Big Market Delusion

Summary

Podcast Summary: The Compound and Friends – Episode "Big Market Delusion"

Release Date: March 14, 2025
Host: Downtown Josh Brown
Guests: Michael Batnick and Rob Arnott
Episode Title: Big Market Delusion

---

1. Introduction and Guest Welcome (06:11 – 07:14)

In this episode, Josh Brown welcomes Rob Arnott, the founder and chairman of Research Affiliates, renowned for his expertise in multi-asset active equity and alternative indexation strategies. Rob Arnott is also a co-portfolio manager for the PIMCO All Asset and PIMCO Rae funds. The hosts express their enthusiasm for having Rob join them in New York, reminiscing about their previous interactions and events they've hosted together.

2. Current Market Sentiment and Potential Bubbles (07:14 – 11:14)

The conversation swiftly transitions to the prevailing market sentiment, with Josh Brown highlighting the "MAG7" (a group of seven major growth stocks) rally and Tesla's fluctuating stock performance. Rob Arnott expresses his nervousness about the market's stability, stating:

“I think we may be seeing early stages of a bursting bubble, but I also see lots of cheap assets out there. So I think turbulence is going to be great.”
(00:46)

Michael Batnick concurs, emphasizing the existence of undervalued assets in areas like emerging markets (EM) and international small-cap value stocks. The discussion underscores concerns about overvalued growth stocks and the potential for significant market corrections.

3. The EV Market as a Big Market Delusion (11:14 – 19:26)

Rob Arnott delves into the concept of "Big Market Delusion," a term he and Michael Batnick coined to describe bubbles where numerous companies within a newly created market are overvalued based on unrealistic growth expectations. He explains:

“Big market delusion is a special kind of bubble...the narrative takes shape that these folks are creating a new world...the bad news about narratives is that they're 100% reflected in share prices already.”
(11:28)

Using the Electric Vehicle (EV) market as a case study, Rob highlights the surge in EV stocks since 2020, noting that despite the influx of new companies, only a few like Tesla and BYD have managed to outperform the S&P 500. The median performance of these EV specialists has been bearish, with a weighted average showing an 80% decline.

4. AI Stocks and the Next Big Market Delusion (19:26 – 31:31)

The hosts transition to discussing Artificial Intelligence (AI) stocks, pondering whether AI could be the next Big Market Delusion. Michael Batnick shares his skepticism about the sustainability of AI-driven growth, particularly highlighting the immense data requirements for effective AI applications. He notes:

“AI is massively data hungry...If your investment horizon is multiple quarters or years, which ours is, there's not enough data. AI is not very useful.”
(28:54)

While acknowledging some firms might be leveraging AI for short-term gains, Batnick remains cautious about the long-term prospects, suggesting that the hype surrounding AI may not translate into fundamental value.

5. Valuations: CAPE Ratio and Current Trends (32:25 – 44:57)

Rob Arnott brings attention to the Cyclically Adjusted Price-to-Earnings (CAPE) ratio, questioning its relevance given historical shifts in valuation trends. He observes that:

“Valuations have been trending higher for 25 years... If you drew a line of best fit through that left graph, it would be upward sloping and it would end at around 25.”
(41:56)

Michael Batnick echoes concerns about the overreliance on valuation metrics, emphasizing that high earnings multiples suggest unsustainable profit margins. He warns:

“In a steady state economy...that's a big deal because tacitly, that says 50% profit margin...that's not priced into the share price.”
(25:03)

The discussion highlights the risks associated with extrapolating past growth rates and the potential for multiple contractions in high-growth sectors.

6. International Markets' Outperformance (56:54 – 64:10)

A significant portion of the dialogue focuses on the recent rally in international stocks, particularly in Europe and emerging markets, contrasting sharply with the underperformance of U.S. stocks. Josh Brown remarks on the unprecedented inflows into European equities:

“The Stocks Europe 600 index have outperformed US stocks by 12 percentage points in dollar terms over the past 20 trading days. That is astoundingly rare.”
(60:32)

Rob Arnott attributes this outperformance to geopolitical factors, such as fear of Russia and increased defensive spending, rather than improvements in corporate fundamentals. The hosts discuss how this shift presents opportunities for investors to pivot towards undervalued international and emerging market stocks.

7. Investment Strategies and Opportunities (64:10 – 70:17)

The panel explores various investment strategies to navigate the current market landscape. Michael Batnick introduces Research Affiliates' strategies, including diversification through lesser-known asset classes like commodities, high-yield emerging market securities, and TIPS (Treasury Inflation-Protected Securities). He emphasizes the importance of "asymmetric risks," advocating for buying undervalued assets that have significant upside potential when the market corrects.

Rob Arnott highlights the resilience of certain diversified funds during market downturns, comparing their performance favorably to traditional 60/40 portfolios. He points out:

“In the US bear market during the global financial crisis, all asset was down roughly half as much as 60:40 was down.”
(73:30)

8. Discussion on Recession and Government Policy (70:17 – 78:39)

The conversation shifts to macroeconomic policies, particularly government spending and its impact on GDP growth. Michael Batnick criticizes deficit spending, arguing that excessive government expenditure hampers private sector efficiency and economic growth. He references their research showing a negative correlation between government spending and per capita GDP growth:

“If you simply take the magnitude of government spending over any five-year span and correlate it with the magnitude of per capita GDP growth, the correlation is minus 50%.”
(49:00)

Rob Arnott and Josh Brown discuss the challenges of predicting economic outcomes amidst volatile policies, such as fluctuating tariffs. They debate the sustainability of current economic models and the implications of potential austerity measures on the stock market and broader economy.

9. Conclusion and Final Thoughts (78:09 – End)

As the episode wraps up, Rob Arnott and Michael Batnick share their personal interests and future plans, offering listeners a glimpse into their lives beyond the financial discourse. The hosts encourage listeners to explore Research Affiliates' resources for deeper insights into diversified investment strategies.

Notable Quotes:

• Rob Arnott (00:46):
  “I think we may be seeing early stages of a bursting bubble, but I also see lots of cheap assets out there. So I think turbulence is going to be great.”

• Michael Batnick (11:28):
  “Big market delusion is a special kind of bubble...the narrative takes shape that these folks are creating a new world...the bad news about narratives is that they're 100% reflected in share prices already.”

• Michael Batnick (28:54):
  “AI is massively data hungry...If your investment horizon is multiple quarters or years, which ours is, there's not enough data. AI is not very useful.”

• Michael Batnick (25:03):
  “In a steady state economy...that's a big deal because tacitly, that says 50% profit margin...that's not priced into the share price.”

• Rob Arnott (41:56):
  “Valuations have been trending higher for 25 years... If you drew a line of best fit through that left graph, it would be upward sloping and it would end at around 25.”

• Michael Batnick (49:00):
  “If you simply take the magnitude of government spending over any five-year span and correlate it with the magnitude of per capita GDP growth, the correlation is minus 50%.”

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Conclusion

In "Big Market Delusion," the hosts and guests dissect the complexities of current market dynamics, emphasizing the risks of overvalued growth stocks, the potential bubble in the EV sector, and the skepticism surrounding AI-driven investment strategies. They advocate for diversification into undervalued international and emerging markets as a hedge against market turbulence. Additionally, they critique government fiscal policies, highlighting the detrimental effects of excessive spending on economic growth. The episode serves as a comprehensive analysis for investors seeking to navigate a potentially volatile and inflationary market environment.

Transcript

[Josh Brown]

How long are you in New York for?

[Michael Batnik]

Till tomorrow afternoon.

[Josh Brown]

Okay.

[Michael Batnik]

Off to Zurich tomorrow, are you? Yeah.

[Josh Brown]

Oh, wow. That's exciting.

[Rob Arnott]

Rob, are you at room temperature or cold?

[Michael Batnik]

Cold. Thank you. You're welcome.

[Josh Brown]

What are you doing in Zurich?

[Michael Batnik]

Client meetings.

[Josh Brown]

Okay. Do you get there a lot or.

[Michael Batnik]

No. About once every two, three years.

[Rob Arnott]

Josh, what was the.

[Josh Brown]

I've never. I've never been.

[Rob Arnott]

What was the mood on the show today?

[Josh Brown]

Buying the dips. Everybody's buying the dip. Well, I mean, good as they should. These are. These are professional asset gatherers. Of course they're behind the dip.

[Rob Arnott]

I'm nervous that I'm not nervous. That's like what's making me nervous.

[Michael Batnik]

Okay. I think I'm kind of the same.

[Josh Brown]

What you're. You're not nervous right now?

[Michael Batnik]

I'm nervous and not nervous.

[Josh Brown]

Nervous and not nervous. Okay.

[Michael Batnik]

I think that we may be seeing early stages of a bursting bubble, but I also see lots of cheap assets out there. So I think to turbulence is going to be great.

[Josh Brown]

Are these assets that have recently gotten cheap?

[Michael Batnik]

No. That have been cheap for a while.

[Rob Arnott]

EM value.

[Michael Batnik]

EM value international value. International versus us, just in general. US small cap value.

[Josh Brown]

Is. This is your kind of market. I feel like this is what you like. This is where your strategy presents more opportunities. I feel like the 2023 market was not your kind of market.

[Michael Batnik]

No.

[Josh Brown]

Very narrow.

[Rob Arnott]

Or the 2015 to the 2013 market. Whose market was that? Yeah, it was Apple, Google, Nvidia, Facebook, Tesla.

[Josh Brown]

Yeah, yeah. So if you're right. So if your methodology doesn't include being 40% 7 stocks, 23 was not fun, which is most people.

[Michael Batnik]

And 24 was not fun.

[Josh Brown]

24.

[Rob Arnott]

I think financial advisors. It's not been a great time unless you've been 100% queues, which no financial advisors are, but at least we're like giving advice and doing other things. If you're purely in asset management, which is the seat that you're in. The last decade has not been fun. It sucked.

[Michael Batnik]

Right.

[Rob Arnott]

Because it's been so easy to beat you.

[Michael Batnik]

Yeah.

[Rob Arnott]

And I used easy in air quotes.

[Michael Batnik]

But yeah, yeah, I see the air quotes.

[Rob Arnott]

So an over a gross oversimplification. But the Fed tried to slow the economy down for five years. Not five years, two and a half years with hiking of rates. I just. Am I naive to think that they.

[Josh Brown]

Should have just done tariffs?

[Rob Arnott]

Right. It was that easy. Just tariffs. That's all they needed to do.

[Michael Batnik]

Yeah, yeah, exactly. Where was Trump when you needed him?

[Rob Arnott]

The obvious counterpoint is like, well, this is not today. The economy right now is not the economy in 2022. I realize that in 2023, but I don't know.

[Michael Batnik]

Well, we came into the year with people absolutely blase about the economic prospects, and that's changed rather abruptly.

[Josh Brown]

Yeah. It feels almost overnight.

[Rob Arnott]

Everyone.

[Josh Brown]

Everyone changed their mind. And the only people that didn't change anything were the Trump people. They said from day one, this is what we're gonna do.

[Michael Batnik]

Yeah.

[Josh Brown]

And everybody's like, yeah, they probably won't do it. And then they did it.

[Michael Batnik]

Of course.

[Josh Brown]

That's the. That's the. That's our story so far.

[Michael Batnik]

Take him seriously, but not literally.

[Josh Brown]

Yeah. Now both. Now. Now both. Where did he just go?

[Michael Batnik]

He said, I feel naked.

[Josh Brown]

Oh. Oh, nice.

[Michael Batnik]

There we go.

[Josh Brown]

I was gonna say, much better.

[Rob Arnott]

My head's too bald to, like, not wear a hat.

[Michael Batnik]

I know. I was getting blinded by the shine from the light off.

[Josh Brown]

Rob's got. Rob's got a full head of hair.

[Rob Arnott]

Way full.

[Josh Brown]

So you know what I'm doing now? I'm doing this thing called prp. I'll let you know if it works. It's too early. They take, like, a tube of your blood, spin it in a centrifuge. The red part separates from the yellow part. So you get what's called platelet rich plasma. Yeah, they call it yellow gold. The woman takes a syringe, multiple syringes filled with the yellow, and injects it into all the spots in my head where I've lost hair. The idea being, if your follicles are dead, it's not gonna work.

[Rob Arnott]

My follicles are dead.

[Josh Brown]

But I think you're done. But if they're just sleeping, this will wake them up and you'll start to sprout new follicles and new hair.

[Michael Batnik]

So the good news, I'll tell you.

[Josh Brown]

If it worked, I'll know in six months if it worked.

[Michael Batnik]

The good news is male pattern baldness is strongly correlated with testosterone levels. Well, you know me, so that means he's the manliest man here.

[Rob Arnott]

I can't help it. I can't help it.

[Michael Batnik]

I'm the girly man.

[Rob Arnott]

I can't help it.

[Josh Brown]

All right, so what are you ready to go? Three claps coming in. Oh, boy.

[Rob Arnott]

Compound and Friends Episode 182 Whoa, whoa, whoa. Stop the clock. Here's a word from our sponsor.

[Josh Brown]

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[Rob Arnott]

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[Josh Brown]

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[Rob Arnott]

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[Josh Brown]

Yeah, C L O I Josh. What? You have a problem with that? And that's a wrap.

[Michael Batnik]

Welcome to the compound and friends. All opinions expressed by Josh Brown, Michael Batnik and their cast mates are solely their own opinions and do not reflect the opinion of Redholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

[Josh Brown]

Episode 182. Ladies and gentlemen, you are in for a treat. We have a very special guest in the house. Michael and I always have incredible conversations with him. We are so happy to be hosting him here in New York. Ladies and gentlemen. Rob Arnott is the founder and chairman of Research Affiliates, an asset manager focused on multi asset active equity and alternative indexation strategies. Rob is a co portfolio manager of the PIMCO All Asset All Asset All Authority and PIMCO Rae funds. Ladies and gentlemen, welcome Rob Arnott. The crowd is going absolutely wild.

[Michael Batnik]

I can see them standing and applauding. It's just wonderful.

[Josh Brown]

It's wild. Now they're whistling. The last time we talked was on stage at Future proofed in 2023, which is a lot of fun. It was. Yes. And one of my favorite moments from that event is we got you to throw a box of T shirts out to the crowd. So I don't know if you saw what we did last year. We actually bought a T shirt cannon.

[Michael Batnik]

Oh.

[Josh Brown]

Which, yeah, we had to get all sorts of insurance waivers on, but we were firing. So next time we get a chance to do that, I'll let you shoot the cannon.

[Michael Batnik]

Oh, great.

[Josh Brown]

Yeah. All right, first things first. I want I bring that up because I sort of want to give you your flowers. You at that moment in time. Let's let's just recap that September of 2023, that entire year is a massive MAG7 rally. And one of the biggest and best performing names of that era was Tesla. It survived the 2022 bear market and then it came roaring right back like nothing ever happened. And you are basically pointing out that this may be the most innovative company of all time. That's not going to save you if you're buying it at 400 times earnings or whatever it was. And it's interesting to note that Tesla from that moment is negative. Michael, do I have this right? Negative 12%.

[Rob Arnott]

But it's even better than that because from the time Rob said that, it got cut in half pretty quickly.

[Josh Brown]

Yeah. So the stock has obviously been way higher since you said that.

[Rob Arnott]

That's when he said it. At zero.

[Josh Brown]

At the zero mark.

[Rob Arnott]

Yeah.

[Josh Brown]

Okay. So this time last year you weren't looking so smart. Elon Musk got himself involved with the administration and the stock ended up having a huge run. It's given all of that back and then some.

[Michael Batnik]

That wasn't this time last year.

[Josh Brown]

23? Yeah, yeah. No, not this time last year, but last fall when it became apparent that Elon Musk was going to be arm in arm with Trump and then Trump won, the stock basically acted as though Elon Musk was now the emperor of the universe. I've never seen a political reaction in one common stock quite like what we saw with Tesla. And the logic at the time made sense.

[Michael Batnik]

Well, we have never had a president who in the first handful of weeks of his administration has ever done as much as President Musk.

[Josh Brown]

Yeah, right. So as co president, though, he is running the table in terms of like going through every government department doing whatever he wants to do. The problem for Tesla shareholders is that hasn't translated to increased sales. Certainly hasn't helped with sentiment around the name. One of the more interesting things about the EV market is I'm guessing up until recently, the majority of the buyers are either Uber drivers or liberals, people that are pro environment and that's what attracts them to an electric vehicle. And since this is really weird situation now where we're getting sales reports and we're getting all sorts of indications that Tesla's having trouble selling product in Europe, we don't know what the spillover will be in the United States just yet, but for one reason or another, the stock has come back to earth in terms of its multiple.

[Michael Batnik]

If one out of four Trump voters buys a Tesla in the coming three years, his sales will go up anyway.

[Josh Brown]

It's Just a totally different buyer base of what normally you've seen with electric vehicles.

[Michael Batnik]

Right.

[Josh Brown]

Okay.

[Michael Batnik]

One of the things that I think is quite hilarious is they now have T shirts that say, I bought before I saw Elon's dark side. And they're for sale at Tesla dealerships.

[Josh Brown]

Okay.

[Michael Batnik]

So that people can buy and wear them and Elon can make a buck or two from T shirts.

[Josh Brown]

Yeah. Do we have audio of what Rob said? What do we have?

[Rob Arnott]

Pull it, John.

[Josh Brown]

All right, let's pull it.

[Michael Batnik]

You would have to use implausible growth assumptions to justify the current price. And part B, a cross check on the first part of the definition. The marginal buyer doesn't care about valuation models. Is that true of Nvidia? I think so.

[Josh Brown]

I think so today.

[Michael Batnik]

So now not all bubbles pop. The exception that proves the rule is perhaps Amazon. In 2000, I would have. I would have said that's a bubble and it's performed brilliantly. But for the first 10 years, the decade of the aughts, it underperformed the S and P. It's only the last dozen years that it caught up with the S and P and then soared past it. So bubbles don't inevitably burst, but they have very high odds of bursting. When I said implausible growth to justify current pricing, I didn't say impossible growth. Aswath Damateran and Brad Cornell coined the expression big market delusion. And we wrote a paper in March of 2021 suggesting that the EV market was a big market delusion. What is a big market delusion? It's a special kind of bubble. It's a bubble in which an array of companies are creating a new market, creating a new world, and the narrative takes shape that these folks are creating a new world. It's going to be big, it's going to come fast, and it's going to be enormously disruptive. The beauty of narratives is that they're usually largely true. The bad news about narratives is that they're 100% reflected in share prices already. And where those narratives can break down. You can't make money on a narrative because it's already in the share price. You can make money always, even if.

[Josh Brown]

You'Re early to it.

[Michael Batnik]

Well, you can make money where the narrative is wrong. And if you're early to it, it means you think that the future is going to be even brighter than that narrative. But once it's fully reflected in share prices, then you need to ask questions. Where can the narrative break down? Where can it be wrong if all of these Electric car vehicles are all going to succeed side by side, even though they're competing with one another. All right, that's a little bit of a stretch if they're going to replace conventional fossil fuel powered vehicles fast. That's not plausible. People don't give up a perfectly functioning, slightly older car just because they want a cool electric vehicle. So the narrative can be correct, but if it's wrong on some elements, then you have big market delusion where everything's priced for perfection. And we wrote another paper just this month revisiting the EV delusion and pointed out market for EV stocks had soared in 2020. I think the composite was up 800%. Something insane.

[Josh Brown]

And tons of IPOs. New companies, new companies.

[Michael Batnik]

There were nine EV specialists at the time. Within two more years there were 30. Now we're down to about 20. So. So there's a thinning in the market happening right now, but the aftermath is that through today, zero of those nine has beat the S&P. Only two of the nine are up at all, BYD and Tesla, and only barely. And the median of. If you equally weighted all nine of them, you'd be down about 80%.

[Josh Brown]

That's incredible.

[Michael Batnik]

Yeah.

[Josh Brown]

So like Fisker, Nikola, all of those. Right. All those companies that came along into that kind of hype cycle.

[Rob Arnott]

So, Rob, you're not an individual investor per se, individual stocks, you're a quant. Right. So you've got all these screens. But what happens once a delusion breaks? Would there be a level in which you saw fundamental value in a name like this, or is it just.

[Michael Batnik]

The short answer is yes, there's a fair price for everything. For some things it's zero. Evidently for Nicola, that's the case, and for others it's distinctly positive.

[Josh Brown]

But it's a good rule of thumb. So when you have one of these narratives that completely takes over everyone's hearts and minds, maybe a good way to say, okay, this is it, is the launch of the Thematic etf. Cause here's why I was thinking about that. Yeah, we just had a product launch and no disrespect to the firm that launched it, I don't know who it is.

[Rob Arnott]

I do.

[Josh Brown]

Hopefully they're not sponsoring the show, but we had a product launch that's now going to hold all of the publicly traded companies that have built Bitcoin treasuries, following in the footsteps of Michael Saylor. And apparently it's a whole index. There's like, how many? 30 or 40 companies.

[Rob Arnott]

I thought you were going to say the ETF that's long Tesla, short Ford. That's not like three weeks ago.

[Josh Brown]

That's not a big market narrative, though. That's something different. Like what Rob's speaking to with these, like, delusional mark. It's like, oh, this is a good company that people are excited about. Great, let's make 50 more. So now all of a sudden you have all these companies and some of them are absurd, some of them are a little bit more serious, but they have all cottoned onto the strategy, literally, that the company strategy is pursuing of building a Bitcoin treasury, which on its surface is bullish for Bitcoin. It's more corporate buyers. But just this idea that there needs to be an index ETF that's going to hold all of these companies strikes me as the moment when a narrative is about to break.

[Michael Batnik]

I love your choosing that as a mechanism for identifying big market delusions. It's a fun way to do it. I would add an additional condition on that, and that's that if it's a new thematic ETF and that index that it's tracking has doubled in the last 12 months.

[Josh Brown]

Okay, so put those two things together.

[Michael Batnik]

Put those two things together. Okay, next, the index for deletions and ETF Architect launched the Nixt ETF in September of last year. That buys stocks that are kicked out of major indexes. And we did work that going back 30 years that found that stocks that are kicked out of S and P or Russell, for instance, outperform by about 5% per annum after they've been kicked out.

[Rob Arnott]

Because what's the average draw then by the time they're kicked out? Down 70, down 80 wells fall very far.

[Josh Brown]

Right.

[Michael Batnik]

On average, they're down by half in the year before they're kicked out. And so one of the reasons we launched that index, and it is a thematic index in a sense, in a.

[Josh Brown]

Sense, from my perspective, it's less thematic and it's more like one of these mechanical indexes.

[Michael Batnik]

Mechanical. Deeply contrarian.

[Josh Brown]

And it's not a big market delusion. It's actually overly pessimistic.

[Michael Batnik]

Right, okay. And so I was raising that topic as an illustrative example of the importance of the price performance element, if you want to call it a thematic strategy. It had not performed brilliantly in the 12 months before we launched the index or before ETF Architect launched the ETF. And what a great time to embrace something totally out of favor.

[Josh Brown]

Yeah, nobody wants to.

[Rob Arnott]

I'm glad you said that because I was going to push back a little Bit against what Josh said, the ETF launch, because there's an ETF for everything. The industry is so vibrant and robust, thanks to ETF Architect and others, that anytime there's even the whiff of something, an ETF launches.

[Michael Batnik]

Yeah.

[Rob Arnott]

But the inverse, I think, is more powerful. So when an ETF shuts down, like the big one in my mind is like coal Kol. When that thing shut down. That's a good contrarian buying indicator when a whole ETF gets shut down because there's just complete apathy and washout.

[Michael Batnik]

That'd be fun to look at and to test.

[Josh Brown]

So here's a category where that's applicable to right now. Weed, cannabis. These stocks are in an average 90% drawdown. Can't find anyone on Wall street who even wants to write research on them anymore.

[Michael Batnik]

Yeah. You know the interesting thing there would be the due diligence required to study the companies.

[Josh Brown]

Yes. Weekends only.

[Michael Batnik]

Yeah, weekends only. Elon Musk blowing smoke on the air.

[Josh Brown]

It turns out none of them have a moat, number one. Number two, the consumer market is just not as big as people thought it would be.

[Michael Batnik]

And it's a relatively stable market. You got the same number of pot smokers now as you had 10 years ago.

[Josh Brown]

Yeah. And I don't know if people know this. It literally grows on trees.

[Rob Arnott]

Boom.

[Michael Batnik]

I mean, it doesn't. So, all right, so it grows.

[Josh Brown]

It grows out of the ground.

[Michael Batnik]

Out of the ground. It doesn't grow on trees.

[Josh Brown]

You can replace it very quickly. Our.

[Rob Arnott]

Our colleague Ben Carlson said that the stock market is like the last apolitical place. You can't bullshit it. And Michael Sembalis, who's been a guest on this show from JP Morgan, wrote his piece yesterday, 50 Days of Gray. And Michael opened it with saying, here's the interesting thing about the stock market. It cannot be indicted, arrested, or deported. It cannot be intimidated, threatened, or bullied. It has no gender, ethnicity, or religion. It cannot be fired, furloughed, or defunded. It cannot be primaried before the next midterm elections. And it cannot be seized, nationalized, or invaded. It's the ultimate voting machine, reflecting prospects for earnings growth, stability, liquidity, inflation, taxation, and predictable rule of law. Pretty well said.

[Michael Batnik]

I like that.

[Josh Brown]

Yeah, I was going to say that that. That almost sounds like kind of California libertarian a little bit. Like, that's. That's like well within your. Your overall vibe.

[Michael Batnik]

It's within my overall vibe. I. I don't think Chat GPT could have written that that any better assemblist.

[Josh Brown]

Is semblance is special. But that's, that's what this year so far seems like it's about. It seems like it's about the stock market derating on a multiple basis. We have not yet seen material cuts to full year earnings expectations. A lot of people are saying next week, well, we're derating now because that's the next shoe to drop. But, but, but we're still in this situation where the largest companies are extremely large relative to the index and extremely.

[Michael Batnik]

Concentrated and extremely high multiple, especially the.

[Josh Brown]

Price to sales and now high volatility.

[Michael Batnik]

Correct.

[Josh Brown]

Every MAG7 is currently in a 15% or worse drawdown from its own all time high and all of them are experiencing multiple contraction because nobody is cutting their earnings guidance for any of them.

[Michael Batnik]

I've, I've heard that Elon's down to his last 300 billion.

[Josh Brown]

He'll be fine. But these companies collectively have lost a couple of trillion dollars and it's happened in like the last six weeks.

[Michael Batnik]

Yep.

[Josh Brown]

So when you see something like that, it validates a lot of the things that you've been saying over the last couple of years. But what's what, how else do you react when you see that? Oh, and what are we showing here?

[Rob Arnott]

So that we've got earnings growth of 1.3% for the S and P year to date and you've got the index down 5.3% more from the high, of course, but down 5.3% year to date. And all of that and more is coming from multiple expansion contraction. I'm sorry, multiple contraction.

[Michael Batnik]

That means that the Shiller PE ratio, that's price relative to 10 year average earnings for the US stock market has fallen from 35 times 10 year average earnings to 37 times 5 year average earning to 35 times.

[Josh Brown]

Boy, what a bargain.

[Michael Batnik]

What a devastation.

[Josh Brown]

Yeah, but when you see that taking place so you're not beating your chest, but I think you pointed out nothing has to change with how fundamentally dominant these companies are. No, all that has to change is sentiment in order for purchases of these stocks at 20 and 30 times earnings to not look so great. And you've also pointed out in the past how quickly things can turn. And that's exactly what we're experiencing right now.

[Michael Batnik]

Yeah. Nvidia came into the year trading at about 60 times earnings and about 30 times sales. Scott McNally in 2002 was asked by Congress about his selling some of his stock, Sun Micro. Sun Micro in the year 2000 before the stock fell 90% and asked what he knew and his Response was, stock was priced at over 10 times sales. Think about that. In a steady state economy, that means for our shareholders to get their money back, I have to give them 100% of gross revenues. I have to pay nothing to create product. I have to pay my staff zero. I have to pay no taxes, and I have to give it all to the shareholders. And the shareholders have to pay no taxes, which is sort of illegal. Yeah. What were the shareholders thinking?

[Josh Brown]

Yeah.

[Michael Batnik]

And this is one of the things I find fascinating. People pay a lot of attention to price earnings ratios, but very little attention to price to sales ratios. Nvidia, 30 times earnings. No big deal. 60 times earnings, no big deal. 30 times sales. That's a big deal because tacitly, that says 50% profit margin. Oh, that can persist.

[Josh Brown]

Well, people would say, look at its revenue growth rate projected, not even what it's already done. Correct. And that's why we're comfortable at the.

[Michael Batnik]

Exactly right. And that's why it would be comfortable at its PE ratio, but not its price to sales ratio. You look back at 2022, I think it was. Yes, 2022, Nvidia's sales were flat for the year and its profits were down by half. Roughly. Then it exploded.

[Josh Brown]

ChatGPT comes along. Now you got a new big market delusion.

[Michael Batnik]

New big market delusion. So the paper we just published revisiting the EV market, we end by saying, so is AI the next big market delusion? That's a topic for another paper. But I'm on record saying I think it's a bubble. But I'm also on record saying, don't ever short sell a bubble. It can go longer and further than you can possibly imagine. A good way to go bankrupt is to short sell a bubble too early.

[Josh Brown]

One of the big bearish talking points on the AI stocks is people say, all right, this is like 20% about fundamentals and 80% hype or whatever it is. Or they'll say, these companies are making tons of promises, but nobody's actually using this for anything other than kids cheating on their papers. You run a big data analytics operation, your research shop. You guys are doing tons of research all the time. Are you using AI internally and is that usage growing and are you spending money on it?

[Michael Batnik]

Short answer is yes to all of the above. But a longer answer would be not necessarily where you think, okay, the. And not spending as much as you would think. If you ask 100 asset managers, are you using AI in your investment process? 95 out of 100 will say, yeah, 90 out of 100 will say we're doing pathbreaking work there, and 80 of those 90 are BSing you.

[Josh Brown]

Okay?

[Michael Batnik]

The simple reality is that AI is massively data hungry. If you've got thousands of samples of data, AI is useless. Millions may be a little useful.

[Josh Brown]

Oh, that's interesting.

[Michael Batnik]

Billions of samples. Now you're talking. And if you've got trillions of samples, forget human intelligence. AI will run circles around humans. Okay, so where do you get trillions of samples of data? The Internet. All of the knowledge that's on the Internet. The library of everything ever written, anything involving visuals, large language models, tick data. So you want to go to Citadel and pitch them on the idea of using AI? You get laughed out of the room. They've been doing it for 20 years.

[Josh Brown]

It's not new to them.

[Michael Batnik]

It's not new to them. Yeah. In fact, I was doing neural nets back in the 1980s, didn't find them very useful, and quickly learned that they needed way more data than.

[Josh Brown]

So we have a hundred years of stock market data. So what are you feeding into this massively powerful AI?

[Michael Batnik]

Is that like, we're not using AI in our investment process, per se? Okay, I will say that right up front.

[Josh Brown]

Okay.

[Michael Batnik]

We're using it in lots of interesting ways. I write a lot of papers. One of the first things we do now before publishing the paper is give it to AI and say, please copy edit this paper and take away repetition. Clean up untidy wording, make it clearer, and in seconds, it comes back with a tidier version of the paper. I accept about 80% of its recommended edits. That's wonderful. Each paper we publish has a graphic at the start of the paper that's intended to be just a visual representation of what the paper says. You look at the visual and think, I don't know what that's about. You read the paper and look back at the visual, and you think, oh, yeah, I get it. That's cool. We used to have graphic artists prepare those. We now do it with AI. Feed the paper into AI and say, give us a visual, and it gives us a dozen choices. Almost always, one or two of those is better than anything the graphic artist could have come up with. So we're using it that way. We use it to. When we're writing papers, what references are we overlooking? What papers are out there on the equity risk premium from the perspective of behavioral finance that we ought to know about and read about and reference? And it'll come back with a list of the 10 most important papers that we've missed. Wow. This is very, very cool stuff.

[Josh Brown]

Yeah. But you don't think there is somebody right now away from Citadel and the market makers? You don't think there's an asset management right now who's doing serious AI driven research that's helping them select securities?

[Michael Batnik]

I didn't say that there are a few. I said that 8 or 9 out of 10 who say they are really, you dig down and they're probably not. But there are a few and it's hard to discern who they are at this stage. But I would say that if your investment horizon is seconds or minutes or hours, there's enough data for AI to be massively helpful.

[Josh Brown]

You think so?

[Michael Batnik]

If your investment horizon is multiple quarters or years, which ours is, there's not enough data. AI is not very useful.

[Josh Brown]

Yeah, it's not big enough.

[Michael Batnik]

Right. So we're finding all sorts of wonderful. The research that's going on in the asset management world is largely focused on shorter and shorter and shorter horizons. So with our focus on medium to long horizons, we're finding lots of new inefficiencies that are just wonderful and that we don't think are likely to be arbitraged away anytime soon.

[Josh Brown]

Because the crowd is increasingly looking at next week, next month, next quarter.

[Michael Batnik]

Correct.

[Josh Brown]

And you guys are thinking on a 3 to 10 year horizon and you have less, you have less competition picking over those opportunities.

[Michael Batnik]

Exactly.

[Josh Brown]

Because they're all running with the, with the herd.

[Michael Batnik]

Exactly.

[Rob Arnott]

So we got a re rating of stocks as, as we mentioned, the MAG7 is now trading at 27 times trailing earnings. And the rest of the market, the 493, around 18 times. John Chardon, please.

[Michael Batnik]

Yeah, yeah.

[Josh Brown]

So we're getting there.

[Rob Arnott]

Doesn't seem outrageous.

[Josh Brown]

And it's happening fast. We're, we're getting into a place where you could conceivably say there are some opportunities on the long side for U.S. stocks or we're not, we're not close yet.

[Michael Batnik]

Well, I would roll the clock back to the year 2000 where.

[Rob Arnott]

Please don't.

[Michael Batnik]

Where the PE ratios were much higher in the year 2000. The aggregate PE ratios and the PE ratios for tech were more frothy. So I don't see this unfolding in the same way as the dot com bubble. But I do think there's a fair amount of froth in that chart. And I do think that one of the issues is extrapolating recent past growth in earnings is very, very dangerous. Nvidia's growth prior to 2022 was wonderful. And was extrapolated. And then earnings fell in half. They're going to have a having of earnings somewhere along the way here. And that's not priced into the share price.

[Rob Arnott]

Let me give some good news to the listener that's probably emotional about the market sell off because it's, it's scary. Stocks are getting. Stocks are getting hit pretty bad. We have Bears have been above 55% in the AAII survey for three weeks in a row. This comes from Subo Trade. This has only happened one other time in history and that was at the bottom in March 2009. Now there's a million. Yeah. Bots and different things between this and 2009. My only point is people are nervous. The market is making them nervous. And is the stock market now the counterpoint is is the stock market likely to overreact or underreact? A perceived threat. It's going to overreact because that's what we do. You already have the median stock in an 18% drawdown. Good news number two. It's bad news. But it's just perspective. And then if you look at the number of stocks that are at least 20% off the high in the S&P 500, this chart comes from Liz Young. It's like half of stocks.

[Michael Batnik]

Yeah.

[Rob Arnott]

And so it's not to say that this is the bottom or that it can't get worse, but you have to expect that people are going to overreact. And I'm not saying that we're there yet, but bad news gets discounted pretty quickly.

[Michael Batnik]

Right. But you also have an issue where the companies that are trading cheapest are the least vulnerable to bear markets. And again, history doesn't repeat, but it sure does rhyme. And in the dot com bubble, the first two years after the bubble burst in March of 2000, between March 2000 and March 2002, the S&P was down 27%. Nasdaq was down about 50% on its way to down 80. So how bad was it for Russell value? It was down 4. How bad was it for small cap? It was up 3. How bad was it for small Cap value? Russell 2000 value was up 53%.

[Josh Brown]

Do you think that small, small value mid value will be as defensive this time around if this turns into a full blown bear market?

[Michael Batnik]

If it turns into a bear market, I would not dare to predict that small cap and small cap value will shrug off a bear market like it did in 2000. I would say that there would be very high odds that it would be hit less Hard. So I look at this sell off I see today as an opportunity rich environment. You've seen our capital market expectations work. Our website, Asset Allocation Interactive. Anyone who Googles Asset Allocation Interactive, the first non ad takes you straight to that tool on our website and it gives you forward looking expected returns for 160 different asset classes. What does it say about US S&P 500? It says about 3.5% return for the next 10 years.

[Josh Brown]

With the inflation rate where it is is a terrible period.

[Michael Batnik]

You can do better on ordinary money market funds or the AG. The value is about 1% better than that. But that's with no mean reversion in relative cheapness. If there's mean reversion, it would win by 5% or more.

[Josh Brown]

Meaning if value catches up to the multiple that growth has had.

[Michael Batnik]

No, if it catches up to its normal discount.

[Josh Brown]

Oh, its own.

[Michael Batnik]

Its own normal discount.

[Josh Brown]

Okay.

[Michael Batnik]

I see right now the spread between growth and value is about eight to one. Historic norms about four and a half to one. So you'd have to have value almost double relative to growth in order just to get back to historic norms of relative valuation. Now that's not a prediction of mean reversion, it's just saying if it happens. That's big. I love asymmetric risks.

[Josh Brown]

Yeah. Let me, let me run one thing by you. So I remember that period post 2000 and I remember the only stocks that were going up were the stocks that nobody was ever talking about.

[Michael Batnik]

Right.

[Josh Brown]

Nobody owned. You owned them. Nobody else owned them. These were not.

[Michael Batnik]

I had a great year in 2000.

[Josh Brown]

So. Right. So and this is shortly after they put Buffett on a magazine cover and mocked him as somebody who doesn't get the Internet. Wasn't long before all those Internet stocks were down 70, 80, 90%. And then you would look at the top performing names and they were companies making dresses. It was absurd. Was furniture companies. It was the most boring industrial stocks left for dead. Yes. This time the version of that that seems to be working is healthcare stocks. They were probably one of the worst performing sectors over the last five years. Nobody wanted to own them for any reason. And yet these are companies with earnings growth for the most part, they seem to be rallying. With the exception of the one that I own, they seem to be rallying this year. And it is a little bit reminiscent of that 2000post.com bubble. These are stocks that nobody talks about. Even the biotechs aren't glamorous.

[Michael Batnik]

Right.

[Josh Brown]

They're going up. Are people thinking about that era and Saying this is the version of small.

[Michael Batnik]

Value, hard to guess what in people's minds. But one thing that may be under consideration and maybe motivating a lot of people is the notion that treating pharma as evil when they're trying to create cancer cures might not be a great thing to do. Trying to force them to stop innovating might not be a great thing to do. And so the notion of deregulatory environment, not no regulations, just back off on over regulation for the FDA and to a lesser extent CDC and others, this might allow them to flourish. Okay, so that might be a driver.

[Josh Brown]

Yeah. And we didn't know. We didn't know we were getting RFK Jr as the head of Health and Human Services. We didn't know a lot of these things. But in the first Trump term, he was yelling at pharma CEOs about drug prices and yelling at them, you have to negotiate lower prices with the government, et cetera. He really hasn't gotten around to that yet this time. So I think those stocks have been allowed to breathe.

[Michael Batnik]

They have been allowed to breathe and maybe he'll put them under some pressure. I don't know.

[Josh Brown]

Right.

[Rob Arnott]

Rob, I want to ask you about your thoughts on mean reversion and if there's been any change in your thinking about this over time. So I know that a lot of the inputs that are used for capital market forecasts, particularly you guys are a fan of, is the Cape ratio.

[Michael Batnik]

Yeah.

[Rob Arnott]

And the Cape ratio today looks a lot different than it did in the past. John, can we have this chart, please? So the long term average is on the left and it's 17 and a half times as we know, it only got below that at one point in the last 25 years. At the bottom in March 2009 at 13 times. And if we look back to 2000, the average is 27.5 times. Now, I don't know if that's right or wrong, but the chart on the right is more important in my opinion, because what this is showing is that had you measure the CAPE ratio with the available data through the course of history, as opposed to looking back 150 years, what it would show is that the Cape ratio bottomed in the 80s and has been on the rise up and to the right ever since. And I'd love to get your thoughts on this.

[Josh Brown]

I'm sorry, for the listener, when we say Cape ratio, this is the cyclically adjusted price to earnings ratio, which Rob refers to as the Shiller pe. But basically it's trying to smooth out the business cycle and taking 10 years worth of earnings and then doing a price earnings ratio on that the way most people are doing it on trailing twelve. Is it good explanation accurate? So valuations have been trending higher for 25 years.

[Michael Batnik]

I look at this graph and I think, well, if you drew a line of best fit through that left graph, it would be upward sloping and it would end at around 25. So we may be in a world where a more mature economy with a wealthier populace, more investors, means that people are willing to accept a lower risk premium than would have been the case in the past. They can absorb more downside risk. The economy is more mature. It's less of a. The beginning of this chart, it was us.

[Rob Arnott]

There was a recession every week.

[Josh Brown]

Wild West.

[Michael Batnik]

It was Wild west. And we were an emerging economy. I mean, we were poorer back in 1881 on real per capita GDP than Pakistan is today. And the notion that that Cape ratio is relevant today is dubious.

[Josh Brown]

We agree with you on that.

[Michael Batnik]

Yeah, but if you drew a line of best fit and it ends at about 25, then that says 35, maybe ought to be 25. That gives you some illustration of the potential downside risk. Now, 13:3 in 2009, I remember remarking to one of our clients, I feel like a kid in a candy store, everything is cheap. Even mainstream stocks look extraordinarily cheap. And they said, please don't say that to our clients because they're all hemorrhaging and deeply depressed.

[Josh Brown]

Well, on 13.3 though, we wiped out a year's worth of earnings to get there.

[Michael Batnik]

We did.

[Josh Brown]

We had massive losses in the banking sector that wiped out S and P earnings. It was artificial. I shouldn't say artificial, it was real. But it was not the normal course of a typical year.

[Rob Arnott]

But do you guys think that earnings are going to get just destroyed over the next 12 months?

[Michael Batnik]

No, but I think earnings as a percentage of GDP are near historic peaks. And that's a formula for pissing off the broad electorate. And if the broad electorate isn't happy, you may see a rejiggering of who gets the goodies.

[Rob Arnott]

So lower earnings and lower multiples, that's.

[Michael Batnik]

No bueno possibility of softer earnings. If you go back historically, earnings have powerful mean reversion. The faster they've grown in the last 10 years, the slower they're likely to grow in the next 10 years. And today earnings are about 50% above the 10 year average, which historical norm is more on the order of 10% above the 10 year average.

[Rob Arnott]

Yeah, we're stretched.

[Michael Batnik]

And so we're stretched. And historically, when it's 50% above the historic norm, the subsequent 10 year earnings growth is approximately zero. So that's not a prediction, that's just history. And history would suggest caution about these 10, 15% earnings growth expectations that a lot of people are talking.

[Josh Brown]

Here's, here's what the risk to, to, to the earnings growth story is the acute risk right now, the tariffs stay on throughout the course of this year. And it turns out as good as we think companies are at passing on higher costs to consumers, they're not able to do it with tariffs. They were able to do it with inflation. In 22 and 23, earnings were okay. And then they got really good. And the reason is Chipotle and Netflix were really good at convincing you that this $14 burrito is now 16. And by the way, you still love it. You're still going to come back.

[Rob Arnott]

Yeah, we did that once, we probably can't do it again.

[Josh Brown]

Nobody canceled their Netflix like Amazon was able.

[Michael Batnik]

Paired with a recession. So.

[Josh Brown]

Right. So the risk here, with a recession, this idea that companies are going to have to pass these tariff costs on to their consumers. What if they can't?

[Michael Batnik]

Yeah.

[Josh Brown]

Then you could say goodbye to these record high earnings margins.

[Michael Batnik]

Yeah. And what if the dollar stays strong so that the cost isn't absorbed and.

[Josh Brown]

They get hit twice?

[Michael Batnik]

Yeah. But you know, one of the things that I find very amusing is you have lots of economists trying to model what 10%, 20% tariffs will due to GDP to unemployment, to inflation. Pardon me, but Trump's very transactional. And modeling 25% Canadian tariffs when one day they're zero, the next day they're 25, the next day they're 50, the next day they're 25th, seems to me pretty naive.

[Josh Brown]

Yeah. What if they name a hockey arena after him and then there's zero? And then you've done all this modeling work and the news, the news cycle is like every 24 hours it's a new number.

[Michael Batnik]

Yeah.

[Josh Brown]

So.

[Michael Batnik]

Yeah. So why on earth do you want to model something that changes day to day?

[Rob Arnott]

What a waste of time.

[Michael Batnik]

Right. So that's one thing that I find.

[Josh Brown]

What should they do? Should they just go right to a worst case scenario and then say, this might be overly negative, but we can't change this forecast every 10 minutes and just assume the worst and maybe the worst doesn't come to pass? And would that be the more rational way to put out a forecast right now?

[Michael Batnik]

A rational way would be to say, here's the worst case scenario, here's the best case scenario, and you pick where you are in the middle. But you should also acknowledge that models historically have done a horrible job of gauging the macroeconomic impact of tariffs. Trump won involved large tariffs, and the economic impact wasn't anything like what economists forecast. The economics community has become overwhelmingly neo Keynesian. If you're not a neo Keynesian, Keynes himself would be evicted from the econ community today.

[Rob Arnott]

What is a neo Keynesian?

[Michael Batnik]

A neo Keynesian Keynes believed government can stimulate and during difficult times you should spend even if you're doing useless stuff. And when the economy is improved, then you can peel back and start running surpluses to replenish your dry powder for the next time you need it.

[Josh Brown]

Now we just spend all the time, no matter what's going on.

[Michael Batnik]

My simplistic definition of a neo Keynesian is somebody who sees no problems with deficit spending, no matter what.

[Josh Brown]

Yeah.

[Michael Batnik]

So the whole econ profession, for the most part, is neo Keynesians. And I'm reminded of George Box's famous dictum that all models are wrong. Some models are useful. If you're all using the same model, then it's probably wrong and not useful.

[Rob Arnott]

Are you worried by the deficit?

[Michael Batnik]

No, I'm worried by the spending.

[Rob Arnott]

What do you mean?

[Michael Batnik]

There's two aspects to deficit spending. One is deficit. Your tax receipts are too low relative to your spending. The other is part of it is spending is too high relative to tax receipts. A neo Keynesian would say, well, if you have to close that gap, raise taxes. We've done research, we published an early version of this in a paper describing government spending as a stealth tax on prosperity. And we're updating that work now. It'll probably come out in the next few weeks. But if you simply take the magnitude of government spending over any five year span and correlate it with the magnitude of per capita GDP growth. Per capita GDP growth is the relevant measure, not aggregate GDP growth. If the population's growing 2% a year and the economy's growing 1% a year. Year, that's pretty crummy. If the population's shrinking a percent a year and you've got 1% growth, that's wonderful. So per capita real GDP growth is the relevant measure, and the correlation between per capita real GDP growth and the magnitude of government spending is minus 50%.

[Josh Brown]

What are we doing?

[Rob Arnott]

Why do you think?

[Josh Brown]

Why is the money going?

[Michael Batnik]

Well, what we're doing is spending too much to do too little. Government serves some very, very Useful purposes, but give it too much money and it starts to divert resources from the private sector to the government sector and starts to invent things to do.

[Josh Brown]

Okay.

[Michael Batnik]

And I don't think any of your listeners, left, right or middle of the road would disagree with the notion that government isn't optimized for efficiency or accountability.

[Josh Brown]

So if the neo Keynesians are running the economics profession, that's different from what's happening now in the administration. They seem to be leaning like Austrian. They're doing fiscal, federal, fiscal austerity.

[Michael Batnik]

I've been shocked.

[Josh Brown]

We've got a Treasury secretary who's taking meetings with Javier Milei.

[Michael Batnik]

Yeah.

[Josh Brown]

And they are literally closing down wholesale entire departments of government. Now you have people saying, well, I like that they're doing that, but I don't like that they're doing this. Cuz everyone has their hobby horse, of course. All right, so what's your perspective on the Austrian bent of what they're doing on the fiscal side? Which maybe would be more palatable if it weren't combined with tariffs, but we have what we have.

[Michael Batnik]

I'll give you a funny story. About 10 years ago I was invited to give a speech in Austria to basically the economics profession of Austria, enclave of about two hundred and fifty economics professors and finance professionals. And I made the observation that it's wonderful to be speaking in Vienna, the home of Austrian economics. And during the Q and A, one guy came, stood up and said, by the way, there are no Austrian economists in Austria anymore. I had to laugh because it was funny. But what year was this? This was about a decade ago.

[Rob Arnott]

What did he mean?

[Josh Brown]

That everybody gave up on Austrian economics within Austria? Yeah, they were infected by the eu.

[Michael Batnik]

Right.

[Josh Brown]

Okay.

[Michael Batnik]

They were all neo Keynesians.

[Josh Brown]

Okay.

[Michael Batnik]

And like I said, even Keynes would be evicted from the castle.

[Josh Brown]

All the Austrian economists are now here. They live in Connecticut and they do radio shows.

[Michael Batnik]

But all three of them.

[Josh Brown]

Yes, yes, we have them all here. But what's your take though? So if you have a problem with deficit spending, then surely you gotta like watching them attempt to cut $2 trillion out of our annual budget.

[Michael Batnik]

Cutting spending is the answer, not boosting taxes. And I can't believe that our economy and our society can't function with a $4 or $5 trillion government spend rate. Yeah, I mean, come on, of course we can.

[Josh Brown]

So what happens? What fills the void if hypothetically few hundred thousand people who are working either for the federal government and then another few hundred thousand who are working for contractors that do business with the federal government if they're all put out of work in the next year. What does that mean for. You're saying there's an opportunity in private sector for all of these people and we all live happily ever after? Or are you in the detox camp that it's going to suck, but we have to do it?

[Michael Batnik]

I'd be in the detox camp. It is going to suck. We will have to do it. But I'd also note there's 3 million government employees, there's 5 million contractors employed associated with government whose revenues are entirely dependent on government. So that's 8 million government employees. Let's say a million of them lose their jobs.

[Josh Brown]

Well, their spending has a ripple effect. Yes, it does, right?

[Michael Batnik]

Yes it does. But people talk about the ripple effect and the multiplier effect on spending. But. But if they're not producing something that's useful, then they aren't boosting gdp.

[Josh Brown]

Okay.

[Rob Arnott]

I think a lot of people would say yeah, surely there's waste in the government spending. Billions, trillions. Of course, no doubt. But if the stock market's going to fall third to get rid of the government waste, keep it, keep the waste.

[Michael Batnik]

I would say look 10 years hence and ask what happens if the US continues to run 6, 7% deficits and has a debt relative to GDP of 150% 10 years.

[Josh Brown]

So if we don't do this now, it's going to get even harder to do.

[Michael Batnik]

It'll get harder to do. Okay, so.

[Rob Arnott]

So worry about the future then.

[Michael Batnik]

Right, but back to my million example. Can the private sector can't possibly absorb a million laid off government workers Come. Of course we can. The private sector loses over 2 million jobs a month and creates over 2 million jobs a month.

[Josh Brown]

Every month, 3.9 million people are leaving one job for one reason or another. Some of them get new jobs, some of them die, some of them retire. And within that 3.9 million there are students leaving college, getting their first job. Yeah, that's like the shuffle. And it's monthly.

[Michael Batnik]

It's monthly. So what we're looking at is a disruption that'll be painful, extremely painful for those who lose their jobs. I mean the old cliche is a recession is when your neighbor loses their job. A depression is when you lose yours.

[Josh Brown]

That's right.

[Michael Batnik]

So for government workers, this is a depression year.

[Rob Arnott]

Do you think the market would care about Doge absent tariffs? Because I don't, I don't know that.

[Michael Batnik]

I'm not sure that it would.

[Rob Arnott]

Yeah, I don't think so.

[Josh Brown]

I don't think the market is reacting to Doge at all?

[Rob Arnott]

I don't think so.

[Josh Brown]

I think the home market in Virginia is reacting to Doge. I don't think the stock market is at all.

[Michael Batnik]

I would also say that the home market in Miami beach is. Nevermind. It's just awesome.

[Josh Brown]

He Rob, I want to go out on a high note and one of the silver linings of what's happening around the world. And of course, silver lining, like somewhat tongue in cheek because a lot of this is geopolitically driven. But one of the bright spots for portfolios this year is the rally in international stocks, including international value stocks.

[Rob Arnott]

Finally.

[Josh Brown]

Yes.

[Michael Batnik]

Yes.

[Josh Brown]

This is the thing that some of us started to think. Not me, but some of us started to think could never happen. We have a negative S and P.

[Rob Arnott]

You should have heard this guy six months ago.

[Josh Brown]

Yeah. So I asked the question rhetorically, but not even, not, not really I actually wanted an answer. I said what on earth could possibly ever happen for? I understand European stocks rallying with US stocks or developed market Internet. But like what could happen where the S and P gets killed and international stocks have a great year? It seemed inconceivable. Turns out the answer is Trump. But I didn't know that. I didn't know that in advance.

[Rob Arnott]

So nobody did.

[Josh Brown]

Okay.

[Michael Batnik]

Or if not Trump, the relative valuation comparison at the end of the year.

[Josh Brown]

It'S not rallying on valuation.

[Rob Arnott]

Needed a catalyst.

[Josh Brown]

They're rallying because they're afraid of Russia and they're spending.

[Michael Batnik]

Yeah.

[Josh Brown]

And they're. They're having a change of heart about their own competitiveness in the global economic system. You agree with that, right?

[Michael Batnik]

I would. I would.

[Josh Brown]

I mean, that's what it took though. That's what it took.

[Michael Batnik]

Look at Europe, the entire continent of Europe. Who is the big path breaking innovator in Europe? That's stand out in terms of relative valuation. It's the maker of a weight loss medicine. Okay. Is that the biggest innovation?

[Josh Brown]

Novo Nordisk.

[Michael Batnik]

Yeah.

[Josh Brown]

Yeah.

[Michael Batnik]

Is that the biggest innovation?

[Josh Brown]

Lvmh, that's the spring line is breathtaking.

[Michael Batnik]

I have to tell you, LVMH is not a technological innovator.

[Josh Brown]

Is Zara, the Spanish clothing retailer, one of the largest companies in the world? I don't know.

[Rob Arnott]

No.

[Josh Brown]

Rob's point is there's not asml.

[Michael Batnik]

ASML is a good example.

[Josh Brown]

Arm holdings.

[Michael Batnik]

But you have to look through the.

[Josh Brown]

I understand they don't have a fang, but that's the point.

[Michael Batnik]

That's my point. That's my point.

[Josh Brown]

We agree. We agree. You like this Rally in European stocks. You think it has room?

[Michael Batnik]

I think it has ample room, especially on the value side of the spectrum, which is where the rallying is happening here in the US Value's being hit hard too. And small caps being hit hard too. I view this as an opportunity rich environment pivot. Take advantage of what's cheap, getting cheaper. Buy on the dip, but don't buy the frothy stocks that are dipping. Buy the cheap stocks that shouldn't be dipping. And are.

[Josh Brown]

Do you think that this is just a rotation or do you think this could be the start of. There have been some secular periods where international developed stocks have done better than the S and P? I would note that those typically happen on the heels of a bad bear market here.

[Rob Arnott]

Yeah. Last time was the last decade.

[Josh Brown]

But like oh, 3 to 07, you could own international developed and you could own emerging markets and you can crush the s and P500.

[Michael Batnik]

Yeah.

[Josh Brown]

So I know we've had those. And that's a, a four year run.

[Michael Batnik]

Yeah.

[Josh Brown]

You think that this looks more like that and less like a six week kind of like rotation that peters out.

[Michael Batnik]

You look at our asset allocation interactive website and you see that the expectation for international value and emerging markets value is 10% per annum compounded for US growth is 1% per annum compounded.

[Rob Arnott]

Not my US growth.

[Josh Brown]

Can we do chart 8? John? I want to show Rob this. This is the largest four week inflow to European equities in 10 years.

[Rob Arnott]

It's been a minute.

[Josh Brown]

So you were a fan of this band before they got famous and before they had a, before they had a song in the top 40. Right. You, you, you've long said this is where there's value and now you're starting to see the benefit.

[Michael Batnik]

I liked this band when they, when they were in the van. Seven years old. Like them better when they're 20.

[Josh Brown]

Okay. All right. Well now it's, this is now a popular trade, but it doesn't have to be a blip. You think this can go on?

[Michael Batnik]

I think it can go on. I mean look back at the dot com bubble where S and p was down 27 and Russell 2000 value was up 53. That's a pretty good spread. You were twice as wealthy with Russell 2000 value as you were with the S and P. After just two years, things are that stretched. The spread between what's cheap and what's expensive is not dissimilar to what we saw then.

[Rob Arnott]

I feel like this particular show is going to age really poorly just where we are in the market of the economy, like right this second, in six months, in a year, every show agent is poured for the record. But things are either going to be so much worse than we're talking about.

[Michael Batnik]

Today or we're going to be more this conversation.

[Rob Arnott]

Yeah. Or it's going to blow over and we're going to look like. What were we even worried about? We worried about like fake tariffs.

[Josh Brown]

Well, that's just the nature because this is a snapshot in time.

[Michael Batnik]

Yeah. Now if this conversation turns out to be irrelevant in six or 12 months, you aren't going to save it and reuse it, are you?

[Josh Brown]

No, we will delete it from the service. To Michael's point though, this zeitgeist, this zeitgeist of get me out of large cap growth, get me into anything overseas that's got a value kind of bent to it. This is from Mike Bird. European stocks. The Stocks Europe 600 index have outperformed US stocks by 12 percentage points in dollar terms over the past 20 trading days. That is astoundingly rare.

[Rob Arnott]

Well, because that's the point. In dollar terms. It's not just that European stocks are rallying, it's that the dollar is getting killed. But my point is there's such a, there's a chance of it either getting a lot worse or. You idiots sold Nvidia and bought these shitty European companies. What's wrong with you?

[Michael Batnik]

Yeah, when, when people think that your views are preposterous, stupid and unbelievable, that you could think that the advice is useful, that's when the advice is usually the most useful.

[Josh Brown]

Yeah. So we're still there. I don't think most people have said to themselves, I fully agree with this. This is the right, this is the right move. Get out of the Mag 7. I think they're because muscle memory. Think about how many V shaped recoveries we've had in the NASDAQ over the last five or ten years.

[Rob Arnott]

But Josh, what's particularly interesting about this moment in time is that they bought the dip when the deep sea sell off happened.

[Michael Batnik]

Yeah.

[Rob Arnott]

Right. So they already reloaded the chambers and now it's like, oh, that didn't work. And for the first time in a long time, mind you, because every day has been bought for the last 15.

[Michael Batnik]

Years and profitably so.

[Rob Arnott]

Yeah, yeah.

[Josh Brown]

Asia, huge rally in Chinese Internet this year. I know those aren't value, but I think the whole Chinese market has done pretty okay.

[Michael Batnik]

China is cheap. I don't particularly like the, the Maoist leanings. I don't particularly like the Fact that they punish people for being successful.

[Josh Brown]

But I know it's almost like Delaware.

[Michael Batnik]

Oh my God. It's not that bad, is it?

[Josh Brown]

But those stocks are working cheap and working is an interesting combination is momentum value and trend.

[Rob Arnott]

Value and trend on your side is powerful.

[Josh Brown]

Yeah.

[Michael Batnik]

Yeah. The spread between China and India is. Has completely flipped. Five years ago, China was one of the more expensive markets in the emerging markets. The Rafi emerging markets portfolio was about 20 percentage points underweight China.

[Josh Brown]

Wow.

[Michael Batnik]

And about 5,6% overweight India. Now it's about 5% overweight China and about 8,8% underweight India.

[Josh Brown]

India and Japan have been rallying for three years now and they've done really well.

[Michael Batnik]

They have. Japan is still. Japan is still not expensive. India is expensive. India is very expensive. It's almost as expensive as the US.

[Rob Arnott]

And Indian stocks have actually gotten pretty. Hit pretty hard over the last couple weeks.

[Michael Batnik]

Yeah.

[Josh Brown]

Japanese stocks. I just wonder what. I don't know. If you read Warren Buffett's letter two weeks ago, he's done really well in those trading companies that he bought, which were these giant Japanese conglomerates that were trading at huge discounts to US Stocks. I know it's not the best comp. They've all doubled pretty much from where he was buying them.

[Michael Batnik]

Yeah.

[Josh Brown]

And he still thinks there's huge opportunity in Japan. What do you think of that, that market as a non European developed foreign market?

[Michael Batnik]

I think broadly Japan is moderately attractive. I wouldn't say terribly attractive. It's as regulated as Europe. I said earlier that deficit spending. The deficit isn't the problem. The spending is the problem. If your aggregate government spending is 30% of GDP, your growth rate tends to be about 2% per capita GDP growth per annum, meaning prosperity doubles every 35 years. That's very cool. If it's 60% of GDP and parts of the EU get awfully close to that, you wind up having per capita real GDP growth of zero.

[Josh Brown]

Right.

[Michael Batnik]

And you know, zero growth takes a lot of time to double.

[Josh Brown]

Yeah, forever. I mean, this is.

[Michael Batnik]

Oh, that's right. That's what the math tells us.

[Josh Brown]

This is the fundamental problem with Japan as a macro theme.

[Michael Batnik]

Right now Japan's compounded by population shrinkage. So their per capita GDP growth is a little better than their aggregate GDP.

[Josh Brown]

Growth because there's less capita.

[Michael Batnik]

Yeah, less capita to.

[Josh Brown]

Right. Well, if you like that, you'll love South Korea.

[Michael Batnik]

Oh my goodness.

[Josh Brown]

Where they're going extinct. Were you impressed, Were you impressed with any of the market reforms, the pro market reforms that we're Hearing about in Germany and France, we saw in Japan, the Nikkei told all its listed companies, we want you to create a plan to get your share price above its book value. And we're going to publish that plan to the, the, to the website and we're going to hold you to it. And a lot of Japanese companies said, okay, here's what we're going to do. And to fire this many people, we're going to buy back this much stock, we're going to do this with it. And it worked.

[Michael Batnik]

Yeah.

[Josh Brown]

And now it seems like that message is resonating around the world. Macron wants to build an AI community and have companies go public. The Germans are apparently rearming for World War three. Like everybody seems to have figured out how rising stocks.

[Michael Batnik]

How would it have played 40 years ago for everybody to be applauding Germany rearming?

[Josh Brown]

Not well, not well.

[Michael Batnik]

But the world does change, but it also changes gradually. And so I wouldn't expect EU or Europe in aggregate to suddenly get capitalist religion, be pulled against its will back in the direction of what works.

[Josh Brown]

Yeah. You don't think this is a revolutionary moment for pro shareholder or anything?

[Michael Batnik]

No. But I would also say that if the markets are priced to reflect bleak expectations, and the reality is anything better than that when I'm blocking on her name, the woman who was president in Brazil, Delmarosa da Silva.

[Josh Brown]

Oh.

[Michael Batnik]

When she was ousted, the stock market was rock bottom. And what a buying opportunity because all you had to do was take a kleptocratic, corrupt government and replace it with something that was a little less kleptocratic.

[Josh Brown]

A little less.

[Michael Batnik]

And that's right. In relative terms, that's wonderful news. The market doubled in the next 12 months.

[Rob Arnott]

Well, Rob, to your point about expectations getting ratcheted down and lowering the bar, we're going to get price cuts this week. Next week we're going to get earnings coming down and eventually whenever. The bad news will not weigh on the market.

[Michael Batnik]

Right. This is one reason, one area where I think 2000 does not repeat. If we have a bear market, and I won't be surprised if we do. I won't be surprised if we don't. But if we have a bear market, I don't see a particular risk of it being severe. And part of the, you know, your bearishness graph, I think is interesting on that score.

[Josh Brown]

Everybody's already there.

[Michael Batnik]

People are already there. That doesn't mean buy the dip in buying what's extravagantly expensive just because it dipped. It means taking what's dirt cheap. And got even dirtier and even cheaper.

[Rob Arnott]

The dips could keep dipping.

[Michael Batnik]

Yeah. And buy something that has room to quadruple. Buy that at the dips.

[Josh Brown]

Right. I love that way of thinking. I want you to tell us about all asset and all asset authority for the, for the listeners and the viewers who are unfamiliar with your funds.

[Michael Batnik]

Yeah.

[Josh Brown]

What is it that, what is it that you're doing with those funds that you're trying to capitalize and what's the strategy?

[Michael Batnik]

I'm allowed to talk about strategy? Not specifically.

[Josh Brown]

Fair enough. Understood. Because you're providing the index to these funds.

[Michael Batnik]

Right?

[Josh Brown]

So talk about the indexes.

[Michael Batnik]

Firstly, these are strategies that embrace one stop shopping for diversification. It's your way of getting diversification away from classic 6040 in one package. Now one of my friends likes to say that diversification is a regret maximizing strategy.

[Josh Brown]

We say that.

[Michael Batnik]

Yeah. In a roaring growth dominated bull market, you regret every penny you have that's outside of that market.

[Josh Brown]

Why do we own this? Why do we own that?

[Michael Batnik]

When that market breaks, you regret every penny you don't have. In diversifiers. I view this as a one stop shop for diversification. Diversifiers are cheap. In our asset allocation interactive website, the average for what I call third pillar diversifying markets outside of mainstream that are lightly correlated with mainstream stocks and bonds and that provide some inflation protection as well. Those markets are priced to give you on the order of about a 7.5% return.

[Rob Arnott]

Are you talking about commodities or what exactly are we talking about here?

[Michael Batnik]

Commodities, high yield emerging market stocks and bonds, TIPS, REITs. These are all out of mainstream. Nobody in the institutional community has a large allocation to any of them.

[Rob Arnott]

So not the ag, not the S.

[Michael Batnik]

And P. Right, Right.

[Josh Brown]

So there's tons of opportunity in those diversifiers still. I mean we've just started.

[Michael Batnik]

They're priced to give you about 7.5% per annum. Classic 6040 is priced to give you about 4.5% per annum.

[Josh Brown]

Now the difference between all ass debt and all Authority, in All Authority, you can actually be net short some of these asset classes or you could par trade them against each other.

[Michael Batnik]

In All Authority, we can short US stocks.

[Josh Brown]

Okay?

[Michael Batnik]

And so what we do is we leverage up the allocation to diversifiers. Usually we short a little bit of US stocks to pull down the beta with the result that all authority is not materially riskier than all assets. Its volatility is about the same, its beta is a little lower. Beta for your viewers means how much it moves when the stock market moves. So it's More differentiated from the stock market.

[Josh Brown]

So you would expect, of course, you can't predict, but you would expect in an out and out bear market for the S and P. That would be the one that does better.

[Michael Batnik]

Correct.

[Josh Brown]

Because it's an active bet against the market.

[Michael Batnik]

Right. Okay. Peak to trough. In the US bear market during the global financial crisis, all asset was down roughly half as much as 60:40 was down. That's actually a big win because 60:40 was down a lot less than the stock market. So peak to trough was rough but not horrible. And all authority barely went down at.

[Josh Brown]

All, which was miraculous at the time.

[Michael Batnik]

Seemed miraculous, but it's a very differentiated strategy. Anyone who buys all asset, all authority really needs to drum into their mind, do not compare this with the S and P. If the S and P is doing well, expect this to be a big disappointment.

[Josh Brown]

It's a hedge.

[Michael Batnik]

It's a hedge.

[Josh Brown]

Okay, Rob, thank you so much for doing this and we're so glad that you made us a stop in your time in New York. We always end the show by asking people what they are most excited for in the future, what they're most looking forward to. And this can be anything. Something professional, something personal. I know you got a trip to Zurich coming up. What else are you excited about? Oh, gosh, more austerity. It seems like you're into it.

[Michael Batnik]

Oh, I'm so into austerity. I'm actually trying to persuade Marina, my wife, to embrace a little austerity.

[Josh Brown]

Good luck with that. I have not found success making that case. My house is the most Neo Keynesian on Long Island.

[Michael Batnik]

Anyway. No, I'm excited by life itself. I mean, what an adventure.

[Josh Brown]

Very confident in my assertion.

[Rob Arnott]

Great answer.

[Josh Brown]

Love that. Say more.

[Michael Batnik]

When I'm not working. When I'm working, I'm having a blast. When I'm not working, I collect vintage motorcycles. I collect fine vintage wines. I collect travel.

[Josh Brown]

I travel wine with you. You know what you're doing. You know what you're talking about. I don't.

[Michael Batnik]

The best wines. The best description of the best wines is yummy.

[Josh Brown]

Yeah. Fair.

[Michael Batnik]

I collect total solar eclipses. There's not one this year. There's one not far from Madrid next year.

[Josh Brown]

Okay. You go out and see them.

[Michael Batnik]

Yeah.

[Josh Brown]

Okay.

[Michael Batnik]

Yeah. So I will be 100 miles northeast of Madrid on. I think it's August 12th or something like that.

[Josh Brown]

Are you going to that one? That seems like it's up your alley. No. Okay.

[Michael Batnik]

So anyway, it's. Oh, and by the way, this airs after today, but tonight there's a total lunar eclipse of the heart. Where you can see it from here.

[Josh Brown]

What does a lunar eclipse mean?

[Michael Batnik]

Lunar eclipse means the moon moves through the shadow of the earth.

[Josh Brown]

Now, what was dark and P doing the last time that happened? No signal. No signal there.

[Michael Batnik]

Not much, because these happen at night.

[Josh Brown]

I see.

[Michael Batnik]

And the market's usually not trading much at night.

[Josh Brown]

Fair enough. What do you got? What are you looking forward to?

[Rob Arnott]

What a great answer.

[Michael Batnik]

Life.

[Rob Arnott]

Life is good.

[Michael Batnik]

Life.

[Josh Brown]

That was his answer.

[Rob Arnott]

I'm agreeing with his answer. Relax. What I'm looking forward to is spring is springing, we've got green shoots, tulips are coming up through the grass, through the dirt, and I am ready for no more winter.

[Josh Brown]

So, Rob in Southern California, he didn't know what winter is. I mean, you've traveled, but you don't experience it.

[Michael Batnik]

I brought some comfortable weather with me on this trip. I can see that.

[Josh Brown]

Fair enough. We're going to Barry Ritholtz's book party right after this. So Barry writes a book every 15 years. That's our lunar eclipse.

[Michael Batnik]

I'm looking forward to the party. I wouldn't miss it for the world, so.

[Josh Brown]

Should be. Should be fun. And I'm proud of him because I've been hawking him. He keeps telling me he's working on a book and this is like every year.

[Rob Arnott]

He was.

[Josh Brown]

Where is the book? Turns out he was all this time. It took him 15 years to write it.

[Michael Batnik]

How not to invest.

[Rob Arnott]

Better late than never. There we go.

[Josh Brown]

Shout out to Barry. All right, Rob, we want to appreciate. We want to tell people how much we appreciate having you. I want to also tell people how they can follow research, affiliates research, and how they can learn more about what you guys do, the way you think. What's the best place for people to go who want more, Rob or not?

[Michael Batnik]

Well, ResearchAffiliates.com is our website, and if you go onto that, you'll see resources. You'll see there's an insight section that.

[Josh Brown]

All your articles that you guys do.

[Michael Batnik]

And We've published over 400 articles in the last 23 years since I founded the company.

[Josh Brown]

That's more than Barry. Yeah, it's a lot.

[Michael Batnik]

Yeah, it's a lot of articles.

[Josh Brown]

I'm not going to tell you I've read all of them, but I think I've probably read like 30 or 40.

[Michael Batnik]

I think there's 30 or 40 really good ones there.

[Josh Brown]

Yeah. But I'm going to tell you I read a lot of them and Michael has to. Well, thank you so much. For doing this. We really appreciate it. I want to shout out the team this week. You guys all did an extraordinary job on all the stuff that we put out. Thanks to Tyler for coming to hang. You have fun today. Yeah. All right. And thanks to you for listening. We appreciate you and we'll talk to you soon.