TDI Podcast: Fallacy of Composition (#893)
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Markers getting angry on mix tech earnings employment report well, it's a non event and well, I would gear enough for the election. Our guest today is David salem from hadji office and much more on episode number eight, ninety three of the discipline investor podcast.

Well, welcome to with the disciplining investor podcasts is into horowitz, and i'm in that big coffee host chair on the new studios for the disciplines of podcast and four D H. And plugged, of course, where we do that the ion every week on tuesday of myself and john c. devi.

Spend some time together, take a look at all the news and information, the stocks that are moving, the economic numbers, things that are really moving markets and talk about that on a regular basis. But we do so in a much different style. If you have not spent any time listening to the ation plugged, I highly recommend that you do so.

You can find that, of course, at any podcast APP out there, you just look up to h employs, look up Johnny to org, look up Andrew horror, whatever you want to do. But I think that's something that you want to do on a regular basis, because we really, we have a lot of fun. We will play a lot of games.

We do some things that are quite funny, and I think you really enjoy that. Of course, you could find the disciplines investor. You can find data blog on any any area, you know, any any podcast APP or go right to the sites.

The discipline investor dot com is how you also get touches me. Let's talk about our guest today because our guests is a really smart fellow, and we have a really great lineup of topics that we laid out as we do each week. But these topics, I think I really there are a high level.

We going to be talking about things related to, I have noted here in a lack of research, and how do you actually make a portfolio understandable and how do you design IT in a way that is made for the individual and the institution? So all of you investment advisors that are listening out there, you know, how do you actually create some these high level portfolio, but at the same time, what mistakes to avoid? That's the big thing.

So gona talk about that with David sale from hedge eye next week coming up time Nelson, time Nelson 的 VP a head， a vast in location over a Frankland temperton. He's going to be great as well. So really looking forward to that. What's happening now, what is happening these days when IT comes to the market is the economy.

While there's a lot of things that are really dry rating and moving around, but I think the front and center item that we're all talking about, did anyone, when you're listening to this, this is a being put out right on the sunday a few days before the us. Presidential election, is what's the outcome? Who's going to be president? Who's going to control congress? These are questions that a lot of people want to know.

A lot of people think there's a incredible correlation potential for who is going to be present and what is going to happen with our economy, what is going to happen with markets. And I would say yes and no. There are four different possibilities that we really need to look out right now.

The four possibilities that are going to really shape the next number of years when IT comes to the economy markets and got, say, a couple of them are did nothing burgers. The first thing we have is trump president republican congress. Trump president, democratic congress and we flip IT over Harris h president, democratic congress, Harris president, republican congress.

If we have a trm president and a democratic congress kind of the same thing as a Harris president and a republican congress, there's a lot a lot of road block. There's a lot of, you know, just gm up the system, nothing happening, nothing getting done as a gridlock in in washington. The only difference is that a few the things that foreign student trump wants to do, he can do with executive order, some of things related to terrorists, which, you know, I am not a fan of terms, and I A fan of free trade, yes. And I A fan of fair trade, yes.

The tariff .

is a tit for tit. Consumer inflation burden is a tit for tat, with countries that if you impose a tf, then there will pose a terf on. You impose a terf. And what happens is, I don't care what anybody saying, the reality is that you and I are paying the excess monies that are opposed as tariff s simple as that. I don't want to even get into a conversation about this because everything is just B S.

There is nothing that we can say that any other country is paying for a tph that we impose on their product, except for if you want to go with the idea that IT is not good for sales of their products. So they're paying not really paying in terms of the dollars they're paying because they may have lower sales, the option to go elsewhere, whether is no terf like by american. Yeah, that makes a lot of sense.

The truth the matter is that though we may see the tariff on, I pick something simple, a widget, the old widget, it's a lot of use. There's a hundred percent terf on a widget that is imported from, let's say, china or somewhere else. What is gonna happen to their american counterparts that sell widget? You know what you're going to do.

They can increase Prices. I talk to my friends colleagues, I talk to manufacturer. They all say, hey, when this terrace, what we could do is we could raise our Prices underneath the level of the terf still be competitive.

But at the end of day, what does that do? That raises Prices that you and I are going to pay. Who is paying for the tires? We are.

Yes, the terrors go into the general income of the U. S. government. So that could offset some tax breaks they are given out here and there. But in the end, IT is inflationary.

And remember that the main issue they were all dealing with right now is the burden of higher Prices. We know that is the big issue and terrorists, our inflationary. But let's talk about some other things.

Let's get past the idea of what's going on with the election. Let's talk about some of the economics for the for the most part, we know this can be volatility around this because emotions come into play. But okay, what else do we have? We have some other items on the menu, right?

Let's agree that inflation, it's not coming down as fast as many would a pot, but the silver lying we have is the economy is doing pretty well. The jobs numbers on friday, but not we only added about twelve thousand to the payroll. I think we need to look past that. Let's not focus on that. And that's not usually what I would say.

I say the numbers, the number, let's not try to make up stories, but here's some stories that we really need to impart into this discussion is part of partial of what is happening right now with the employment number because we still have, if you didn't notice behind the scenes, a four point one percent unemployment rate, still very good, relatively three percent. But it's still, you know, it's strong. A forward on unemployment rates is a product.

Ninety six percent of the eligible employed people are are working pretty good, but only twelve thousand. Oh my god, we're going into a recession. No, we have strikes, we have weather issues and we preelection jitters by employers.

So i'm i'm really gonna focus on that. I don't think markets really focus on that either. We saw I mixed other econet conomo numbers, but GDP came in pretty strong rates. The ten year holding at the top of the range, about four point two five percent on the ten year oil, getting a pretty significant bid. We saw that I ran on was that wednesday, thursday of last week vows to retaliate using proxies like iran for the israeli strikes.

What is that going to happen? How is that going to happen? At what level is that going to expand the conflict to know another country? All the surrounding countries from israel are pretty much holding in.

And what does that mean for the U. S. Jumping in and other allies jumping into the sides of a, of a visual, really concerning issues. So generally, all the things were talking about here add up to what a big nothing. There's nothing different aside in the end of the presidential campaign cycle, which hopefully will end sharply at the right time on tuesday.

And whoever the outcome is and whatever we find to be whatever quadrant t that is, the in republican house republican, a White house republican congress, republican White house democratic president, republican congress, or whatever the particular order of that is will shake out, will figure out what we're onna be dealing with at that point. In the fact is we did see, yes, a two percent again again on thursday as meta. And we saw, for example, microsoft disappointed.

Did they really disappoint? Numbers are pretty good. Did apple really disappoint? The numbers are prety good, I think.

Is the services a major hundred billion dollars on apple? We saw A M zon approaching all time highs AMD. We knew that was going to probably we talk about that. That's a short position we have on the game over on D H, on plug, again, talking about that, the game that we talk about, our weekly game that we play of our stock picks. That is a pic that I put on some time ago because we know A M, D is a different animal than in video.

But the fact is that this two percent reduction we saw was because, well, special Price to perfection, any slip of margins of maybe uh, cat free cash flow or possibly even spending or some other you not descript issue underneath. And a footnote was well sited to end, stacked down, only took back what they probably made of last couple weeks. But there was a pretty sharp reduction.

And what is that? The pavlovian response to any kind of two percent. That's the new correction, by the way. Two percent, not five percent, is correction. You know, ten percent is is a major correction, and twenty percent bears like two, four and six.

Now me, you know, there so much money sashed among so many people interested and seeing what's going on in the excitement of A I and technology. And this next turning is the fourth turning, if you will, again, of what we're going to see in the future that people are pretty excited. Lot of short tweet going on, companies like carvin.

A, you seen that wow, prety impressive and crap earnings is from ford as especially compared to G M. So nothing really changed there. Nothing's really happening. Status quo. Big news can be next week, have some discussion that the weeks to follow.

But with that, we're going to bring on our guest and I think a spending time talking about ah this long list of items I have, particularly things I want to get into about some of the governmental entities that are actually players in these markets these days. So lets get that on right now. And I yesterday is David salem's, imaging director of capital allocation at hedgie, which as we mentioned, I go back way back with head. I so David, first time on the show, welcome.

My pleasure. Thank you.

So let's start with the question I D like to ask people and go back to um how that how do you get interested in the whole world of investing? Where to start where where's that was the genesis of this?

That's a long story but i'll make IT very sure I think into money management as I like to say. They they have finished ing graduate school and uh had a great good fortune to uh be employ initially uh a great mail, an lue now known as G M O.

So that was quite a really interesting emerging of baptism and in our crazy industry and from the L I was very fortunate to get some funding from the mastha foundation to start, but became more of the investment fund for foundations. Tiff did that for a good many years, actually very proud of what we did there and happy to chat about IT and then more recently, a bit advising some very large scale investment programs. And that's what brought me here the hedge.

I is a member of the team on the payroll, having been like you actually a client, pay a few paying client of her in canada with my own nickles, in fact, for many years. And now I sort of grew in memory. What was going on here suggested to the powers of the be here that they could adapt what I thought was a really genuine system for higher churn, cover shorter horizon investment programs, and adapted to meet the needs of folk sitting and seats like the one I used to sit in and some extends still, do kind of overseeing a large scale investment program.

Some stuff good. So yeah, so you just for our listeners that have no idea what some of things are that you mentioned, for example, you said the letters G, O. Just to be clear, that's not genetically modified organ. No, no, I know what I know what that is. I mean, if you got the big boy of, I mean one of the most, one of the most respected names in the industry is Jenny grantham.

yes. And I had the great pleasure of spending counters hour sitting next to germany, as i've said, and not the media. Um jeremy absorbs information the way L B J used to absorbs information by by talking. But I had a great good form.

E of sitting next to germany for many hours at the G M O headquarters, boss listening to him talk and time the telegraph through my own body language, whether I thought what he was saying with sound or not. And I I really almost never had the chance to inject any words edge wise. But he was great fun in great training in the very early stages of my career.

Quite a gentle man, that fellow. Yes, see you, at least for what i've see you up close, maybe different to story but and and he's been relatives, you know I want to focus on him but just a point of reference. Yeah he's been relatively from what I can see at least on the outside uh, I would say the dower on market for a while.

Yeah we don't know generalize because if you look at the way they are actually to plain capital, they aren't engaging in mistaking. It's just maybe now with the self that is um you know front and center on mass media these days you know max seven and the like that you can talk about and as you see that but I I will say this is what I have the floor a on the same that i'm a graded mirror of jeremy but great mentor r of mine in some ways of personal hero because of philanthropy, generosity, his empathy.

But I think actually even at this point in his long career, but certainly when it's finishing, we're looking back in grading IT. I think IT will be the case that in all of the major inflection points with the kind of imperfect timing that we always see in our business, 没有 jeremy will be judge to have been generally correct。 And that's a pretty powerful claim that.

that is especially because there's so many there's so many inputs. It's trying to understand all things that are coming at us, whether it's from media, whether it's from actual sources, new sources, opinion. It's like trying to take a sip at an of an open water hydrant, you know, and and IT comes out as fast and furious and trying then also the desert, the voice within us. Am I right?

Am I right? Yes, you're right about that, though, is a great only here, as you know, sitting in touch I headquarters, speaking to you, surrounded by people that collectively I have referred to as the greatest productivity hap at hack i've ever encountered as A C I O. And let me just take, you know twenty seconds to explain what I mean.

It's precisely responsive to what you just said. We are swimming Browning in the sea of, you know a combo of noise and signal, a lot of Browning emotion for sure in financial markets. And you know, job number one, two and three, for anyone sitting on top or overseeing or managing a large scale and investment problem, Frankly, you know, even a smaller portfolio has to content with the near impossible task of separating noise of signal and and in doing that, in a time and cost fishing manner.

So that's how I came to you know hedi has a client. And ultimately, when i'm working here now, I don't want to focus on doing on hedging. I just want to agree with the premise that you put forth of you know when you last spoke and say, but there is a way to get to deal with that, I think successfully, if you really judicious about how you allocate your scare resource, which is actually not capital in the case of, you know, stewards of large scale and western programs, their scarce as .

resource is, of course, time. So let's talk about some of the things that we have lined up to discuss. And I don't know we can just go in the order, no particular order. So you know of the course of your your career. Um and I look at this also just like, oh, I remember when I was tinker around with neural um which is probably called A I now but neural um type of back testing and of of modeling and in very hard core asset allocation based on mono portfolio theory and all these tools and techniques and but a lot of things that change this is what the things that had worked for what you thought would work and kind of maybe to stop using or or may be changed over the years.

Yeah let me great question. Let me give you a fun question too. Let me give you two party answer and kind of chocolate to myself because the first point of two that i'm going to make in response to a great question is that one of my, you know, lasting lessons from Jerry my is, like you said to me early on in my tenure, A G M.

O. Um look, dave, to take everything you learn to that fancy business school you went to, I want to apply IT rigorously here. A G M, O, but do so in reverse.

You know, traditional cap m and modern portfolio theories says like the beta of a stock is sensitivity to systematic changes, you know is positively correlated with its long term return. The higher the bet, the greater the long term return. Actually statistically actually that's incorrect.

If you Operate on the opposite of premise um you know give or take your Better off o that's part one of the of the answer you good question. I don't know if you have a to push back on that. So I mean.

this is kind of this, Steve, into that for a second. So the theory is I assume that the outcomes will be Better because the markets in the long term are the one of the most the best places to create capital. So therefore, a higher beta will actually get you towards under under not long enough period of time and reasonably Better return and the risk dissipate over, over the time. Is that kind of what you're saying?

Well, that is almost the academic definition of how it's supposed to work. But in practice, IT actually, at least a historically has not work that way. Just reverse the sign. And that as well, which is to say neglected lower bank stocks have over the long term compound with their shareholders capital at a rate on average greater than that of hybrid stocks. Now actually, if I can just do a quick side bar here, we don't get too mentioned, but the kind of the minor two third point of mine now, you know multiple decade career sort of academics and and then almost instantly, practitioners got wind of that very fat and started to orbit away by piling into love to stop, causing the very long term historical tendency to itself reverse。

So always the case of ce, you once you find something that is either work or does that work, and then somehow IT get picked up, the whole thing is ruined typically.

And that's how I can turn a part two of my answer to a good question. But before I do so explicitly makes say, you're exactly right. right? As I like to say, if you if you wait long enough for all the data to roll in right as a print for ducit might otherwise be inclined to do the in the data points to a really great long term opportunity in the rear view mirror. It's almost surely too late to do anything about IT, right? We're actually if I can say i'm so .

right about this, i'm right about no, you were you were right about this.

I am kind of diagrams sing but I hope in a way that welcome you in your audience I think that you know the most configured manifestation of this, as we speak, is, of course, private equity.

When you have billions, almost trillions, literally, of dollars of dry powder waiting to be put to work by private equity managers, ers who are asked or accumulated those commitments from their generally institutional limited partners, because those institutions were looking in the review mirror, twenty, seventeen and eight hundred and twenty right through twenty one, saying private equity in the subset of IT called venture capital is a superior way to compound wealth. I think our pile billions to, and they all did so, you know generating A A great example of what we call course, the fallacy of composition. You and I decide we're gona sneak through that.

You know the exit door of the crowd is either it's great if they just one of two of us try to get through IT, but if everybody tries to get through the same time, finances of composition, they want to achieve their stated names. And that's been the case with private equity here quite recently. We can go back to the history of institutional investing, back to the dawn of my career and and identify numerous instances where what I just described has happened to the great, lamenting regret of the people moving money in the direction of what they thought.

We're going to be very, very, you know, a plentiful passengers. Based on review. Mirror thinking .

is interesting because i've looked recently at some portfolio that have come through here with gobs of positions in private equity and hedged funds and odds. But am I talking about? I'm talking about straight up like right in. And the managers seem to believe that they can manage this totality of all of these individuals as if they were index funds and utilizing them as a as allocation.

You want him saying here and i'm like, how the hell seriously, I like, how do you how do you have even of a list of these are on the watch list these are going to be i'm thinking, first of all, tell you know list you tell me you think about this, you're investing in private equity. Do you really know what the valuation is of that portfolio any given time? Unless you're the last guide, get out when the whole thing you know eventually closes, maybe you could be very good.

I mean, the valuation models of private equity and entirely different bottle then A A cap of markets where IT is openly traded on, on a regular basis, right? Would you agree with that? yeah. So now we have something you have this gobs of this mark, quote on quote, market to market, uh, investment within a portfolio if this kind of make this up.

So there's ten different private equity positions you have from these no firms, high network client and and and you're trying to as an advice or overseeing this, look at this and then listen to what what are you listening to? You listening to the the quarterly the monthly calls and spread cheats and the commentary, which what do they they going to do, they're going to make IT all look good enough course. Hold on the books of the valuations that seem to be reasonable side pocket the rest. I'll stop their commentary on that.

I think generally speaking, one of my great lessons time to the course of my career is the danger of over a generalization about anything having to do with markets of finances, the economy. That said, however, I generally do agree with your generalization. Yeah, that is was going this actually another great irony here because you mentioned her hinted earlier, you know, uh H A H G I client and subscriber and so it's now two fifteen eastern time and by tomorrow morning, forgive me, but I have to deliver tomorrow's early look to hedge ei clients world why this is the topic and i'm writing about because it's already you know I only have twelve hours to finish the down and think now so it's party two thirds finished.

And this is exactly the issue that i'm expLoring at the suspect valuations in in, in quite seriously and do and very importantly, in the context, most of my career has been spent, very fortunately for me, gratified advising damon's foundations and some sort of not for profit actors that have accumulated a lot of wealth. Big universities and foundations in the life. It's really rewarding work uh, but most of them either because IT statutorily Mandates as as with private foundations like rock fom master or because they know of prints that they have to adopt a sensible spending or withdrawal from here like a big college university.

And you know they sort of migrate towards five percent of a sensibly computer denominator. And that's the key point i'm driving in, which is the sensibly compute denominator is typically, I think for potential reasons, sensibly, it's like a twelve quarter moving average of the of the part of monies value. Well, what do you do when you have thirty five, forty, forty five percent and liquid and you just know if you're being honest with yourself? Another is sitting around the table that the Marks on those things are highly suspect.

But but the the the application of the spending formula will call the simple simplicity, say five percent. Imagine it's a an institution with the ten billion dollars right now. And you can do the math, right, five percent of ten billion, okay, we can withdraw that much, you know that that five hundred million dollars a year and transfer over to the budget with some institutions do.

But wait a minute, one, what if it's not actually worth ten billion, right? What if it's worth like eight or seven, right? And but we won't know that for several years when .

all the does something like drilling on a tooth that seems fine. Also there's a cavity in there somewhere.

You but you know exactly. You wake up three, four, five years later and you say, wait minute, we have dramatically overspent.

Well, by the way, i'm going to give you another analogy, gy, that you can use if you're going to be writing about this. I'm going to give this to you. It's the sync le effect.

Basically, you have a road that looks very solid to be driving over just fine, but underneath all of that is actually A, A, A, A river that is eroding the underbelly of that in one day that top layer just can hold. Or maybe maybe you actually decided that that's an area that you need to be chipping out and you didn't realize that there's nothing underneath that. So if you want to use that for your peace, a on on this item for valuation question. Um i've used that many times. I created that the single effect.

Yeah appreciate that. Let me just extend that thought if you don't mind for a minute or two.

Uh, I use the same analogy, right? That image are you driving down the road? And there is maybe in the your in your example there there will be in there is a single the question, the matter question we have to ask is, why did they drive down that road to begin? Did they need to? Was IT the only way to get from point a to point b and they needed to get point b that sell them.

If ever the case for fully globalized, what we call around here, as you surely know, we call IT a goal anywhere, but don't go everywhere approach to invest, right? That's really. And this is where I would make the argument.

You know, this is coming from somebody, as you know, I was for many years of founding C. E, O and C, I O, the number of fun for foundation and from you know a starting uh base of zero dollars and mailed in the no employees when I left almost twenty years later was something like nine billion. And the point of driving at is that more than half of that, yes, that face the A U M.

And the free generating you know assets on the management. We're tired of one form another in private illiquid strategy. So I know all I know not only have a lot of experience contending with them, but you would say, you know, for most of my career, I certainly don't have a bias against them.

That said, I ve actually never encountered a, you know, an an ultimate acid owner, the border trust and downed foundation, the overseas of a sothern. Well, fun, a big family office. I never encounter one who are articulated aims, ultimate aims of compounding wealth that I didn't believe could be achieved to the exclusive deploy yet of capital among markable as distinct private security.

Yeah, IT puts the hair the back of my next up a little bit when I see a portfolio come in. And then maybe good reason that I they know, but that IT seems like again, they're trading around private equity positions or ketch fund positions or like, wait a minute, can somebody really tell me what's going on inside all of these? And like use that as other other roads to actually get there.

There could be the equivalent. Let's hold on that first, second, and we go to a quick break. Come back. I wanted talk about some of the mistakes we were talking about institutional investors. I want to talk about some of the mistakes that individual investors are making because I I do believe, by the way, hold you to answer this right after this.

But I do believe that even though we try to have listen, same investment committees or or or lets us bring down the individual that wants to believe they understand what is happening within their portfolios, um a lot of things like just got I just hope that works out well. You know I think you should work but doing not work on this. But and he has worked, everybody else is doing IT.

So okay, we'll go along with that. Hang onto that one second and let's spend the moment talking about interactive brokers again, because interacted or brokers has key competitive advantages for sophisticated investors like you. I B, K, R, S, margin loan rates are from just five point three three percent to six point three three percent, rated among the lowest margin fees by stock brokers.

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But I want you to check this out because the best informed investors choose interactive brokers, go to I B K R 点 com slash compare。 I were back with the David salem managing director, capital location at hedge I and we left to offer the question about mistakes that institutional investor and individuals make a from all these different things. And I think I guess i'd throw to you that what do you see out there that that are are the most blant mistakes that really be made yeah .

I will blame common and avoidable yeah ah so why do .

I just roll .

quickly with a couple and you just jump in if you to go actually you know the the most common by far, and is certainly avoidable, is is people that try to serve multiple master equally. I mean this online in the bible about that don't do that. And in this context, that means that you have failed to rain quarter your pursuit of absolute or relative returns. Relative can be a benchmark S, N, P or a peer group in the case of a big university.

And but you need to specify in rank order because they will come into conflict, right? I mean, I have lived in breaths in my career, ninety ninety nine for sure, and even twenty o seven to some extent they twenty old six, where you know, prudence, in my view as A C, L, dictated that we back off assets, that we're climbing ever higher evaluation out of prints, right? But of course, the relative return started to dep, and people started to lose confidence in we saw this massively.

We ve worn off and bircher in one thousand nine hundred and ninety nine a year I already alluded to. So trying to serve multiple masters equally is a path towards you know recent ruin and investing um next on my list is kind of people tend to waste time getting to know and o not kay and no but um by getting to know of course I mean do enough diligently you can look at something and say, you know that doesn't meet my. Needs, I need to move on and I see way too many investors spending way too much time doing seme deeper, deep dives into things that rate up front.

They could have concluded work going to meet their needs. Um another mistake. I see that common, blatant, avoidable, uh, mistaking marketing schemes, rasim classes, some of my favorite historically. You know, when a neo on the africa and I was saying, put your money in the bricks, right? Brazil, russia, india, china, south africa, those countries, if you really thought about for ten minutes, actually nothing in common in terms of fundamental risk drivers.

They made no sense of, well.

well, from marketing schemes. IT was more from marketing scheme. I would actually argue to you that I mean, certain in esg is is today's posted or let maybe last year post to child for my marketing skin masking is an S A class but infrastructure too I would are you um I got a few more do but you I think it's fascinating .

the way you talk about uh you know the bricks and and people obviously the bricks are really quick now very difficult to be as A U. S. Investor and average U.

S. Investor, to impossible to invest in russia. So the bikes bricks have turned into bikes, which is, just to be clear, brazil, while the old ones, brazil, russia, india, what I miss.

see what I miss.

So those were the 啊， will go with emerging slash, maybe frontier on the south africa side, those nations. And that was this kind of like, hey, let's this group those together and and create etf muto funds and and all the stuff in the reasons rational, the and the rus of paper that were printed to prove the point after the marketing team had done right.

It's good way right? right?

So so 你 你 continue with with some of these mistakes， but in terms of I think the one thing also is, is a assumption, right? Assumption that everything will be fine, everything will be that that's very gentle. But the fed has are back, that the market always go up that um you know that that um the management will take care of things that company like boeing, you know nobody will let you go. The too big to fail. These are like these these baseline assumptions that we all have, what we have to have some that that that we we live by when we invest, right?

Yeah so that actually brings you back to part two of the good question you post you know five five minutes earlier um and and IT brings me to a quick comment, at least quick comment and you can ask me to elaborate if you want a double collect. And what's really fundamental changed in markets and in the you know the consanguineous stewardship of large scale investment programs over the course of my career.

And when i'm driving at the course, the very forces in factors you just catala, you know, where are we with the fed, right? Is the fed put to what extent is my friend then hunt likes to say, have we let authorities convert capital markets into essentially political utilities? And that is not a partisan statement, right? I'm not going to get in to my own politics here.

It's a bipartisan or rather non partisan statement. But there's is a really important corner and it's one that I think many investment professionals who like me, you know, cut their teeth many years ago and have stayed added, kept you know, large noses to the grind stone ever since. We really lammed the fact that for many years now, at least a half dozen, maybe going right back twenty eight, nine flows have dominated fundamental doing part, if not large part, to the active intervention of governmental actors and what would otherwise be a freer market, pricing securities in the cost of capital.

And that has made life punishingly difficult. Many investment professionals, to the point where, and I know you would degree that, that many of them very component, very skilled and certainly very experience, have just left the industry ah one of their place because they said, I don't know what to do about this now without you know engaging an excessively shame with promotion about what goes on here and hedgie. I this was the principal reason that for many years I opened my own wallet and paid hej a lot of my own personal money to help me understand and exploit, rather than being exploited by these float. I'll stop, right? You can actually really .

think about the flow discussion because anytime somebody brings this up, the concept that a listener I think has is, well, yes, the central banks are in taking rates down that providing stimulus. They are doing things like central central bank I would call IT buybacks s but on another way, look at this quantification right um and and but was really interesting. I did some research last week on D H M log no show.

We do uh the actual intervention that people don't recognize of of direct investment in equity market. Japan does IT outright in don't they tell you they do IT in their own market? I think is something like seventy percent of japanese market is owned by etf.

To own by japan is something is some crazy number. But you have the bank in norway, which you have probably six or seven different central banks that are actively involved in buying bookers. And there was last week, sweet nothing I was video the after in video a stake of of that big money that's that's that's big money that is unlimited. And I think that's a pretty interesting point right there that has to go into our conversation about what central banks and and and government actors are actually doing. Don't you think?

I do two comments in response to what you just said. The first is rather obvious. But I think, you know one of us should underscore IT during this conversation.

I'll do so briefly right now. The real problem with all of that and you're right, B, O, K, that's the bank japan. The bank is swiss national bank s and be IT said it's said it's prety lonely.

The key point is that they are non economic actors. So when they're buying and selling, they are not principally thinking about return generation or capital preservation. Consequently, they are likely not certain but likely to um to become accomplishes to the crime of mispricing capital.

That's just not a good thing for society in the world. That's what I meant when I said I originally. That's the conversion of capital markets into political utility.

Um but let me mention something else that sort of the first because wants to move that bring us back to the U S A right um the fact is that a lot of the flow SHE excuse strike that the systematically driven flows both buying and selling, and these days he tends to be more buying and selling and has been for several years, is animated and citi zed by governmental regulations, particularly as applied to four one case four o three bees. What you and I would call define contribution pension schemes where you have a safe harbor. I know you know this intimately.

I'm surely Better than I doing you safe harbor that the government says. And if you're managing, you know for one k money and you put IT essentially into a target date fund or sixty forty, seventy thirty construct, you're gonna fine. You'll never get soon and will never come after you for improve, right? And that that is created an enormous continuous flow.

What others, you know, they have experienced the trading death would be a bit under the Price of of of securities that meet that profile. Now would be particularly course, the capitated S M, P, five hundred and U S. Treasury bonds.

So one of things i've talked about, and I and i've I named as a construct, is when people ask me why, why the markets going up, what what's happening? I called the mechanics of the market the fact that everyone that is working is getting paid every single week.

But more so, the markers are getting paid every single week because the money that you're being paid, part of its being sliced off and sent over your four one k provider, automatically put into what whether it's a target date fun like you mention or something else that is somehow involved in equity markets. And the fact is that is a mechanical process that goes on every single week of the year infinites. m.

And because because we don't have defined benefit plans anymore, we don't have real pension plans anymore. We're responsible for all there where we have to keep putting money in the only time that's gonna any kind of hick up if is an any significant mass employment situation that could have a real problem because no longer that person being paid not planning money into the four one cake. But mechanics I see IT like A A A steam engine IT just keeps on rolling in, keeps on rolling in. Its its it's a wonderful uh wonderful pension for the for the first fidelity, the number one pension for k provider in the world is their pension .

a pension on the pension? Yeah yeah yeah and the form of annuity for the Johnson .

family the .

wonderful no yeah. And I I know many of those people. I like them some of the clients of.

So I don't want to be early critical, but but truly, they're trying to do the best they can underbid dry conditions that from a society wide point of you are so self optimal, in my opinion, I agree with you. That's the point. We're drive. Yeah it's very unfortunate.

Switch something into A A total left turn, shall we? Let's talk about china. You're been to china. Have you've been to china?

yes. extension. yeah. I mean.

china. I love china, by the way, I do. I, I really do love china. I love china when I went.

I don't even love IT today but I did love china going up and down to um the various cities north south. Um culture is the food. Uh just the whole vibe just is so much different than here, right? It's so much different than here.

Um but you are, as you would say, a uh a perm bear on china and and uh and very bullish on japan. And you know it's funny. I love I really like china. I like some of things we've done over the years to markets now japan, i'm just so aggravated with japan is just with the negative interest rates and with the what they've done and how I see them manipulating markets and constantly manipulating the currency was the of course, they're not a currency and never will will never take that that envelope out of the pocket right of the treasurer to to give IT to japan and see your currency manipulator. But we know what they do is very clear. You can see at eight P M at night or so when currency markets reopen and and the pan comes on for long business, they take the end down and they be taken down for a while. Tell us why you have these not actually polar opposite, but these differing opinions on china versus japan.

Is that real quickly here? Obviously, my time is here is, but just to be consistent and in in, in interested gravity. So on china first is kind of a subjective comment.

Although I secretly kind of think it's objective and then an objective one rooted rooted in in professional porfolio management, the sort of subjective comment is simply that um I find that extremely depressing to be in china. Um I guess course the food is great. Some of the engineering mars, the list goes on and on and on.

But the fundamental core reason why I find IT depressing is because they look around, and I realize these people do not have, and likely to ever have in their lifetimes, the kind of freedoms and liberties that we enjoy. And I find that overwhelmingly depressing and IT just violates my very soul. Okay, I get get that relate to the second part, the object, the objective reason why I think it's just persue important to commit capital of any kind, but particularly long horizon capital.

So securities of companies that are domicile in chinese, I want to be precise in my language, although like a point of what to call the V I E. And sure, you familiar them the variable interest and and they are often in the came in islands that proportionally give you exposure to major chinese companies. But the key reason and driving and is very simply stated, there's so much dominance of the government in the economy that you don't have the assurance that on someday probably not announced in advance, you will wake up in all of the capital you have employed deployed in china domicile companies.

Well, if I have been taken away or have essentially gone to zero, and of course, we do have a recent example of that immediately following russia second invasion of ukraine in twenty twenty two, the first one having come in twenty fourteen. So then what do you do is an investment professional. If if you think about the four range of plausible outcomes, and do you look at the left tail, you say, wait a minute is a worrisome, the high probability this is gna go to zero IT doesn't mean you don't do IT right, mean the whole venture capital industry .

based on the that's exactly binary, a binary .

that the point is, do you have a sufficiently high expected return? The so called right side of the tale, it's commentate with the risk you're taking because the plumped probabilities at the left side of the distribution, which are the losses and that's the key core argument I make against having a big scale investment program commit capital to china.

And I have maintained this position to the entirety of my career going back, predating chinese admission to the W T, O. And two thousand, which I think was one of the greatest policy, or is this country has ever committed. Now let me just stop there. Before I go over to japan, he wanted discuss china for the I mean.

I get IT. I mean, you have obviously a lot of state run enterprises, and obviously, they are holding up a lot of things. We know that what's going on with real state market is a disaster. I personally tell if you haven't seen IT, i'm telling you and my listeners heard me talk about this back in the day when they were talking about ghost cities.

I witnessed fifty miles I drove, and at the whole time my mouth open while going, oh my god, of empty buildings after buildings, after buildings that were just not gonna be completed nor ever would be completed. And we're just put up just we put up and we know that, uh you know from satellite imagery but i'm telling you I was there I was IT was weird. And we know that also the banks are being held up by the government. And at the same time, taking another discussion, we've seen basically uh panel van black bag over the head kind of uh CEO a kidnappings, right is that that's exactly what happened, I guess, put up into hotels and that were at least reasonable and forced to pretty much discord money back to .

the government. yes. And and i've been um the beneficiary of some private conversations with the gentleman. We're doing an increasing amount work here in hedge yes named das quaker is the former member of the home com legislative liamine uh now living here in new england for reasons that a germain .

and the converter yeah no penel. No, no, no black.

So what what have you've seen publicly, invisibly, andris, lamentably, sadly, only the tip of the iceberg, very ugly iceberg, of what actually goes on. And this isn't some big time conspiring theory. You know, I just think this is a sugar, objective assessment of the risks.

Again, i'm perfectly prepared. I have a lot of experience ongoing experience in venture investment. I fully expect some of the holdings and in financing to go to zero, right?

The question is you have upside. The commentor IT with those acute risks. In the case of china, I don't think you did.

So what about japan? What is that that that you like about japan? Because, you know, we can point to aging population.

We can talk to a government and dimension that is really without it's going to college. You talk about a year that's going nowhere. We can talk about deflation.

Is not onna stop. H shall I go on? Or how about you just cut me off to tell me what you like about IT?

I'm happy, happy to cut you up with a smile on a chuckle. Um and and I think hopefully again in the interest being very conscious um my concerns in an animist toward china are talk down. My bullishness on japan is bottom up. okay.

So all of the factors, demographic, monetary policies, you know often male functioning, this functioning government though it's a very long less right, which I would argue I suspect you might agree, but perhaps not um is is already reflected in security Prices, the bottom of opportunity instead of company, my company one by one with the probable permanent exclusion of a lot of big multination companies that I would never invested in japan, right? But small, you know, as we say here are smith, right? Small and mid caps that are undervalue, that are under increasing pressure to get their share Prices above their book values and for a whole host of other reasons, including importantly, because this is qazi demographics.

Last point, and i'll turn IT back to you, you actually do have a passing on the biden and many of these companies where very elderly management is passing the baton on a leadership and management to Younger generations that are hungrier, energetic. They wouldn't think of leaving japan for perceived Greener pastures. They're gonna stay the course and they will over time. And maybe I can say this is the key point, right? IT will generate, I believe, shareholder returns that are commentor IT with the very minimal risks that I perceive on a bottom up basis by investments in companies like the ones I described.

Yeah so almost the .

mira it's almost the mirror image of china.

And it's also, if I can .

just interject you in a crucially important geopolitical and military sense, japan and china are exact opposite of each other from the viewpoint of a patriotic america. We desperately need the alliance with japan for geographic for literally, you know, supply side, supply chain, ship repair reasons. I think we also need them. There are certain, you know, forms of machining and machining of machine tools to be very specific that can only go on in japan, and we really need them and they have problem.

Well, let's say this. Could I say this, have you ever used a chinese knife in the kitchen versus a japanese knife in the kitchen? That's what you're saying, right? Total different in the quality of the material.

Yeah, I don't do much of that, but I will take you on no.

this the same thing as A A chinese product for a japan's product, you know I mean, this is a whole different thing. And by the way, um I think I think there's someone we said about the low interest rates except in japan. But i'm with your met I mean I get IT IT IT IT IT IT um .

there is definitely can if I can just come back and i'm sincerely interested in your what you make of the fact that the B O J at least trying to Normalize things.

I mean, I think it's a fascinating that can be very difficult for them because it's been so deep rooted for how many years has been that they have ridiculous ly low interest strates and that how to do with obviously a lot of things about their um the economics of of the country, the demographics about the country and and where they were. I mean I I think it's a bold and and beneficial uh, opportunity.

We had a little yen blip, uh, after they started, know what? Two months ago, three month ago when I was and you know, things got a little crazy with the Carry trade, but that's not therefore necessarily pursue, although you know been behind with backing the fact that the end shouldn't be as low. But IT is I mean, I I think is an interesting process. I don't know how further you able to get to be .

honest with you here, that was obvious fifth, that you are learning to memorable day ah but but if we would if we just want to roll the clock back up just a bit further because when I when I landed A G M O to started my career in money management, right, G M, I was already managing a lot of international equity, uh, money against what was called the eva bencher, which is europe, australia, in the far of which japan comprised.

The day my G M O career started, roughly seventy percent year of the global X U. S. Index, seventy seven zero. You want to guess what gm OS actually weight was in the portfolios .

on that date? No idea. Zero really. yeah.

A A, you know, a career defining and potentially career ending back, right? Which, for the three years ago before I arrived, A G, M, L, almost put the firm out of business right in the reason i'm pointing to this, I don't want to get two in the weeds. But whenever you get an extraordinary outcome, in my experience based on study of history, it's always taught logically the result of a confluence of extraordinary events, plural.

In the case of japan, you got one of the most prolonged bare markets in the history of marketable securities investing. We're started on the first business day of nineteen and ninety. Why had japan gone up so much so fast in the ninety eighties? IT was because what's called cross hold right is for whole much to reason going beyond the scope with this pod cause that upward itself reinforcing uh reflective cycle of every razing valuations.

IT took many, many years for that to sort of boil off, but we're at that point right now, not completely, but substantially. And and and it's really important to recognize the change in corporate governance in in capital allocation that has resulted in will continue someone fall as a result of there's not a the ural legal ban on crossed holdings, but there is now a strongly cultural imperative against them. As there was a cultural imperative in favor of them, them as the japanese market was reflexively moving higher. And in the nineteen years.

I want to have a stay on the subject of a central bank concept and government and some of things that are going on. We know that your firms outlook on inflation is is that is not going to be as cool as the fed is thinking is going to be right.

And and the um the interest thing is that we've been hearing from the fed and the fed speakers that I call the the march of the wooden soldiers you know coming out and i'll talking about the same thing, china jammed up but you know interesting last week or so there was A A former fed governor, Kevin war. He came out and he discuss the federal reserve s policy. He broke his from ranks.

You never see this. I don't think you know you want you're in the federal you know it's always the secret society of the fed right, the wing and the handshake and the general agreement that, hey, we're not going to talk badly about stuff were going to stay on the same page. He actually came out and talked about the puzzlement of the fed fifty basic point cut um arguing that the contradicts the previous statements of policy.

He criticized the fed for not having a clear theory of inflation of being there depending also mention the feed shift in focus from core pcd, core services excluding housing and now then the importance of wages and there all over the place i've been a uh a fed um uh and say anti fed is not the right way to say but and why everybody is so behind everything in realizing that years ago they're just cheer leaders okay. Um and I thought that inflation was this was a bad move, this fifty based point move. I'm going to stop there, bring you in now. okay. So what do you think?

If you only gave me like ten few than ten seconds to respond, I would say they are manifestly and unfortunately making IT up as they go up right.

right right now. Now but that you .

know that address is kind of raises an open question, like what's wrong with making them up as you go? And there is there a lot of things that are wrong with making IT up as you go when you have dominant control over the most important Price in any economy, right, which is the Price of money, right? Right because everything else is rooted in IT.

So yeah where when mister walsh said we could argue that he's the exception that proves the rule I actually would dispute with you just you know almost for the entertainment value of but seriously, I I actually don't think the culture is a sort of um suffocating as many outside observers think or surmise. I actually think it's something a little bit different in solo IT just attracts people who are comfortable in an environment of group like. And a further if I can be even more critical, right? That's not univerSally true.

P, obviously, we have Kevin, once we addick Fisher running the dollars fend for some years, who was an further exception that proved that rule, right? But but i'm marvel truly, Andrew. I I almost cannot believe when I hear of the deficient and like respective fed watchers, getting back to the original main thread here, which is are still above consensus view of in inflation, right?

I cannot believe the degree to which they are either consciously or maybe worse, sub consciously or unconsciously, ignoring all important base effects. And they're thinking about inflation. Now, what is inflation, right? Inflation can be mathematically computed, this Price against the Price of a good service at some point in the past. And you divide the one by the other, you get you get a ratio and accurate and flash.

But it's obvious if you do that math, like what six greater can do is simple algebra, right, that the denominators in that's called the base effect in this context, right? So when we do extremely careful study of base effects, which is one of the hallMarks, what goes on here in her eye, either in our macro work or, you know we have you know teams of analysts looking at individual companies and using base effect thinking to to think about acceleration or deceleration in their sales, in their profit, in their Operating cash lows, that the company basis where you can do that at the at the society wider or macro level as well. And when you do that, and I think in these days, IT takes like twenty minutes to look at the real of view, mirror carefully and say how pausch is IT.

The inflation is going to reach the fense much discuss target of two percent or anything close to IT as we move through the current quarter and into twenty twenty five will say through maybe the middle of twenty twenty five, which is about as far as I speak right now. As our models can go with a high degree of confidence, they're going to be a and what they're telling graph ing to us based on careful consideration of base effects and of course, other variables, is that inflation, at least in the foreseeable future measure by C P, I headline has bottled and is going up. It's not going to seven or eight or nine will call IT mein three. And I think actually in the last few weeks, I don't want to take this podcast and duly, but the market is start of out of moving caze point of view. Clearly, the curve is shifting in a manner, yes, I mean, look what's happen the rates.

So you talk about this basic and inference now is, is that is that the equivalent of looking at a moving average, a stand moving average, right? Just a basic moving average. We just take the latest day in divided by the last fifty, for example, versus waited moving out where you take a awaiting of the most recent data as a more much more important aspect of the information. Is that what that means?

Yeah, I think the second way is is is is a is a pretty good way of describing, you know I mean, you can be even more general. And so what is basing an infant big in twenty five, seven words? It's just simply just when you make judgements doing analysis, why did you just use the best available data that's i'm saying .

you would think that that's the place as long as you using the right way, way as long as you're using the right data, as long as you not flipped around and changing the numbers and doing like the Jerry Lewis movie, you know don't raise the bridge, lower the water, right? And and where we have a situation where we're going to say, okay, you know what, let's change the definition and statistical calculation of inflation. So that weekend, which they did, by the way, last year and we've done over the years, as long as we keep a standardized level of some of this, we understand what our goal posts are. I think that's a basic principal comment .

to that when I never tired of making because I actually think immodest, sly, it's actually quite important for us as citizens and voters and is like I hopefully everything i've said here is not partisan but politically charged. I said IT earlier when you said, you know, David, what are these mistakes that people tend to make their black and common and avoidable? And I said, well, number one, in the less no cloud.

Second is trying to serve multiple masters equally. What's the germaine's of that to our discussion right now of the here IT is, you know who oversees and gave fed the monday congress? What did he do when he gave fed monday, which is most recently revised in one thousand nine hundred and seven eight to the hunt hawkins act, which you ensure you familiar? It's said, okay, your Mandate is three.

Four, right? Is stable Prices, maximum employment and literally in statute, moderate interest rates. They never rank ordered the three. They did not specify a time horizon over which they shall be measured by the fed in pursuit of this holy, unworkable, incoherent monday. So it's not entirely the fed fall, although I will be critical of certain people that have worked for the fed because I think they displayed IT and do basically an ethical fAiling is taking good money for their good work for the fed but not putting their hands up and saying the congress, forgive me with all, do respect the Mandate you've given us, makes no sense what so ever is not serving amErica or are citizens well, you you can do Better than you must.

That's where we are. We are, but unfortunately, just as sad as you see the things that china that's just as sad as here, that's not going to change either that one point. You know, I think that it's it's in a way maybe a unintentionally but intentionally now done to create the the the aspect of b, do whatever needs to be done and keep IT so confused and confounding people that nobody exactly could put their finger on a the moving targets of what they're doing a while they are doing IT.

So I I can't disagree or dispute what you just said. I think i'm more optimistic, maybe even much more optimistic than you are about the potential for reform. And its time is not gonna en tomorrow. So I gona happen you know, when the next year or so, but but sooner than than later, I think that swap, if you will.

will get strange. David sale managed rector capital allocation at head a fascinating discussion. By the way, we have to do this again a soon.

I'm surprised all these years, you know, we will doing this for a long time. This is episode number eight, ninety three. Ah, this is going on. And so seven, I think that is so we're going to have a Young again soon.

I appreciate your time, pleasure. enjoy.

And let's go rap up another episode, the disciplines investor podcast. Thanks to tell me this week look a vote to next weekend, next few weeks or some great guest. Brian shine is coming on.

Dec, fallon, jack swagger going to be our end of year, by the way. That's all december. I mean, I can go through the rest of november two.

I mean, a job piano is going to beyond Carry lots. Harry dent is coming back. Got freeman.

List goes on. Thank you so much for joining me this weekend. Every weekend, i'll see again.

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