Radio Show – Inflation or Deflation?…Foreign Stocks….Value and Momentum | #322

Episode Summary

Executive Summary: The episode argues for building portfolios that can withstand multiple regimes—especially inflation, deflation, expensive U.S. markets, and changing global leadership. Meb and Justin emphasize diversification beyond U.S. mega-cap growth into foreign stocks, value, real assets, trend, and tail risk; disciplined rebalancing; and understanding fund structure, especially the tax advantages of ETFs over mutual funds. They also discuss how investor behavior often undermines good strategy.

Main Topics: Portfolio resilience across inflation and deflation: The hosts stress that no one can reliably predict whether the post-COVID environment will be inflationary or deflationary, so portfolios should be built to handle either outcome through real assets and flexible exposures. International stocks and the value rotation: They argue U.S. stocks remain expensive while foreign developed and emerging markets are cheaper, and that the recent rebound in value may extend globally as the world reopens. How to respond to stretched U.S. valuations: Meb outlines a framework for reducing risk in expensive markets: avoid concentrated risk, diversify into cheaper assets, add value and momentum, and consider tail-risk hedges. Behavioral discipline and rebalancing: A major theme is that investors chase winners and avoid selling what has worked; the remedy is a written plan, preset rebalancing rules, and automated investing behaviors. Combining value and momentum strategies: The hosts discuss whether value and momentum should be implemented separately or together, concluding that selecting either is more important than the exact implementation, but methodology matters. Portfolio design for all market regimes: Drawing on Chris Cole’s '100-year portfolio' thinking, they advocate a globally diversified mix including trend, commodities, long volatility, and other nontraditional diversifiers. ETF conversions and tax efficiency: The episode highlights why mutual fund-to-ETF conversions are accelerating: ETFs generally have lower fees and much better tax efficiency, especially in taxable accounts.

Key Arguments: Investors should not try to forecast inflation or deflation; instead, they should own assets that can perform under either scenario, such as real assets, commodities, and trend-following exposures. U.S. equities are unusually expensive by multiple valuation measures, so relying heavily on them creates poor forward-return expectations and justifies diversification into foreign and value-oriented assets. Value has begun to outperform after an extreme period of underperformance, and that rotation may continue beyond the U.S. to foreign markets as reopening broadens globally. A written investment plan and explicit rebalancing rules are essential because investors naturally chase recent winners and resist selling appreciated assets. Combining value and momentum can be done in multiple ways, but the key decision is to move away from market-cap weighting in the first place; methodology transparency matters. ETFs are structurally superior to mutual funds in taxable accounts because of lower capital gains distributions and generally lower expense ratios. Good portfolio construction should consider human capital risk: people should not overexpose themselves to the same sector, region, or cycle that already drives their earnings. Tail-risk and long-volatility strategies can be useful because portfolios often fail exactly when liquidity and prices matter most.

Data Points: Long-term U.S. CAPE ratio: around 38 - Used as evidence that U.S. equities remain highly expensive versus history. Average foreign developed valuation: around 23 - Presented as cheaper than U.S. stocks, with roughly double the dividend yield. Average emerging markets valuation: around 15 - Cited as downright cheap relative to U.S. equities. U.S. market cap as % of household assets: above 45% - Meb notes this level is near or above the 1999 peak and likely higher on a delayed basis. Prior peak in household assets: about 45% in 1999 - Historical comparison for stocks as a share of household assets. Household assets during financial crisis bottom: about 22% - Shows how far the metric fell after the dot-com era peak. 10-year real returns after CAPE >= 35: about zero on average - Historical observation for U.S., foreign developed, and emerging markets at very high valuations. CAPE > 35 occurrences in major U.S. markets: about seven times - Illustrates the rarity of current valuation levels. CAPE > 35 occurrences across individual countries: about 55 times - Used to support the claim that starting valuations matter globally. ETFs with capital gains distributions: about 5% - Compared with mutual funds to show ETF tax efficiency. Mutual funds with meaningful capital gains distributions: about two-thirds - Supports the argument for ETF structures in taxable accounts. Annual drag from active mutual funds vs ETFs: about 70 bps per year - Estimate cited for tax-related costs alone. VIX pandemic high: in the 80s - Referenced to show how much tail-risk strategies have become cheaper since peak volatility. Current VIX level: around 15 - Indicates substantially lower volatility and cheaper implementation costs for hedges. Typical inflation-safe CAPE range: about 17 to 21/22 - Meb says low inflation historically allows somewhat higher valuation multiples, but not near current levels. Dividend yield: U.S.: about 1.5% - Compared against foreign markets to show relative attractiveness. Dividend yield: foreign developed and emerging: above 3% - Used as another reason to prefer non-U.S. equities. Example rebalancing/hedge buckets: 25%, 50%, 75%, 100% - Describes a value/trend-based strategy that increases hedging as valuation and trend conditions worsen.

Pivotal Quotes: "I mean, the short answer is, of course, you never know." — Meb: Used in the inflation discussion to emphasize uncertainty and the need for resilient portfolios. "My favorite phrase being most investors be better suited being Rip Van Winkle than Nostradamus trying to predict the future." — Meb: Explains why forecasting is less useful than building robust portfolios. "You should always know what you own and not just on a superficial level." — Meb: Said during the discussion of fund structures, closet indexing, and methodology transparency.

Implications: Listeners should favor diversified, rules-based portfolios that can survive multiple regimes, not just current winners. The episode suggests a continued shift toward value, foreign assets, and ETFs, while warning that discipline and structure matter more than prediction.