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

Episode Summary

Executive Summary: Meb Faber and Justin discuss how to position portfolios for inflation, deflation, and other market regimes. They highlight the comeback of international stocks and value investing, the benefits of tax-efficient ETF structures, and the importance of discipline and defensive strategies. Key recommendations include diversifying globally, tilting toward value and shareholder yield, using trend following, and codifying an investment plan.

Main Topics: Portfolio Positioning for Inflation & Deflation (Priority: 5/5): Discussion on preparing portfolios for both inflation and deflation, emphasizing real assets like commodities and real estate, and the benefits of trend-following strategies. International Stocks & Value Comeback (Priority: 5/5): Analysis of international stocks and value investing making a comeback, with comparisons to historical valuation spreads and the potential for outperformance. ETF Conversions & Tax Efficiency (Priority: 4/5): Exploration of the trend of mutual funds converting to ETFs for better tax efficiency, lower fees, and structural advantages for investors. Developing Discipline & Playing Defense (Priority: 4/5): Practical advice on building investment discipline through automation, codified rules, and tail-risk strategies, tailored to human capital correlation. Diversification Beyond the 60/40 Portfolio (Priority: 3/5): Critique of traditional 60/40 portfolios and promotion of global diversification, including farmland, trend following, and long volatility strategies. Behavioral Pitfalls in Investing (Priority: 3/5): Discussion on common behavioral mistakes, such as chasing past performance, and the importance of sticking to a written plan.

Key Arguments: Investors should build portfolios resilient to both inflation and deflation, not try to forecast which will occur. U.S. stocks are historically expensive (CAPE ~38), while international developed and emerging markets offer cheaper valuations and higher dividend yields. Value investing, particularly shareholder yield strategies, is undervalued and poised for a potential multi-year run, similar to the post-2000 period. Mutual fund-to-ETF conversions offer significant tax advantages, potentially saving ~70 basis points annually in taxable accounts. Automated investing and codified rules help investors avoid emotional decisions and maintain discipline. Tail-risk strategies and trend following can protect portfolios during market downturns, complementing a diversified core. Investors should consider the correlation of their human capital with their portfolio to avoid concentrated risk.

Data Points: U.S. CAPE Ratio: ~38 - Current U.S. stock market valuation (Shiller CAPE) is around 38, historically high. CAPE for Foreign Developed: ~23 - Average foreign developed market CAPE ratio, cheaper than U.S. CAPE for Emerging Markets: ~15 - Emerging market valuation, considered 'downright cheap.' U.S. Dividend Yield: ~1.5% - Current U.S. stock dividend yield, lower than international. Foreign Developed Dividend Yield: >3% - Dividend yield for foreign developed markets, roughly double the U.S. Stocks as % of Household Assets: >45% - All-time high in Q1 2021, exceeding 1999 peak. Median Short Interest: All-time low - As a percentage of market cap, short interest is at historic lows. Annual Tax Drag of Active Mutual Funds vs ETFs: ~70 bps - Estimated yearly cost of holding active mutual funds in taxable accounts vs ETFs. Former Top Mutual Fund Managers Outperformance Next Decade: 0 out of 100% - Top-performing fund managers of the 2000s all underperformed in the following decade. Value Strategy Worst Year (2020): Worse than 1999 - 2020 was the worst year for value investing historically, even worse than 1999.

Pivotal Quotes: "Forecasting, my favorite phrase being most investors be better suited being Rip Van Winkle than Nostradamus trying to predict the future." — Meb Faber: Emphasizing the folly of market timing and the value of a resilient portfolio. "The biggest muscle movement in the first place is moving away from market cap weighting." — Meb Faber: Highlighting the primary importance of diversification over precise factor implementation. "We always say you want to have a portfolio that's resilient to either [inflation, deflation, everything in between]." — Meb Faber: Core philosophy of preparing for multiple economic scenarios rather than predicting one.

Implications: Listeners should reassess their portfolios for inflation resilience, consider diversifying globally into cheaper value and international stocks, and leverage tax-efficient ETF structures. Automation and written plans can improve discipline, while tail-risk strategies may provide downside protection in expensive markets.