or do you cast dispersions?

A (32:43)

Certainly they're more highly regulated and in being more regulated they have not experienced growth. I mean any CEO will tell you the more regulation I have to face, the harder it is to grow. And certainly European banks have had a much tougher time than US Banks in terms of regulation. Even though every US bank complains about the amount of regulation, it ain't nothing compared to what you see outside the United States. So the, so their growth rate has been, has been tempered to say the least. However, if, if, if the. Well, let me put this way. We, we started underweighting financials within the past six weeks. Now I can't remember the exact date. So let's say within the last four to six weeks we started under underweighting financials. And the reason why gets back to what I said before. The credit spreads are very tight and if we think that you're not being rewarded for credit, okay, we have no, we have no corporate credit nor fixed income portfolios. Why would we be overweight financials? Okay, so, so you can see we're starting to sense there's more risk in the financial sector in the US Than people are anticipating right now. However, non US Financials, because they were so regulated, probably don't have that risk. And so they may prove to be a little defensive relative to US Financials.

B (34:07)

Do I catch a hint of an RBA European Private Credit fund? You're going to go over there and probably not. Yeah, that's probably for the better. That's probably for the better. We talked a lot about the narrowness of the US Market last time you were on and per the comment you just made with financials and on stateside and whatever else, anything broadening in the U.S. is there any hint of that starting to happen?

A (34:31)

You know, Matt, we had like A hot second. Like people say, ah, man, there was like a hot second where the US Market broadened. But the interesting thing was that broadened when there was massive uncertainty. Right. If you think about around Liberation Day and that whole period, all that volatility, the market actually broadened, which was, which was really interesting. So, you know, right now, through the end of October, the U.S. the S&P 500, is tied with 1998 for the most narrow year in the last 45 years. So we are tied, we're neck and neck with 1998 right now, which is amazing because what actually happened in the tech bubble was the market actually broadened. Even despite the bubble, the market started to broaden with a very small B, but starting to broaden. But in this situation, the market's gotten more narrower year by year, which is crazy. I mean, that, that's really an amazing phenomenon and unsustainable. I mean, the, the economic implication of such narrow research is we're heading for depression. I just don't think that's in the cards.

B (35:39)

I want to talk about the Fed for a second and the inflation target. I know it's a hard pivot from where we are, but this is an interesting one. As we come into the end of the year, so we think about what 2026 is going to hold. Is there anything changing about inflation's stickiness above the Fed target and how we should as investors interpret this? Because to your point before, we don't get the data we used to get amongst.

A (36:07)

Yeah, we're kind of flying blind little bit. So. So here's. I'm going to sound a little bit professorial for a second, and I apologize to everybody for, for saying that, but I think everybody has forgotten. And to some extent, I think the Fed has forgotten. I say that with all due respect. It's very hard being. Being a Fed chair and, and everything. You know, it's like, it's. This is sort of like me criticizing, you know, the, the Ranger. You can see the Ranger jersey behind me. This is me criticizing the Ranger coach for not doing something right. It's easy to sit here and criticize. I get that. And I, I deserve all the pushback that I will likely get for this. But I think people have forgotten what the role of the Fed is supposed to be and how they are the central bank, and the key word there is bank, that the Fed does not directly influence the economy in any way. What they do by raising or lowering interest rates is they try to raise or lower the cost of funding for the banking system. So if the banks are lending a lot and that lending is causing growth to overheat and inflation is starting to go up, the Fed will raise interest rates to make the cost of funding more expensive for the banks in hope that that higher cost of funding will start to constrain lending in hope that that constrained lending will slow the economy. Okay. Or vice versa. When they lower interest rates, they do so explicitly to lower the cost of funding for banks in hope that they will lend more in hope that that additional lending will spur the economy. Right? We all know about the long lag times between monetary policy and when it actually gets to the economy. That's the reason why the Fed does not directly influence the economy, it's indirectly through the banking system. Okay? So the question we should all be asking now, as there is considerable political pressure on the Fed and the Fed has begun to lower interest rates, is the question we should be asking is where is the hiccup in the financial system that is constraining lending and accordingly slowing the economy? The answer to that question is it doesn't exist. Right? Credit spreads are historically narrow. M and A activity is going through the roof. IPO market has come back to life. We know about SPACs, we know about off balance sheet lending, right? Where is the hiccup in the financial sector that is constraining lending, that is prohibiting growth? It just doesn't exist. So why does the Fed feel this need to lower interest rates? And so the point I'm trying to make here is that one could say, oh, employment is weakening, or one could say, oh, housing is weakening. There's all these things. But that's not happening because of the banking system. That is not happening because of interest rates. Right? That may be happening because the misallocation of capital to AI or to cryptocurrencies or to something other. But it's, but it's, it. The Fed will not be able to fix that by simply lowering interest rates, because what's what started to happen as the Fed did lower interest rates. Speculation just picked up. It was all excess liquidity and the market narrowed dramatically. And we're just misallocating capital within the economy more and more and more. So this is not, I would argue the Fed should be much more concerned about the inflation side and adding more liquidity to the economy and having greater misallocation of assets within the economy and capital within the economy that, that ultimately could be quite inflationary. They don't seem to understand that. And look, I'm not smarter than they are, but I'M confused as to why they don't appreciate that.

C (40:11)

I wanted to pivot off the macro for a second here and just ask about investment process a little bit because you guys run a number of different strategies and there's, there's two I want to focus in on, but I wanted to first talk about, and I love this name for a strategy, Global Dividend Kings. Sort of talk about that strategy, that portfolio, what you guys are actually looking for with those types of companies and stocks.

A (40:38)

We've actually trademarked that by the way. So nobody else should get, should get like a, you know, don't, don't have the light bulb go and somebody, somebody tried to copy it. And of course the lawyers got involved and they, they started calling them the Monarchs instead of the Kings. And it was like, oh, come on. Like really? But there's nothing we could do about that. That they started calling their stuff the Monarchs. The, the Global Dividend Monarchs. I mean, come on. So, but anyhow, Global Dividend Kings. Global Dividend Kings is a very straightforward approach to dividend investing. We just have some very, very simple construct in terms of debt, in terms of dividend growth, you know, those type of things. Looking for companies that can maintain in and grow their dividends, but do not the difference. I think one of the interesting things is that we don't look for high yield per se. Right. One of the things that we should all take away from the bond market is that high yield bonds have a high yield because they're riskier. It's the same thing in the equity market. If you find a stock with a significantly high dividend yield, it's probably riskier. Probably means the dividend's going to be cut as opposed to you just found a great opportunity. And so this is not looking in that world. There is a whole investment strategy out there. A lot of people follow it looking for high dividend yield companies and assessing their cash flow strength and, and determining if the market is wrong, the dividend will not be cut. That's a whole different story. That's not what this is about. This is really about consistency of dividends through time and the ability to continue to pay. And it's worked quite well through time.

C (42:20)

One of the, my favorite metrics with like dividend growth stocks is like the yield on cost. Like when you have a dividend grower and you know, look at it, you know, over a 10 year period if dividends are growing at like 10%, like how the yield on cost can be just ridiculous because you get the dividends and the dividend growth and compounds.

A (42:38)

Yeah, yeah. It's huge. It's one of the easiest ways, Justin. It's one of the easiest ways to build wealth through time is the compounding of dividends. And you know, normally people appreciate that when we get into these kind of speculative environments, people don't want any stinking dividends. It's, it's not exciting. Right. I mean, so, but that's, that's where we are right now is all over dividends.

B (43:00)

Who needs dividends when you have single stock covered call ETFs.

A (43:04)

Right?

B (43:04)

Yeah, well, that's the environment we're in.

A (43:06)

That's the environment. That's right. I mean, unlevered. Right, right. You know, think about, you know, levered ETFs. Why do I want dividends?

C (43:14)

The other investment process question I have for you, and we're coming out of the stock portfolio, but to the ETF strategies that you run, which are like kind of go anywhere tactical strategies, and they vary depending on, you know, the investor's risk tolerance and what their goals are and stuff. But I, I kind of, it would be interesting to hear, sort of walk us through what you're looking at when you're selecting those ETFs, because based on, you know, this is kind of from your site, it's a combination of fundamentals, corporate profits, liquidity and investor sentiment that you're trying to capture within this, I think, systematic ETF selection process. And, you know, you don't have to talk about any specific, like strategy like the aggressive or the balance or the moderate, but like, just generally how you go about viewing, you know, selecting the ETFs for these strategies.

A (44:06)

Right. So, so it goes back to what you said just in a couple of minutes ago. We store with a macro appraisal. We are, you know, a macro firm in, in English, that means we know nothing about Coke versus Pepsi. We make no claims to be able to pick individual stocks, but rather what we try to do is drive our portfolio performance through, you know, size, style, geography, quality, you know, all these other kind of macro characteristics. And it does start with that process that you just mentioned about corporate profits, the profit cycle that Matt brought up before liquidity and then sentiment and valuation. So what we try to look at to shorten the whole story, what we try to look, if look for are situations, segments of the global markets where fundamentals are improving, liquidity is good or improving, and everybody hates it. That's kind of what we try to do. Or vice versa. We try to stay away from situations where fundamentals are either deteriorating or not superior, where liquidity is drying up and everybody loves it. And so that's kind of the framework that we work in is that type of thing. And so what it ends up in very often, because that notion about where everybody just that third comment where we try to look for things that everybody hates. People say very often that our portfolios are highly contrarian. I don't like that word. And I don't like that word because people very often use it derogatorily. They say, you're just a contrarian. As though if they say up, I'm going to say down. If they say right, I'm going to say left. Right? Just to disagree. A contrarian is always going to say, no, you're wrong. That's not what we do. We're a contrarian because of what I said before. We're looking for these situations where fundamentals are improving and people don't appreciate it. Like non us quality is a pretty good example. But the beauty of including our portfolios, and I'm not doing, doing this from a marketing perspective, I'm saying, you know, whether it's us or somebody else, the beauty of including this type of portfolio is that it is contrarian. And the beauty of a contrarian portfolio is by definition diversifying. Right. People don't think of it that way because if you love everything in your portfolio, by definition, you're not going to be diversified. Right. There's got to be something in there that makes you feel uncomfortable, that doesn't agree with your view of the world. Because if your view of the world turns out to be wrong, then it'll work. And that's the whole point of diversification, is to have something in the portfolio that disagrees with you in case you're wrong. And, and that's the role our portfolios have always played. So what's interesting as, as you can imagine in an environment where everybody is super soaked and there's tons of speculation and, and narrow leadership and everything else, people don't view us as a contrarian anymore. They view us as idiots. And I. Nothing makes me more excited. I mean, it sounds weird, I know, but you know, when people just don't care about diversification anymore, that's a, that's a great time to be diversified.

C (47:13)

Well, on that contrarian point you made, the one thing I'll say about you in following you over the last year, know, 15 or 20 years is, you know, it's not easy to go on CNBC, you know, early 09, mid 09 and even a year after that and be bullish. It's, it's like, you know, it's almost like, well, what is this guy? But no, you had a, you know, you had your belief about the markets and what stocks were going to do, and you sort of stuck to that. And that I think that has, you know, you've been, at least from my perspective, you know, way more on the right side of it than the wrong side of it with your calls.

A (47:53)

Thank you for saying that. Yeah.

B (47:56)

In this whole idea too, of being like contrarian for contrarian sake and not being all in or all out.

A (48:02)

Right.

B (48:02)

That's part of the nuance here too. Right. Is saying, like you're identifying these parts. How can I tilt, for lack of a better term.

A (48:11)

Exactly. So here's, here's a, here's another way to think about it. You know, when we started RBA and I said it was the beginning of the bull market, people were hesitant to invest with us because we told them our goal is to put up 8 to 10% a year, you know, in equity, something like that, you know, whatever the marketing line was. And people said to us, you're never going to be able to do that. Equities suck. You know, you're never going to be able to do that. And we've more or less done that depending on the portfolio you mentioned, there's like a bazillion five portfolios, but they've all been within kind of the promised range through time. And now people are hesitant to invest with us because it's not good enough. That shows you the change in sentiment from where we were 15 years ago and how people just don't want to be diversified anymore.

B (48:53)

It's pretty wild when above historical average is no longer good enough. Those are usually the times, correct?

A (48:59)

That's exactly right. Yeah, that's exactly right. What do you think?

B (49:03)

As we're coming towards the close of this year, if you were going to put together sort of like the key risks that things are going to in a very bad direction versus stuff softening, take a little bit of caution. Can you just help parse out things that would make, make you very, very concerned versus things you go, I think we get over this, we don't need to react too strongly.

A (49:26)

So what makes me concerned more than anything else would be if the Fed really does continue to cut rates, because I don't think that's needed in the economy and I think that that will just cause more speculation. Now people say, well, what's bad about that? What's bad about that is that you get the gross misallocation of capital in the economy. You know, in the, in the tech bubble, the gross misallocation of capital went to the, went to Internet companies and he bailed out of the Internet and fiber optics and all that kind of stuff. And what got ignored was the energy sector. And, and at the time, refineries in the United States were literally exploding. It was 1970s technology that had, had, had no new investment, and the stuff was exploding. And we said, well, this is kind of silly. Why is all the capital going to the Internet and nobody cares about refineries and energy anymore and things like that? And I think that's true again today. I think the way I describe it to people is we've had pretty good inflation in electricity prices. I think everybody knows that. In the New Jersey gubernatorial race right across the river here, it's actually become an issue. Electricity prices have become an issue in that race. Well, the way I describe it to people is imagine of all the capital that had gone into cryptocurrencies instead went into the US Electric grid. I don't think electricity prices would be an issue right now. And that shows you the misallocation of capital in the economy. Or you think about supply chains and, you know, there's a, there's a big article, there's been a series of articles rather in the last week about delayed deliveries of, I don't know, F16s. I think it's F16Vs to Taiwan and things like that. Imagine if all the capital are going into the defense sector instead of into cryptocurrency. You can see where bottlenecks, where the capital is actually needed versus where it's been going. And that's the element of speculation.

B (51:23)

I think when we see those misallocations of capital in that type of a scenario. And I think the tech bubble one is extra, extra interesting, if not downright striking, because of what happened in the oil and gas and refiner space, because it created the opportunities that.

A (51:38)

Oh my God, yeah.

B (51:39)

Followed in post, especially post 9, 11 and all the things that followed suit after that.

A (51:43)

Absolutely.

B (51:44)

What could be sowing the seeds of the next opportunity if we have that stumble here?

A (51:48)

So I actually think, you know, and I'm sure we discussed this last time I was on your, your podcast. I think the opportunity, the big theme that everybody should be thinking about is deglobalization in one form or another. I think that is. It is. This has been a theme of ours now for 14, 15 years. It's kind of starting to become mainstream finally. But I think the forces of deglobalization are very much intact. I don't think they're going away. I don't think we're all going to be singing Kumbaya and, and supply chains are going to magically reopen. I don't think that's going to happen. And so in the United States that presents tremendous opportunity because of our trade deficit, which everybody knows about. Now we have this monster trade deficit. We could spend another whole podcast about whether tariffs are the right way to solve this problem or not. But that's another story for another day. But, but there's tremendous needed investment in the manufacturing infrastructure. Not just manufacturing so, but the whole manufacturing infrastructure in the United States. And we're never going to become the manufacturing powerhouse that we were in the 50s and 60s. That's not, that's not going to happen. We don't have the workforce for, we don't have the, the, the skill sets for it or anything like that. But if we can just regain a small market share, the re industrialization theme becomes a home run.

B (53:13)

It's interesting to think how in a globalizing world that's something that policy can actually have a direct impact on.

A (53:22)

Yeah, yeah, it can. I mean, again, you know, tariffs are a whole, I think personal opinion here for a second. I think tariffs are pretty ham handed way to try and solve our trade deficit problem. I don't think it's a very effective way to do it at all. But yes, I mean, you know, at least the problem is being recognized and I think the administration should get some credit for emphasizing that issue and the dire need for investment in the US economy in the manufacturing base. I think they should get credit for that. But you know, is this, are we handling it? Well, I'm not so sure about that.

B (53:58)

Yeah, I can hear where you're coming from on that one. I want to ask you one of our standard closing questions, variation on what you answered last time. We want to ask what is one thing you believe about investing that the majority of your peers would disagree with you on?

A (54:13)

When I used to teach in the grad school at nyu, one of the questions I used to ask the MBA students was what's the difference between the stock market and a horse race? And MBA students should actually be able to answer that question. They could not. They had a very tough time with it. And the reason why is because most investors, including professional investors, think of the stock market as a horse race. In other words, people use the vernacular. They say, I'm going to make a bet on Amazon or I'm going to make a bet on something. No, and, and I alluded to this very briefly before that the stock market is an exchange of corporate ownership. And I don't think people appreciate that, that it is not a horse race. It's not Seabiscuit in the 7. It's more like somebody owning Seabiscuit and having to buy the horse and then, you know, train the horse and groom the horse and stable the horse. And then there's stud fees after the, after the races and are all done. The racing life is done and things like that. And it's a series of cash flows that come from this horse. And, and that's actually what the stock market is. So what people do, including professional investors, they concentrate on the race and they don't understand the bigger picture of, of ownership and what the point of the stock market is. You know, we've, we, I think people have taken on too much of a trader mentality and have gotten away from the investor mentality. And I think. I'm not sure that completely answers your question, but that's the way I would, I would kind of look at it right now.

B (55:51)

I think that's a very fair answer. I like that we've gotten horse racing, loan sharks and a number of other details into this.

A (55:59)

Exactly, exactly.

B (56:01)

You've got me thinking way too deeply in the back. I'll be up at three in the morning wondering if the classic Paul Newman movie the Hustler is just an allegory for active management. Maybe this is already seeping into my head in line with that. And this is not to suggest that you're going to go start anything else, but with that, with the pure ownership hat on. And in 2009 you went and launched an asset management company. But if you're going to, if you're going to run a business in 2025 and any, any domicile, I'm going to let you go anywhere in the world. I'm going to let you pick any like, business type. What's the business you would start right now or want to be in right now that you went, wow, there's an opportunity for outsized economic benefit.

A (56:41)

I don't have the expertise, so I clearly could not do most of these things. What's like the funniest one that I can give you? Something like carbon wire.

B (56:54)

Okay.

A (56:55)

Carbon wire. The electric grid is still basically 1950s and 60s technology. And a lot of the wires that if you're my age and you still have radios in Your car, your AM radio, as you drove under, these wires would get all staticky and then it would go away. Those wires, those, those high tension wires are mostly still copper and aluminum. And I'm pretty sure you can increase the capacity of the grid by about 30, 40% by just switching those copper wires to, to carbon, to carbon fiber. And I think if, and, and the regulations are such that it's easier to do that now. So I, I would maybe try to do something in carbon wire. I don't know.

B (57:40)

It's interesting. I heard somebody and it was part of like a copper pitch on how we need all the wiring and everything else. And, and part of the footnote was unless we convert this all to carbon, in which case there's a completely different thesis.

A (57:52)

Right. Well, there you go. Right. So I'm done. So the problem, just not to, not to nerd out on this, but the problem with copper and aluminum is that when they get hot, they sag. The wires sag, and as they sag, they lose conductivity. Whereas it doesn't happen with carbon wire, carbon based wire. And so you don't lose the conductivity and you keep the, the grid going.

B (58:12)

All right, well, I'm going to encourage you towards, if you decide to throw in the towel, go carbon wire. Don't buy the Rangers. I hear it's not the best investment you can make.

A (58:20)

Yeah, the Rangers. Yeah. No, sports teams. Yeah.

B (58:24)

Rich people want to follow you on the Internet, get more insights from you and your team. Where would you like to send them?

A (58:29)

So our website is RB advisors.com on Twitter, we're @RB advisors and we're on LinkedIn too. But I actually don't know what our LinkedIn thing is, but you can just search for Richard Bernstein Advisors and we'll pop up.

B (58:45)

Make sure you follow Rich in all the places. It's always a pleasure to have you here on Access Returns with us. Thanks for joining us, Rich.

A (58:52)

Thanks, guys. Yeah, it was fun. Thank you.

C (58:54)

Thanks, Ray. Thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or 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.

B (59:15)

Should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.