Radio Show - Since 1989 80% of Stocks Had a Collective Return of 0%... A Goldman Bear-Market Indicator at Its Highest Point in Decades... and Listener Q&A | #132

Episode Summary

Executive Summary: This episode focuses on late-2018 market conditions and portfolio construction: why a small fraction of stocks drive all equity returns, how taxes and embedded gains trap investors in bad portfolios, why U.S. stocks look expensive while foreign markets look cheaper, and why trend, value, and momentum can improve outcomes. The hosts also discuss the dangers of naked option-selling, the value of tail-risk hedges, and practical views on bonds, commodities, ETFs, and diversification.

Main Topics: Equity returns are highly concentrated (Priority: 5/5): Meb explains that most stocks contribute little or nothing to long-term market gains, so broad indexes work because they ensure ownership of the rare big winners while also holding the losers. Taxes, embedded gains, and bad legacy portfolios (Priority: 5/5): The discussion highlights how investors hold onto poor funds or concentrated stocks because of capital gains taxes, even when the long-run cost of staying invested is worse than realizing gains and rebalancing. Global valuation and asset allocation (Priority: 5/5): Meb argues U.S. equities are expensive relative to the rest of the world, while many foreign markets and some sovereign bonds offer better value; he favors global diversification with foreign tilts. Factor tilts and trend following (Priority: 5/5): The episode distinguishes value/momentum tilts from trend following, arguing that factor tilts can modestly raise return while trend following primarily reduces drawdowns and improves behavior. Option-selling blowups and tail-risk management (Priority: 5/5): The hosts revisit the repeated collapse of naked option-selling funds, emphasizing unlimited downside risk, the need for diversification and position sizing, and the usefulness of tail-risk hedges for some investors. Bonds, commodities, and portfolio construction (Priority: 4/5): They discuss how bonds can preserve wealth and sometimes outperform stocks for long stretches, while modern commodity indexes, futures mechanics, and roll yield make commodities a nuanced but sometimes useful diversifier. Launching ETFs and product design (Priority: 4/5): Meb outlines the economics and criteria for launching an ETF, stressing that most products should not exist unless they are differentiated, research-backed, personally owned, and likely to gather enough assets to survive.

Key Arguments: A tiny minority of stocks generate most equity market returns, so diversification is essential and market-cap indexes naturally keep the winners while losers shrink out. Market-cap weighting is not deadweight; it is a mechanism that guarantees exposure to the eventual winners, which is why stocks as an asset class have worked over time. Investors often hold junk portfolios because they overfocus on taxes; in many cases, paying taxes to exit a bad holding is better than preserving a poor allocation. U.S. stocks are expensive and foreign stocks are comparatively cheap, so a global portfolio with foreign tilts is more attractive than a home-country-biased one. Value and momentum tilts can add a modest return premium over plain market-cap exposure, while trend following mainly helps reduce volatility and drawdowns. Naked option selling is structurally dangerous because it can produce small gains for years and then catastrophic losses when markets move sharply. Tail-risk hedges are often unnecessary in a purely mathematical sense, but they can be useful if they help investors stay invested and behave better. Bonds remain an important wealth-preservation asset because they can still provide diversification and crisis protection, especially in deflationary shocks. Commodity funds can be useful, but the strategy depends heavily on the quality of the index design, futures mechanics, and roll yield management. Most new ETFs should not be launched unless they fill a genuine need, are supported by research, and can reach enough scale to be viable.

Data Points: Worst-performing stocks share: 11,500 stocks / 80% of all stocks - A Longboard chart discussed at the start of the episode showed that this large group of stocks had a combined total return of 0% since 1989. Best-performing stocks share: 2,942 stocks / 20% of all stocks - The same chart showed that this smaller group accounted for all market gains over the period. Stocks vs. bonds outperformance: 2.2% per year - Meb referenced a long-run estimate that U.S. stocks outperformed bonds by roughly this amount over the past 40 years. Time frame of stock underperformance: 20 to 30 years - He said stocks can go nowhere after inflation for decades, including globally diversified equity portfolios. Strategy evaluation horizon: 20 years or more - Meb suggested that evaluating many strategies on a 10-year horizon is too short and that 20 years may be more realistic. Historic bond underperformance stretch: 68 years - He cited an example from 19th-century history where stocks underperformed bonds for this length of time. ETF launch legal cost: $20,000 to $30,000 - Meb estimated basic legal costs to start a fund, excluding the broader operating expenses. ETF ongoing overhead: $150,000 to $200,000 per year - He described the approximate annual cost burden if a fund launches and sits at zero assets. Minimum viable ETF assets: $20 million to $40 million - He said this is roughly the range needed for a low-cost fund to survive, with higher thresholds for some complexes. 2-year CD yield: 3.1% - Used as a reference point in a question comparing CDs to intermediate bonds. Tail-risk hedge cost: 5% to 6% per year - Meb estimated the cost of fully insuring a U.S. stock portfolio with at-the-money puts. Value factor valuation level: historical long-term low - Referenced via Eric Falkenstein as a reason value may be attractive now. U.S. vs. global stock return outlook: U.S. stocks expensive; rest of world cheap - Repeated several times as the core valuation view behind his global tilts.

Pivotal Quotes: "The good news is, over the past 60 years, 80 years, we've developed a lot of literature... that shows: hey, here's some things you can do to increase your odds of owning the good stuff and excluding the bad stuff." — Meb Faber: Explaining why factor tilts such as value, momentum, profitability, and quality can improve equity portfolios. "Don't do it, don't do it." — Meb Faber: His blunt answer to the question of whether someone should launch an ETF, emphasizing how many product launches fail. "Picking up pennies in front of a steamroller." — Jeff / Meb: Describing the risk of naked option selling strategies that produce steady gains before a catastrophic blowup.

Implications: Listeners are urged to diversify globally, use factors and trend to improve risk-adjusted outcomes, avoid concentrated and tax-trapped bad holdings, and be skeptical of yield-chasing or complex products that can blow up.