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Merryn Talks Money
Best of: The 'Humble' Investor Says Sell Private Equity, Sell US Tech, Buy Polish Small Caps
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- [00:00]
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Dan Rasmussen
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Marin Sut
Oh no.
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- [01:41]
Marin Sut
Marion Talks Money listeners Before we come back with our new shows next week, we wanted to republish another of my favorite episodes from the year. It's a conversation with Daniel Ramuson, founder of Verdad Advisors and author of the Humble how to Find a Winning Edge in a Surprising World. We talk about the book why he Thinks All Forecasts are wrong and his take on US Tech stocks and artificial intelligence. Enjoy. Welcome to Marin Talks Money, the podcast in which people who know the markets explain the markets. I'm Marin Sumset Web this week I'm speaking with Dan Rasmussen, founder of the investment management firm Verdad Advisors. Before starting Verdad, Dan worked at Bain Capital Private Equity and Bridgewater Associates, and he's got a book coming out which I have read already called the Humble how to Find a Winning Edge in a Surprising World. It's available for pre order now and out in bookstores in early February. I strongly recommend that you order it. The underlying theme as Dan puts it is the future is hard to predict, actually impossible to predict. So don't assume you really know anything. The best approach is a humble one. The best investment opportunities come to you when you can see other people's arrogance identify where they are too confident, be they too optimistic or too pessimistic. We're going to get into all that. Plus his thoughts on investing during stock market bubbles. Are we in one now, by the way? European and UK equities, Japanese equities, and what he is most bullish on Dan, welcome to maritalks Money.
- [03:14]
Dan Rasmussen
Thanks for having me.
- [03:15]
Marin Sut
It's a pleasure. Now, I am excited to have been one of the first outsiders to have read your book. I finished it this morning and it is excellent. And as I said to you before we started talking, it fits with so many of my biases that I particularly enjoyed it. Every page an affirmation of thoughts I have already.
- [03:31]
Dan Rasmussen
Nothing works like things to confirm my biases.
- [03:34]
Marin Sut
Oh God, absolutely. Absolutely. We'd be having a different conversation if I'd gone through the book going, no, that's not what I think already. Don't try and persuade me about things like that. Now, I wanted to start actually at the very beginning of the book, what you talk about first, which is this idea. And it's particularly important this time of year, by the way, when we are overwhelmed, aren't we, by forecasts from everybody in the market about what they think is going to happen in the coming year. And we know, we know, you and I and pretty much everyone else in the market from my years of experience, that every single one of those forecasts is wrong. Well, not all of them. There'll be one in the middle by happen chance. That is correct. So I wanted to start by talking about that forecast. You say forecasts meet reality.
- [04:18]
Dan Rasmussen
It's probably the single idea that most changed my career, which was, you know, I started out in investing like many of us do, you know, building these discounted cash flow models, the LBO models that forecast revenue and profits years into the future. And there was so much emphasis put in on getting these Excel models right or whatever. Right meant that I never stopped to ask, how good are we at predicting what's going to happen three or four years from now on the side? And I didn't start out, I didn't study finance or accounting or economics in undergrad. And so when I started working investing, I talked to my sister and a few other folks who are in the business and they said, well, why don't you go read as much as you Can. And so I started reading all these books about theory and academic research and investing. And one of the ideas that I came upon was Phil Tetlock's work on forecasting. And Tetlock finds that experts in their fields are no better than non experts at forecasting things, even in fields in which they're experts in. The only difference is that they're more arrogant about it. And I said, gee, I wonder if our growth forecasts are right. How would I sort of figure this out? And I've done a variety of studies since having that original question. And the answer that I've come to is that our forecasts are really bad. We really don't know much about the future. And the farther into the future we try to peer, the worse we get. In fact, Andre Schleifer at Harvard has done this wonderful study where he shows that long term growth forecasts are actually perfectly negatively correlated with stock market returns. In other words, the more optimistic you are about long term growth, it's actually a totally contrarian signal. Now, short term growth next year, for example, there's a little bit more accuracy. People have some good, decent chunk of ability to forecast okay, when we're talking about revenue or EBITDA, for example, or profits, what's going to happen in 2025? The problem is that it doesn't actually help you. So I just finished this wonderful study where in Japan almost all companies are required to issue one year forward guidance on revenue and net income. And so you can take, I took 20 years of this data and said how accurate are they? And then what does it mean for the stock prices? And what I found is that if you divide it into slow medium and high growth on a one year forward basis, Japanese companies are about 50% accurate. So 30% would be pure chance, 100% would be totally accurate. 50%, right.
- [06:43]
Marin Sut
That sounds fine. That sounds good.
- [06:46]
Dan Rasmussen
Yeah, it sounds okay. Right. But the challenge then is if you say, okay, well, let's say you're forecasting really high, you then think, oh well, I should buy all the companies that are forecasting really high growth because if they achieve that growth, it's going to be great. Well, it turns out that the companies that achieve high growth have sort of average returns, right? They forecast high growth and they achieve high growth and they have average returns because that high growth was priced in with the time the guidance was issued. But the 50% of the time those companies that forecast high growth don't have high growth. Their stocks collapse. And so you end up doing worse in the companies that forecast high growth or about average in total, but a little bit worse. Whereas if you go to the companies that are forecasting Low growth, yeah. 50% of the time they hit low growth. Right. But then when they do the stock returns average, they return the same as the high growth firms that achieved high growth. But when the slow growth firms achieve high growth, which they do 50% of the time, their stocks do really well.
- [07:42]
Marin Sut
Okay, so knowing the growth numbers in advance doesn't help you any, even if you did. And is it also true to say that over those very short periods, so over a year or so. What we're not necessarily saying is that anyone is particularly good at forecasting anything out over a year. What we're saying is that people are jolly good at extrapolating the future, the short term future from the past. And unless something goes wrong, it's quite likely that the next year will be similar to the previous year.
- [08:07]
Dan Rasmussen
Exactly. And this is where things get quite interesting, because I think you're exactly right, Marin, that the way people form their forecasts is they look at the recent past and they extrapolate that forward. That's the most common forecasting method in markets, which is why you see all the S&P 500 forecasts for next year cluster around exactly what The S&P 500, 500 did last year. And there's a wonderful study that I updated and have done, you know, through for the last 20 years of data where I look at the level and persistence of growth rates. And so you basically say, okay, let's look at, you know, every company's trailing growth over, you know, let's say a one year, three year, five year period. Does that forecast their growth rate over the next one, three or five years? And what you find is that revenue on a one year basis is a little bit forecastable. And then everything else is total chance. It's just pure coin flips. There's no relationship between past and future growth. And that's probably the single hardest thing for people to understand because it's just so against our views. Right? Because if you said, well, gee, Microsoft and I don't know, the Gap or some apparel retailer, I'm trying to think of something very boring. Have an equal chance of having high growth over the next five years. You'd say, come on, that's absolutely nutty. There's no way that that's true. But statistically it is true. And I think that when you start to understand that and you combine that with the insight about what's priced in and what's not? You start to see how the importance of understanding the structure of forecasts is to being a good investor. Because I like to say that investing is not a game of analysis, it's a game of meta analysis. It doesn't matter what you think. It matters what you think relative to what the market thinks. And so you need to understand what other people are forecasting, knowing that everyone else is forecasting. And then you have to think, well, what if they're wrong? How would I make money if they're wrong? And that, I think, is my sort of key to unlocking or starting to think about what should work as an investing strategy based on behavioral economics.
- [10:12]
Marin Sut
Yeah, I mean, it's not just. We'll come back to that. I wanted to talk about an anecdote that you had in the beginning of the book about the weather, because one of the things that we often talk about is why do we bother with these forecasts? I mean, not just at the company, but at the inflation level, GDP level, interest rates, et cetera. They're always wrong. And we have these GDP forecasts come out over and over from all our governments telling us GDP is going to be whatever it is with a couple of decimal points after it. And we look at it, we're like, this is nonsense. We know it's nonsense. Why do we listen? So tell us this lovely little weather anecdote from. From the book which explains it.
- [10:46]
Dan Rasmussen
Yeah. So this is Ken Arrow, the famous economist, was in the Weather Corps in World War II, and being the genius that he was, and by the way, the Weather Corps asked for one year forward weather forecasts, and so they could plan troop movements and things like that. When are the roads going to be too muddy? When's there going to be snow? By day? And so he was tasked with creating these and he did a little bit of research and he found these forecasts are completely wrong. They're completely useless. And so we just stopped doing them. And I'll just send you the historic average table and just use that. And he sends a note to the general and saying. Laying out his argument, and he gets a one sentence, one back, and it says, the general knows that the forecasts are useless, but he needs them for planning purposes.
- [11:37]
Marin Sut
And there you go. That's exactly it, isn't it? We need something to anchor what we're doing around. Even if we know it's wrong, we need the anchor.
- [11:46]
Dan Rasmussen
We need some way to plan. And even if we're not doing it consciously, we're often doing it subconsciously. And so you need some alternative way of thinking. And I think a lot of the research on forecasting suggests that the best way to make forecasts is to use base rates. So you take a long historical time and you sort of say, what's the average over this long period of time? And that's generally the best you're going to get. And so I think that in my mind, the game of investing or the way to make good investment decisions is on the one hand to take those base rates, to study history, to understand what the context is over a long period, not one year, not three years, but what's the 10, 20 year context? And what's the sort of distribution of potential outcomes? And then secondarily to say, because we know everyone else is planning, we know everyone else is forecasting, where are they concentrating, their excessive optimism and their excessive pessimism. And those are the places where we're likely to be able to find an arbitrage. Just betting that nobody knows, Right, like Nobody knows is AI going to truly revolutionize the economy or is that 1 trillion these companies are spending going to be a waste of money? Maybe no one knows. And if no one knows, what's the bet that we should make?
- [13:02]
Marin Sut
Yeah, if everyone else is betting that they will, but we know that nobody knows, then we should bet that they won't.
- [13:08]
Dan Rasmussen
Exactly.
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Marin Sut
And that brings us to this idea of investing being not a game of analysis, it's a game of meta analysis.
- [13:14]
Dan Rasmussen
That's right.
- [13:14]
Marin Sut
It's all about the relativity. All right, so with that in mind, that would make almost all the models that we use at the moment irrelevant. One of the models that you talk about in the book, the dividend discount model, the way of investing by saying every company, every equity is worth the value of all the dividends that'll be paid to the owner of that equity in the future. And people spend hours on these models, don't they? Days, Days. Working out what it's actually worth. But as they have absolutely no idea whatsoever what those dividends are going to be, the final number they come up with is nonsensical.
- [13:47]
Dan Rasmussen
Before you do the company, you're the world's leading expert on you, so just tell me, what's your year end bank balance going to be in 2030. And by the way, what's your income pre and post? Your pre tax and post tax income. Exactly. For the next five years and just model that first. And if you can't do that accurately, why do you think you can do it for Coca Cola? Right.
- [14:10]
Marin Sut
Okay, interesting. So let's go move then to what you think might work. So if none of these models that most people use, that everyone who has an mba, et cetera, sits around making these spreadsheets all day, none of these work, what does? And the thing that you say is that one thing that never changes and you can extrapolate from is human psychology. Which brings us back to this idea of the meta analysis and the in this section of the book, you use the analogy of ships because you spent some time observing how shipping works, right? And this is a one of my colleagues, when I was first starting as a broker, explained this to me in terms of chips, in terms of semiconductors. But you do it much better with chips.
- [14:52]
Dan Rasmussen
Well, it's a wonderful paper by a consulting economist here, verdad. Sam Hansen is a presser at Harvard Business School. Really brilliant guy, and I love the shipping industry. I actually spent a summer in college working at a Greek shipping company, and I find that endlessly fascinating. The personalities involved and the dynamics and the way it interacts with global trade. I mean, it's just so cool. But there's this fascinating insight that these economists have by looking at shipping companies. And what happens is that shipping rates are very variable, right? So sometimes it's very expensive to ship freight. Sometimes it's very cheap when rates are very high. And you plug those rates into a model of whether you should invest in a new ship or not. It turns out that investing in a new ship looks really profitable whenever shipping rates are high. And so people plug these into their model. Now, the challenge is that it takes three or four years to build a new ship. And so these Greek shipping companies, they see the high rates and then they go and they order ships from these South Korean shipyards. And then three or four years from now, the ships are delivered and what ends up happening? And he calls this competition neglect, which I think is such a wonderful and relevant term to what's going on in AI, by the way, competition neglect. They don't realize that all their other buddies also ordered ships at the same time because they all also did the same math and they plugged the same shipping rates and the same cost to build a ship. And so there's this glut of ships that then show up on the market all at the same time, three or four years down the road. And all of a sudden shipping prices crash because there are too many ships. And so you see the competition neglect, the inability of these shipping companies to anticipate that their competitors are doing the same thing is what's Exacerbating the cycles and driving shipping rates too high and then too low and then too high and then too low, and then everyone seems to be getting burned at the same time. And I think that that's such a wonderful analogy to what's going on in markets, right? You sort of say, wow, like, AI is such a great opportunity, I should buy into it. Well, what if somebody else figured this out before me? Or what if the fact that I thought it means that everyone else is thinking at the same time?
- [17:02]
Marin Sut
So do you think that there is overinvestment in AI or too many companies investing at the same time and the same things like the ships?
- [17:10]
Dan Rasmussen
Well, I think there has to be, right? I mean, you just think about how many of these AI companies there are, all of them are trying to build pretty much the same thing, as far as I can tell. And I think there are a few things that are clear, right? Like we can study the history of the Internet and one of the things that we observe that tends to be winner take all, the best model tends to work. Google wins search, Amazon wins retail. You know, Microsoft wins productivity. So why should we think that AI will be 20% chatgpt, 20% Gemini? 20%. Right. Like Claude, 20% anthropic? It just is. It's not plausible based on the history of the tech industry.
- [17:51]
Marin Sut
And we can't choose. And we can't choose the winner, and.
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Dan Rasmussen
We can't pick the winner. So some of these things are just incinerating capital, right? They've got to be probably all but one of them are incinerating capital. We just don't know which of them is incinerating capital, which of them are and which of them aren't.
- [18:08]
Marin Sut
And does that mean that as investors we should avoid all of them?
- [18:11]
Dan Rasmussen
I think so. I think they're all terrifying. There's too much hype, too much optimism. How long have we thought that we would have robots that could think like us, right? Like, this isn't idea. Humans are perpetually attracted to the idea of anthropic robots that can speak and think like us. And every time we've tried to do it, it hasn't worked. And it's not going to work this time, I don't think.
- [18:31]
Marin Sut
Why do we think, why do you think we're attracted to it? Is it because we're lazy and we're just hoping to be able to invent something that can do everything for us?
- [18:39]
Dan Rasmussen
Oh, it's the. It's the ultimate vanity to create something in your own image, isn't it the closest thing.
- [18:45]
Marin Sut
Oh, it's a God complex. Okay. One other tiny question before we move on.
- [18:50]
Dan Rasmussen
Not that any of our friends in the tech industry have got complex. No, not got that complex.
- [18:54]
Marin Sut
Absolutely not. This idea about the meta analysis, what does that lead us to? What does that tell us about how we can actually invest? How can we really do it? What works?
- [19:03]
Dan Rasmussen
Yeah. So I think that if we step aside and we say, gee, forecasting doesn't work and the future is too unpredictable and actually markets are too volatile, which is another thing. This is what Robert Shiller won the Nobel Prize for. It's this idea of excessive volatility. What Shiller did, which is so brilliant. He said, if the dividend discount model is right and the net present value is equal to the sum of the future cash flows discounted by the interest rates, and if we know future cash flows and we know future interest rates, we can tell you what the net present value of the stock market should have been at any given time and how much it should have moved as those things changed. And he finds that about 80 plus percent of stock market volatility is inexplainable by changes in fundamentals.
- [19:48]
Marin Sut
Okay, so even if you had the information for the model, it still wouldn't work.
- [19:53]
Dan Rasmussen
Exactly. Even with full prescience, you can't explain a very high percentage of the volatility. And so where is this excess volatility coming from? And I love this theory by this Stanford professor, Mordechai Kurtz, and he comes up with this theory that what's happening is that everybody's making forecasts and then the future happens and 80% of people realize they're wrong, and so they sell and they buy something else and then they make new forecasts and then the same thing happens. Right? And it's that dynamic. And he used some fancy math show that could explain it all. That's what's going on. And I think what I sort of love about that idea, and we're so focused on efficient market theory, and efficient market theory has so many wonderful implications, Right? And it's so useful. But I think one challenge to efficient markets theory is that it often gets interpreted as the price is always right. But anybody who's actually invested in markets at any point knows how frequently they make mistakes, and not only how frequently they make mistakes, but how frequently the market seems to make mistakes. Right? I mean, how could a stock be down 30% in a day if it wasn't a mistake yesterday? Right? I mean, like, yes, the new news came out, but clearly the market didn't get that right, otherwise the price wouldn't have moved as much as it did. And I think trying to reintroduce this idea of mistakes back into our vocabulary when we talk about markets and make it more human, right? Of course mistakes are an integral component of investing. How could they not be? How could anybody who's ever experienced markets not know that mistakes are a part of things? And how is that therefore driving rebalancing decisions? And then how can we as investors think through if other people are making mistakes? If we're making mistakes, how should we build portfolios that take into account the idea that we are going to make mistakes and that everyone else is making mistakes too, and that that's part of the dynamics of what's driving market volatility?
- [21:42]
Marin Sut
Okay, so what's the answer? How are we going to build that portfolio?
- [21:46]
Dan Rasmussen
What we're looking for is some barometer of optimism or pessimism, right? If we could just have some barometer of how optimistic or pessimistic the market was about individual security, about the market as a whole, gee, then we'd be in very good stead because we'd have a very good way of saying, here's the stuff that's too extreme on one end or the other and going long or short, that it turns out, in fact, that we have a very simple metric for doing that. And in the stock market, it's valuations, right? You can pick almost any multiple revenue multiples or book multiple, and you can array stocks on a ranking system, and you'll find that the ones that are the cheapest end up doing the best, and the ones that are the most expensive end up doing the worst. And that value reliably predicts stock returns. And in fact, over the last few years, it hasn't in the United States, we should talk about why, but it has. Even internationally, people have declared the death of value investing. But value investing, or the idea of ranking stocks by their relative optimism or pessimism and going long on things other people are pessimistic about and short things they're optimistic about should work. And I think you can also, and we should talk about this separately, apply that to thinking about whole markets and whole economies. But I think in the context of single stocks, what we've seen over the last few years has been some of the worst performance of value investing over its history. The last time it did this badly was in the late 90s during the tech bubble. And so we have to reckon with that, right? So I think it's all well and good for me to argue that we should use valuation ratios as a metric, or optimism or pessimism, and that we should be long things other people are pessimistic about. And there's an intuitive logic to that. But there's also grappling with the fact that that hasn't worked recently in the United States. Again, it has worked internationally, it hasn't worked in the U.S. and so why. And actually, there was a period from COVID until the release of ChatGPT when it did work. And then ChatGPT just totally nuked value investing again. And so what I like to say about value investing, what's going on in the market today, is that we've had a period in the 2010s where there were a very small number of companies where they were forecast to grow fast, and then they grew faster than the forecast. And they did that a few years in a row. That was the sort of fan mag stocks, as they were called then. What is that attributable to? I'd say it was an innovation wave. And these innovation waves happen. They do. They happen with the Internet, they happen with railroads, and when they happen, there are these abnormal profit pools that are earned by the innovators. Now, that doesn't last that long because at some point the customers need to benefit more than the innovators. And at some point the innovation get commoditized. And so these innovations don't last forever, but in early Windows, they can be huge, huge booms. And that's what we're in the middle of.
- [24:30]
Marin Sut
In the middle of or towards the end of?
- [24:33]
Dan Rasmussen
Depends on the future of AI. Everything hinges on that. And again, that's what you saw, right? Like the sort of tech mania seemed to actually peak in Covid, right, in 2021. And then with the release of the vaccines, you had all that stuff clearly coming off. It had all gone too far. Zoom had gone. People were using Zoom too much, right? People were buying too much on Amazon. It was peak Internet. And then it declined. And then it looked like we were going to sort of return to a normal market where value investing worked again. And then ChatGPT was released and it's just unleashed this total mania again. And it now feels like we're back at 2021 peaks. I mean, you look at things like FartCoin, and it's even worse than the SPACs. Like, at least the SPACs are companies. What the hell is FartCo? And yet it's valued at most more than 90% of Japanese companies. For example, you have to understand that markets are reflective of human history and human events. And it's not a linear math problem. And we know that there are certain things that we can rely on and should rely on, which is betting against hubris, betting on things others are pessimistic about and being skeptical of things they're too optimistic about. But sometimes the optimists are right. And they were right during the 2000 and tens. And the question now, the only question that matters for markets right now, in my mind the most important question is are they right about AI or not?
- [25:58]
Marin Sut
I mean, the other thing you can say surely is that value investing doesn't work during a bubble.
- [26:02]
Dan Rasmussen
It doesn't work during a bubble.
- [26:04]
Marin Sut
Answer, it doesn't work during a bubble. And so you can then make the case, or you might or might not want to make the case, that the last few years are being suggestive of a bubble in the US market. And you look at the valuations and these are bubble valuations. So that could be the simplest way to look at it.
- [26:18]
Dan Rasmussen
I think so too. And I have this piece in the book about the 90s because I spent a lot of time thinking about bubbles. I went back and I read a bunch of investor letters from the great investors. Ray Dalio, Peter Lynch, Howard Marks, Seth Klarman, what were they saying in the 90s? And it was really interesting because all these great investors knew it was a bubble. They all wrote about it. Ray Dalio said, we're approaching a blow off phase of the US stock market. Peter lynch said not enough investors are worried. The only problem is that those two quotes are from 1995. So investors are often smart, data driven people. You can pick up on these things and say the valuations are too high. The problem is that smart investors tend to be way too early. The bubble didn't burst for five years, we were too early. And each subsequent year it doesn't burst. You look stupid and the people that supported the bubble look right. And I think that that's the type of situation we're in now. And it actually turned out that value investing, if you looked at it from 95 to 99, it looked like the stupidest investment strategy on the planet. So did international diversification. But if you just fast forward two or three years, the bubble burst so quickly that value investing, international diversification, all these things came out ahead with only one or two years after the bubble. And so I think that having patience and I think understanding that there is historical context, being patient, but being guided by a sensitivity towards These behavioral insights that it doesn't, you know, don't, don't overthink it. You don't have to, in some ways you don't have to have the answer. I don't need the answer to the eye. I don't need to know that it's extended, will succeed. All I need to know is are people too optimistic about it or not? And what would be the signs of that excessive optimism? And if people are excessively optimistic, what should I do? I should stay away.
- [28:11]
Marin Sut
And so there is this sense from you anyway that investors in general are over invested in the US underinvested outside the us overinvested in AI and underinvested in value.
- [28:21]
Dan Rasmussen
Absolutely. And I think one interesting sort of dynamic that's been going on, right, is the rise of passive investing, which is a wonderful thing, right. There are many reasons why passive is a wonderful, wonderful thing for investors, right. It's been great for consumers. I love passive investing. I love Vanguard. The only problem I see, and maybe there are others that other people can talk about. The real problem I see with passive investing is that when people go passive, they don't say I'm going to put my money in the S&P 400 Mid Cap Europe index if such a thing exists. They think I'm going to put in the S&P 500 or the Vanguard Total Stock Market Fund. And I think when I last did this math, about 80% of Vanguard's assets were either in the S&P 500 or in the Vanguard Total Stock Market Fund. In other words, passive has herded people into the same idea. And when Mordecai Kurtz, who had that idea of rational expectations, said the thing we need to be most careful of is correlated beliefs. Correlated beliefs create risk. When investors beliefs are too correlated when everyone thinks the same thing, that's the problem.
- [29:32]
Marin Sut
And there was an interesting bit in the book where you Note that around 75% of the US relative outperformance has come from valuation changes as opposed to revenue and profitability changes. And that's really interesting because it reflects pure optimism as opposed to reality, which.
- [29:48]
Dan Rasmussen
Is always the case. Marin, because if you go back to Shiller's work, it's always valuation changes, it's always changes in our expectations about the future that drive the majority of stock market volatility is always the case.
- [30:00]
Marin Sut
And then you say, which again I thought was an interesting way to look at it, that perhaps investors who want to think about this a little bit more closely should look at, not necessarily at market Cap when they come to invest internationally. But look perhaps at percentage of revenues or net income that comes from the US against other countries, and that would be about 30% US, right. So that, in fact, if you were going to look at it in terms of the revenues from each country, you should have about 30% of your assets in the US as opposed to what you probably do at the moment, which is more like 60%, maybe. More.
- [30:29]
Dan Rasmussen
Exactly. And I think the sort of negative side we've been talking so much about being skeptical of bubbles. But we should also, and this is a big part of my investment strategy, be excited about things people are pessimistic about. And when we see people giving up, when you see magazine covers about the death of. That's the time that I get really excited about things. And I think there's actually a lot to be excited about right now. It's just not where other people are looking. I actually love the UK and Europe.
- [30:55]
Marin Sut
We love to hear that. I've skipped the Europe bit. We love to hear you love the uk.
- [31:01]
Dan Rasmussen
And actually, it's funny, I was visiting with a friend who was a big Brexit supporter, and I follow politics as closely as any normal person, but I honestly didn't follow the UK stuff so much. And I said, well, reading the FT and the Economist, I've come to the. It sounds like it's been a complete disaster and what were you all thinking? And he said, dan, pull up your computer and look at UK GDP growth since Brexit, and then compare it to continental Europe, GDP growth since Brexit. And so I went and did it, and all of a sudden I found the UK had grown faster than continental Europe. And he was like, that's the only argument I need to make. And I sort of thought to myself if my narrative about that was a little bit wrong, maybe the common narrative about Europe as a whole is wrong.
- [31:47]
Marin Sut
Although I do. I hate to say this, Dan, but you need to go and look up GDP per head growth in the.
- [31:52]
Dan Rasmussen
Okay, all right.
- [31:54]
Marin Sut
That might be a little bit of a downer for you, I'm afraid, but I'm with the sentiment that Brexit really hasn't been so bad so far and could even have. Well, it's likely to have very positive ramifications in the future, but GDP per head doesn't tell the same story as gdp. We've had a very fast growing, growing population. Sorry.
- [32:12]
Dan Rasmussen
All right. No, no, that's helpful moment. I'll go back and revisit my analysis. But I think when I look Globally, at valuations, what you see is that Europe is phenomenally cheap. It's cheaper, way cheap relative to long term averages, way cheap relative to the us, UK in particular. And what's sort of the second layer of that analysis? Because you don't want to just be a contrarian for the sake of being a contrarian and you don't want to buy cheap things just to buy cheap things. If the cheap things are bad, you want to buy cheap, good things. And one of the interesting things, if you look at return on asset type metrics, or my favorite is gross profit asset, European companies are really high quality businesses. They're very well run, they're very high margin, they're very high return on asset. And in fact the sort of lean years have actually that sort of capital starvation has forced the return on assets to go higher, created higher discount rates, higher bar for new investments. And so when you look at Europe, you're not just buying really cheap companies, you're buying really cheap, really well run, really high return on asset business.
- [33:15]
Marin Sut
Absolutely. And same in the uk, we have some really brilliantly run businesses here and they're incredibly cheap relative to similar businesses in the us.
- [33:24]
Dan Rasmussen
Exactly. And it's funny, I did this analysis where I took share of revenue in the US and then I said whether it's listed in the us. So it was a two part regression. And what I found is that because there are a lot of great UK companies, for example, that have 50% or plus of their revenues in the US. I mean, it's not unusual. And it turns out that, that the share of revenue in the US doesn't matter at all. And all that matters is where the company's listed. And I think that sort of relates to this sort of passive investing or the sort of structure of investing that a London listed company is just treated differently than a US listed company.
- [33:59]
Marin Sut
Yeah, I mean the problem for us there is that lots of these companies are now looking at whether they can relist somewhere else, get a higher valuation. So we don't want that to happen. We don't want that to happen because we rely on the infrastructure of our capital markets in the uk. So it's a big part of our economy.
- [34:12]
Dan Rasmussen
In my mind, the greatest trade available at the moment is to buy high quality, cheap European businesses. Sometimes when everybody understands that there's a problem, you almost know it's going to get fixed. So what are the big problems facing Europe? One is this Ukraine war which has dragged down valuations a lot. And you wonder how far off is that from getting fixed. How far off of a peace deal are we? Maybe closer than we think. And I think, second, this regulatory burden, which is just obviously a problem. And you say, like the U.K. for example, Brexit has given the U.K. an option on deregulation. They haven't exercised that option. Okay.
- [34:49]
Marin Sut
We have certainly not exercised it yet. We have not.
- [34:52]
Dan Rasmussen
But they bought the option. Brexit bought them the option. And there's a path to potential deregulation. And if UK and Europe can deregulate and if they can solve the Ukraine issue, why wouldn't valuations go up?
- [35:05]
Marin Sut
I suppose the other big problem in Europe and in the UK is energy prices.
- [35:09]
Dan Rasmussen
Right.
- [35:09]
Marin Sut
Particularly in the uk, stunningly high industrial electricity prices.
- [35:12]
Dan Rasmussen
Right. And who knows how that gets solved? But there seems like there'll be a lot of pressure on people to solve it.
- [35:18]
Marin Sut
Yes.
- [35:18]
Dan Rasmussen
And there are paths to do it.
- [35:20]
Marin Sut
Yeah. Yeah. Okay. Brilliant. Now, that is all fascinating and as I say, fits neatly with lots of my biases. Thank you very much. The other thing I really wanted to talk to you about, you have a chapter in the book about, is private equity. And I know that you are very concerned about private equity. And you make this. This great point that people talk about it as though it's a diversifier. It diversifies us from our equity holdings. But of course, private equity is just equities that aren't listed. They're exactly the same, and we should treat them in the same way. And your concern is that there's trouble brewing in that sector.
- [35:50]
Dan Rasmussen
There are a few sort of very important facts to know about private equity. The first is, you know, what is private equity? Well, what is a private equity as opposed to a public equity? And it's really two things are different. Right. The first thing is that, that private equities tend to be much smaller than public equities. They're all micro caps. They have about a $200 million valuation on equity market cap on average. Right. And that's compared to, say, 30 billion or something for the S&P 500. Right. And the large end of the micro cap index is 400 million. So the first thing you know is they're really small companies. What do we know about small companies? We know that small companies have higher default rates than big companies. We know they're riskier, they're less diversified, they're lower margin. Right. All of these things are stylized, true facts about small companies. Of course, once you get bigger, you're more stable, you're more diversified, you tend to have scales, higher margins, less volatile. Et cetera. But these are small companies. Not just small, but really small. So if you love private equity, but don't love public small caps or public micro caps, ask yourself why, what's the disconnect? The second thing you have to remember is that private equity backed companies are very leveraged. Generally 50 to 60% of their total valuation is funded by debt. And that's mostly coming now from private credit. And it's usually coming at very high rates. And I joke that lending is the second oldest profession. There are no new innovations in lending. And so if a company has to borrow at very high rates, the reason they have to borrow at high rates is that they're very risky. And so you're looking at equity that's subordinated to very high interest rate debt issued by these private credit firms that is reflective of the underlying risk and the underlying volatility of these businesses. Now the reason people don't think it's risky is because it's private. And so you only get a mark once a quarter. And who does the mark? Accountants. Well, if you look at the volatility of private equity marks, it's about as volatility as the volatility of book value of public companies. It just isn't related to the market. And so people get fooled by that lack of volatility into thinking that these tiny little companies with a ton of debt really aren't very risky. And of course they are, they're very risky. We just haven't realized that risk yet because we've had a period of very declining rates. And then I think coincidentally or not coincidentally, but importantly, private equity over the past 10 years has massively shifted in its sector composition to focus heavily on technology stocks. And that's been a boon. But any turn in the future of the tech industry is massively going to hurt private equity. It's become a highly levered bet on micro cap software companies and also very expensive.
- [38:32]
Marin Sut
One of the things about when the whole idea that you should invest in private equity as a massive diversifier first began was private equity companies were very cheap, right? You could get them at a stonking discount to publicly listed equities. And now of course that is no longer true. And in fact the valuations of private equity companies tend to come in above those are publicly listed, right?
- [38:51]
Dan Rasmussen
Like why should I pay more to have a higher risk? A small, smaller, more risky, more levered company that I can't buy and sell every day? Why should that be more expensive? It just boggles the mind. And I think, you know, We've seen this, this correlated belief, right? It's a correlated belief that. But from all these pension funds and college endowments and fancy investors that you need to invest like Yale, you need to invest like David Swinson, you need to have maybe 40% of your assets, assets in private equity. And I did the simple math, which is to say if you take the aggregate size of private equity backed companies, how big are those companies relative to public companies? And they're about 2 to 4% of the total revenue of public companies. So it's a tiny, tiny, tiny set of companies. And so to have 40% of your assets and 2% of the company and 2% of the revenue share of the companies. Right, because there are a lot of small companies, they just don't make much money.
- [39:48]
Marin Sut
That seems completely insane when you put it like that. Completely insane. But of course it's very nice for fund managers or for people managing large pools of money because it looks better with the smoothing, it looks less volatile, it looks calmer, it looks like a diversify. It's quite relaxing for you really. You don't have to deal with that pricing every day nonsense.
- [40:11]
Dan Rasmussen
Exactly. And you get this veneer being able to tell everyone that you improve companies. I'm a hedge fund manager. I buy and sell shares. What do I contribute to, to society? What do I know about companies? How can you feel that good about investing? Like maybe I'm a little smarter. You're right. Like, well, with private equity, you know, I've been on the board and I really helped the company grow and I talked to them about this new product and then we, you know, we opened a new factory. It's a sound, sounds better. And I think it's actually hogwash, right? Like you know, and, and, and you sort of know it's hogwash by just looking at the LinkedIn profiles of who works in private equity. Right? Like they're all former bankers.
- [40:45]
Marin Sut
This is exactly the point where I say to all the listeners, send your hate mail directly to Dan, don't send it to us. And directly to Dan. He's ready.
- [40:55]
Dan Rasmussen
But it's like, you know, when did the two years you spent building Excel and PowerPoint models as a junior banker, you know, give you this great insight in how to run like mid market industrial companies in Germany, right. Why is that logical? I'd be like, oh God, it's going to do so much better under private equity management. It's like, okay, so the junior banker from Goldman is going to do that much better of a job than like the 50 year old veteran, been running.
- [41:17]
Marin Sut
That business for 30 years.
- [41:19]
Dan Rasmussen
It seems much more plausible that what the banker is really good at is adding a lot of debt to the balance sheet and doing add on acquisitions and maybe dressing it up for sale that they seem good at. But the idea that they're better at running companies just seems a little crazy.
- [41:33]
Marin Sut
Well, we'll find out soon, won't we? Because a lot of private equity companies, they're going to have to start moving assets on and they can't keep handing them around between each other. So there's going to be surely a spate of listings coming up where we will see what private equity companies are really worth on public markets and that will be fascinating. Okay, Interesting, right? Something completely different. You talk about gold a little in the book and when. And when you shouldn't invest in gold. Now we have a lot of gold bug listeners and I'm a little bit of a gold bug myself, so maybe we could talk a little bit about your views on gold and where they fit in this. Where it fits in this cycle.
- [42:07]
Dan Rasmussen
Yeah, I think gold is a very important portfolio tool. And if you think about why it's an important portfolio tool, we need some low risk diversifying assets. Right. And one low risk diversifying asset is bonds and one low risk diversifying asset is gold. The challenge with bonds is that they react very negatively to inflation. And our country economies had a bit of an inflation problem of late. And gold in the opposite way reacts positively to inflation because you can inflate the currency, but the price of gold should be unaffected. And so what I think is that you should depend, your low risk portfolio should alternate between bonds and gold depending on your views of whether inflation is present. If you're worried about inflation, you should have more gold and fewer bonds. And if on the other hand, you're worried about deflation, you should hold more bonds and less gold. But the idea that gold has to be a tool that you're using, it's so important and it trades so differently that it gives your portfolio more degrees of freedom if you include it in the parameter of things you're considering and you don't have to have a big allocation for it to make a big difference.
- [43:12]
Marin Sut
Okay, and what about bitcoin, which I notice you do not mention at all in the book?
- [43:19]
Dan Rasmussen
Oh dear, Bitcoin.
- [43:21]
Marin Sut
I mean, you clearly are not going to say, well, bitcoin is digital gold. It's the same thing. I'm not hearing you saying that.
- [43:27]
Dan Rasmussen
I'm not saying that because I don't think it's true. I said that gold was a low risk asset. Right. Look at the volatility of gold. It's like the volatility of bonds. It is a low risk asset. That Bitcoin has the volatility of the NASDAQ or micro caps. Right. It's crazily volatile. So it's not low risk, it's high risk. And then what's it correlated with? Right. Gold is sort of anti correlated. Gold's its own thing. It marches to its own tomb. That's why it's valuable. But bitcoin is not. Bitcoin is very correlated with say the Goldman Sachs highly shorted basket of US Stocks. It's very correlated with Robinhood stock. Right. It's correlated with any type of gambling activity that you see in public markets. And I think it's part of a broader trend towards people finding gambling opportunities in public markets as opposed to finding them betting on sports teams.
- [44:13]
Marin Sut
Yeah, interesting. Do you think now, as there's lots more institutional interest in it and there's going to be a lot of passive investment into Bitcoin that it might get caught up in the same sort of momentum trade as perhaps a lot of the US tech companies have over the last couple of years?
- [44:28]
Dan Rasmussen
I think it certainly will. And I think institutional adoption of Bitcoin today is about as smart as institutional adoption of investing in China 2017 or 2018. It's equally as much of a mania and it's equally as dumb.
- [44:40]
Marin Sut
Okay, I think we have a very clear view there. And again, just let me repeat hate mail direct to Dan Dunn. Can we find you on Twitter so they can send you a hate mail direct to you on Twitter? Because that's where I get most of them.
- [44:49]
Dan Rasmussen
Absolutely.
- [44:50]
Marin Sut
What's your handle there? Just to make absolutely sure it goes to you, not me.
- [44:53]
Dan Rasmussen
It's erdadcap.
- [44:54]
Marin Sut
Okay, everybody, if you feel strongly about bitcoin, feel strongly about private equity, strongly about any of those things. Please let Dan know directly and do not copy me into your aggressive tweet. Thank you. Okay, so at the end, I normally try and ask people what they would invest in now, but I think we have a pretty clear steer from you on the value front that you're interested in UK equities, you're interested in European equities. Is there any sector in particular that interests you or any part of the market or even any particular company that you're finding fascinating at the moment?
- [45:24]
Dan Rasmussen
You know, I actually like Eastern Europe. I find a lot of interesting things in Poland and I think that people have tended to overlook Eastern Europe in particular because of the Ukraine war. But I think it also has the most leverage to any peace deal going through that you'll make money in Polish equities. They're very thinly traded. You have to buy small caps, but I think it's quite attractive.
- [45:44]
Marin Sut
Okay, that is interesting. Polish small caps have never come up on this podcast before, so thank you very much for that. Congratulations.
- [45:52]
Dan Rasmussen
Make your money out of Bitcoin.
- [45:53]
Marin Sut
Something new. Something new.
- [45:54]
Dan Rasmussen
Here we go.
- [45:55]
Marin Sut
Okay, last question. Your book I think is excellent. And just to repeat again, everybody buy this book. It's excellent. Everything we've talked about is in the book, plus a whole load more in but we didn't get onto private credit. Another fascinating chapter in it, the Bond chapter, also excellent. Do read that. But Dan, if you were going to recommend one book written by somebody else, is there anything you've been reading recently that you've really enjoyed and think is would be helpful for our listeners?
- [46:19]
Dan Rasmussen
Well, I don't know about helpful to your listeners, but by far the best book that I've read recently is the History of the Conquest of Mexico by William Prescott, which came out in 1830 and it tells the unbelievable story of how Cortez conquered Mexico in 1510. And as a story that I glossed over in the history textbooks, but it is unbelievably fascinating. 800 men conquering several hundred thousand person civilization. It's just an insane story and beautifully written. So if you're looking from a break from markets, I recommend it.
- [46:55]
Marin Sut
I imagine people are going to be looking for a break from markets relatively soon this year, but we'll see. Dan, you thank thank you so much for joining us today. Congratulations on an excellent book.
- [47:04]
Dan Rasmussen
Thank you. Maren.
- [47:11]
Marin Sut
Thanks for listening to this week's Maryn Talks Money. If you like our show, rate, review and subscribe wherever you listen to podcasts and keep sending questions or comments to marianmoneyloomburg.net you can also follow me and John on Twitter or x. I'm Erin SW and John is John Underscore Stepek. This episode was hosted by me, Marin Sut. Web was produced by Sam Asadi, production support from Moses Andam, and special thanks to Dan Rasmussen.
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