The 40 CAPE Conundrum | Meb Faber on What High Valuations Mean for Markets

Episode Summary

Executive Summary: The discussion argues that today’s expensive U.S. stock market does not guarantee an imminent crash, but it likely implies lower future returns and stronger opportunities in diversification, foreign equities, real assets, value, and trend-following. Meb makes the case that regime changes repeat through history, that concentration and market-cap weighting are risky without valuation anchors, and that tax-efficient tools like 351 exchanges and broader ETF suites can help investors reposition intelligently.

Main Topics: U.S. stock market valuations and future return expectations (Priority: 5/5): Meb argues U.S. equities are very expensive by multiple valuation measures, which lowers expected future returns but does not necessarily mean an immediate crash. He emphasizes valuation changes the odds, not the certainty, of outcomes. Diversification beyond U.S. equities (Priority: 5/5): The conversation highlights the case for foreign stocks, emerging markets, cash/T-bills, real assets, and globally cheap value stocks as better menu choices than being all-in on U.S. market-cap exposure. Trend following and managed futures as diversifiers (Priority: 5/5): Meb presents managed futures/trend as the premier portfolio diversifier, especially for drawdowns and regime shifts, and discusses how different trend implementations and long/short structures behave differently. Concentration risk and market-cap weighting (Priority: 4/5): The hosts discuss how market-cap-weighted indexes become dominated by a few names/ sectors in booms, which can work for a while but lacks a valuation tether and tends to sow future underperformance. AI, market analogs, and investor behavior (Priority: 3/5): AI is framed as both a content/tooling opportunity and a reminder that investors often seek simple historical analogies (like dot-com) that rhyme but do not repeat exactly. The key issue remains behavior, not prediction. ETF strategy, product design, and 351 exchanges (Priority: 4/5): Meb describes lessons learned in building ETF businesses, the importance of launching differentiated products, and the tax deferral benefits of 351 exchanges for highly appreciated or concentrated positions. Value investing persistence and selling discipline (Priority: 4/5): The discussion revisits value investing’s long-term validity, warns against right-hand chart bias, and stresses pre-committing to exit rules because investors usually sell after short-term underperformance rather than at rational intervals.

Key Arguments: High U.S. valuations imply subdued long-run returns, but valuation alone does not cause immediate declines; it changes the probability distribution of outcomes. Periods of 15%+ annual stock returns over a decade are rare and historically followed by painful reversals, suggesting regime shifts rather than permanence. Investors should not treat the U.S. stock market as the only option; foreign equities, cash/T-bills, value, and real assets are legitimate alternatives. Trend-following and managed futures are powerful diversifiers because they can profit in crisis regimes and in persistent uptrends, especially when stocks and bonds fail simultaneously. Market-cap weighting has no valuation anchor, so it can become dangerously concentrated and vulnerable even though it captures winners during bull markets. Gold and other real assets can play a meaningful portfolio role; the conversation cites evidence that replacing bonds with gold historically did not destroy returns. Simple value strategies remain relevant because buying very expensive assets has historically been a poor long-term decision. Most investors evaluate strategies over too short a horizon; selling rules should be established in advance to reduce behavior-driven mistakes. Tax-efficient structures like 351 exchanges can unlock diversification for concentrated investors who otherwise feel trapped by embedded gains. AI is useful for synthesis, content, and idea exploration, but the hardest investing problems are still judgment and behavior, not model output.

Data Points: Periods of 15%+ annual stock market returns lasting more than a decade: 4 - Roaring 20s, Nifty 50 period, internet bubble, and the current “COVID meme stonk” era were cited as the only four such periods in 100+ years. U.S. stock market 10-year PE ratio: 40 - Used as evidence that broad U.S. equities are expensive by historical standards. U.S. dividend yield: 1.17% - Cited as being near all-time lows. Internet bubble dividend yield low: 1.1% - Referenced as the prior extreme low for context on current U.S. market valuation. U.S. CAPE ratio: 44.5 - Presented as another sign of elevated valuation in the U.S. market. CAPE ratio at start of post-GFC bull market: 12 - Used to show how cheap U.S. equities were in 2009 compared with today. Typical CAPE range: 18 to 22 - Described as the range where valuations often cluster historically. Rolling 10-year return of cheap CAPE ratio ex-U.S. countries vs. S&P: Outperforming over 1, 3, and 5 years - Used to illustrate that foreign value has recently begun beating U.S. equities. Global momentum/trend ETF current holdings: Mostly stocks, mostly ex-U.S. stocks, some sectors, a large slug of precious metals/miners, and a sliver of Bitcoin - Illustrates what trend currently owns without needing a forecast. Managed futures trend index performance: Worst 12-month period in the SocGen Trend Index history - Used to show that even diversifiers have bad stretches. Maximum position thresholds for 351 exchange eligibility: Top position below 25%; top 50 positions below 50% - Explained as diversification rules for contributing to a new ETF under Section 351. ETF business startup cost (historical): About $500,000 and over 1 year - Meb described the old process of launching an ETF as expensive and slow. Relative size of U.S. stock market: About two-thirds of world market cap despite roughly one-quarter of global GDP - Used to argue U.S. investors are under-diversified internationally. Average public fund closure rate: About half close over a decade - Meb used this to caution investors about product survivorship and asset-manager incentives. Long-term portfolio spread: Around 1 percentage point over 30 years - He argued many portfolio differences look huge in the short run but converge over long horizons. AI-trained custom GPT coverage: Books, white papers, blogs, and Twitter - Meb described a custom GPT built on his content to answer investment questions in his style.

Pivotal Quotes: "If we say today, and I will say this, that the US stock market is very expensive. I will say that. They assume that means it has to crash, it has to go down. That is absolutely not what it means." — Meb: On valuation: expensive markets can continue rising, but expected returns deteriorate. "You cannot be an honest person with a straight face, a mathematician, a quant, a scientist, and look at the historical evidence and claim that managed futures and trend is not the premier diversifier to traditional portfolio." — Meb: On why trend-following deserves a central role in portfolio construction. "The problem is, you know, the vast majority of the industry today is on the opposite side of the problem." — Meb: On ETF launches and industry incentives leading to too many similar, fee-driven products.

Implications: Listeners should expect lower U.S. equity returns than in the recent past and consider broader diversification, trend, and real assets. The industry may see more tax-aware transitions, and investors need clearer selling rules to avoid performance-chasing.