Latest / Merryn Talks Money / How to Outsmart Your Investing Instincts

Transcript

How to Outsmart Your Investing Instincts · Merryn Talks Money

• 0:02
  Speaker 1: Bloomberg Audio Studios Podcasts Radio News Welcome to Merrin Talks Money,
• 0:19
  Speaker 1: the podcast in which people who know the markets explain
• 0:21
  Speaker 1: the markets. I am Merrin Somerset Webb, and this week
• 0:24
  Speaker 1: I'm speaking with Alex Edmonds, Professor of Finance at London
• 0:27
  Speaker 1: Business School and author of the new book, The Madness
• 0:29
  Speaker 1: of Markets, Why Smart Investors Make Crazy Decisions. and how
• 0:33
  Speaker 1: to exploit them.
• 0:34
  Speaker 2: And here it is.
• 0:35
  Speaker 1: I want to speak to Alex today because we've had
• 0:37
  Speaker 1: him on before, and we had a fascinating conversation about
• 0:39
  Speaker 1: his previous book, May Contain Lies, how story statistics and
• 0:43
  Speaker 1: studies exploit our biases and what we can do about it.
• 0:46
  Speaker 1: But in this conversation about this book, we talk about
• 0:49
  Speaker 1: why even the smartest fund managers still invest irrationally, the
• 0:53
  Speaker 1: link between football results and stock market performance, how luck
• 0:56
  Speaker 1: and skill influence how we perceive investment performance, and much,
• 1:00
  Speaker 1: much more. Alec, thank you so much for joining us today.
• 1:03
  Speaker 1: I really appreciate it.
• 1:04
  Speaker 2: Thanks, Melvin. It's great to be back. As I say,
• 1:07
  Speaker 2: I love this book.
• 1:07
  Speaker 1: I thought it was absolutely great. But you know what?
• 1:10
  Speaker 1: If I was a bookshop owner and I was looking
• 1:13
  Speaker 1: at this and I was going, hmm, where should I
• 1:15
  Speaker 1: put this in my bookshop? I would find myself hovering
• 1:18
  Speaker 1: between whether to put it in finance and investing or
• 1:21
  Speaker 1: in self-help. Because it does what self-help books do, right?
• 1:26
  Speaker 1: It tells you, well, this is the way the world
• 1:28
  Speaker 1: is supposed to be. And oh dear, it's not that way.
• 1:31
  Speaker 1: Your life isn't working out as you thought. So here's
• 1:33
  Speaker 1: how it should be. Here's how it really is. And
• 1:36
  Speaker 1: here's what you should do about it. And that's basically
• 1:39
  Speaker 1: how all self-help works.
• 1:41
  Speaker 2: So that's why I'd be hovering.
• 1:43
  Speaker 1: But in this case, when we look at the bit
• 1:46
  Speaker 1: about how the world should be, and we're talking about investing,
• 1:50
  Speaker 1: it's supposed to be efficient. It's supposed to be about fundamentals.
• 1:55
  Speaker 1: And it's supposed to be about fundamentals all the time.
• 1:57
  Speaker 1: The market is supposed to know everything. The market is
• 1:59
  Speaker 1: supposed to be based on discounted cash flow, on dividends,
• 2:03
  Speaker 1: on P ratios, on press-to-book ratios. But your starting point
• 2:07
  Speaker 1: is that it demonstrably isn't. And the idea that anyone
• 2:11
  Speaker 1: still believes any version of that is absurd.
• 2:14
  Speaker 2: That's correct. And that's what motivated writing this book. So
• 2:17
  Speaker 2: I did my PhD at MIT in finance. I looked
• 2:20
  Speaker 2: at what drives the stock prices. My professors were saying
• 2:22
  Speaker 2: it's fundamentals, forecast future cash flows and discount rates with
• 2:26
  Speaker 2: some hopelessly complicated model. But I had spent a couple
• 2:29
  Speaker 2: of years at Morgan Stanley in London and also Morgan
• 2:32
  Speaker 2: Stanley in New York, and I saw that even really
• 2:34
  Speaker 2: sophisticated people, yes, they did use equations and quantitative factors,
• 2:38
  Speaker 2: but they are human. They are affected by emotions. And
• 2:42
  Speaker 2: then one of my earliest papers, I looked at, can
• 2:44
  Speaker 2: the market be affected by something as crazy as a
• 2:47
  Speaker 2: football result? So what do I look at football? Well,
• 2:49
  Speaker 2: there's other things that drive national mood, such as a
• 2:52
  Speaker 2: lockdown or a plane crash. But if you found the
• 2:54
  Speaker 2: market fell after a plane crash, that could be just economics.
• 2:57
  Speaker 2: It could be that there's going to be less travel
• 2:59
  Speaker 2: and more restrictions.
• 3:00
  Speaker 1: And there aren't quite enough as well to really, I mean, fortunately,
• 3:03
  Speaker 1: there are not quite enough plane crashes. In countries with
• 3:07
  Speaker 1: big liquid markets, for make this a reasonable way to
• 3:09
  Speaker 1: look at it.
• 3:10
  Speaker 2: Exactly. So when you have a small sample size, it
• 3:12
  Speaker 2: could be due to some confounding factors. But what Michael
• 3:14
  Speaker 2: and I were able to look at was 1,150 football matches.
• 3:19
  Speaker 2: And the idea is that football doesn't affect profits or
• 3:21
  Speaker 2: dividends or non-farm payrolls. But we found that the market
• 3:25
  Speaker 2: systematically fell the next day after a defeat. And this
• 3:29
  Speaker 2: was interesting and surprising to us because most people will agree, yes,
• 3:32
  Speaker 2: my emotions are affected by my sports results or my
• 3:35
  Speaker 2: family situation. But when I get into the office, I'm
• 3:38
  Speaker 2: going to put my game face on. I'm a professional.
• 3:40
  Speaker 2: I'm going to forget about this sentiment. But again, you're
• 3:43
  Speaker 2: human and a human will be affected. Your judgment might
• 3:46
  Speaker 2: be clouded by some of these extraneous factors. And then
• 3:49
  Speaker 2: this led to the open the door to the wider
• 3:52
  Speaker 2: measures of sentiment that can be affecting your emotions, your decisions.
• 3:56
  Speaker 2: And that's what's in the book.
• 3:57
  Speaker 1: Yeah, there were two other little interesting things on that
• 3:59
  Speaker 1: football story which I found fascinating. One was that there's
• 4:03
  Speaker 1: a rise in death after a football loss, a rise
• 4:05
  Speaker 1: in heart attacks. So, you know, the market is probably
• 4:08
  Speaker 1: minor next to the fact that a football loss actually
• 4:11
  Speaker 1: increases the number of heart attacks. And also that after
• 4:14
  Speaker 1: a win, the market doesn't go up. So the market,
• 4:18
  Speaker 1: in terms of sentiment, feels misery more than it feels joy.
• 4:21
  Speaker 2: Yes, sadly, these are quite depressing findings. So let's go
• 4:24
  Speaker 2: through them in turn. So the effects of emotions. Yes,
• 4:27
  Speaker 2: I feel sad if England gets knocked out or if
• 4:29
  Speaker 2: my local team loses. But you might think, well, this
• 4:32
  Speaker 2: is just going to lead to some just minor mishap. However,
• 4:36
  Speaker 2: people have died. So in England, heart attacks went up
• 4:39
  Speaker 2: when England were knocked out of the 1998 World Cup.
• 4:42
  Speaker 2: If you cross the pond, you go to Canada. Suicides
• 4:45
  Speaker 2: rise when the Montreal Canadiens get eliminated from the ice hockey.
• 4:50
  Speaker 2: And while in Canada, people kill themselves, in America, people
• 4:54
  Speaker 2: kill each other. So sadly, murders go up in the
• 4:56
  Speaker 2: local city after the NFL team is eliminated from the playoffs.
• 5:00
  Speaker 2: And you might think, well, on the flip side, what
• 5:01
  Speaker 2: happens when you win? Are you jubilant? Do markets rise? Sadly, no,
• 5:05
  Speaker 2: it's only a negative effect. And this could be because
• 5:08
  Speaker 2: of loss aversion. So a win hits positively much less
• 5:12
  Speaker 2: than a loss hits negatively. And also it could be
• 5:15
  Speaker 2: that supporters are overconfident about their team's chances of winning.
• 5:19
  Speaker 2: So for 60 years now, England have gone to every
• 5:22
  Speaker 2: men's World Cup thinking this is the year. And if
• 5:24
  Speaker 2: you think you're going to win, you do win. You're
• 5:26
  Speaker 2: not too surprised. But if you lose, you're bitterly disappointed.
• 5:29
  Speaker 1: We'll get to overconfidence later. But there was another idea
• 5:34
  Speaker 1: used about sentiment, and that was the weather, which I
• 5:36
  Speaker 1: thought was quite interesting. I don't I'm sure you've read
• 5:38
  Speaker 1: these studies as well, but they may still be coming out.
• 5:41
  Speaker 1: I don't know, but 20 years ago or so, people
• 5:42
  Speaker 1: were constantly telling us that the stock markets moved with
• 5:45
  Speaker 1: the moon, moved with the lunar cycle, and that was
• 5:47
  Speaker 1: to do with serotonin in the brain. And now you
• 5:50
  Speaker 1: tell us that, in fact, markets move with weather.
• 5:53
  Speaker 2: Yes, and this was actually the inspiration for my football paper.
• 5:56
  Speaker 2: And this was taught to me at MIT by somebody
• 5:58
  Speaker 2: who believed in efficient markets, actually to argue why markets
• 6:02
  Speaker 2: were efficient. Because he said, yes, there are studies which
• 6:05
  Speaker 2: show that weather affects stock returns. But how do you
• 6:08
  Speaker 2: know this is not a spurious correlation? You could correlate
• 6:11
  Speaker 2: stock returns with cloud cover and rainfall and snowfall and
• 6:15
  Speaker 2: wind and so many other factors. And if one of
• 6:17
  Speaker 2: them just happens to be significant, you show this to
• 6:20
  Speaker 2: everyone and you hide away the results that don't work.
• 6:23
  Speaker 2: He was saying, and I think there is some truth
• 6:26
  Speaker 2: to it, is there a really convincing reason why the
• 6:29
  Speaker 2: weather will affect your trading behaviour? Yes, you might feel
• 6:32
  Speaker 2: upset on the commute to work if you're being rained on,
• 6:35
  Speaker 2: but you are working from an air-conditioned, heated office. That
• 6:38
  Speaker 2: should be something you're able to put aside. This is
• 6:41
  Speaker 2: why I decided to look at football results, is that
• 6:43
  Speaker 2: you have a much stronger effect than you do of
• 6:46
  Speaker 2: the weather. Nobody has died or had a heart attack
• 6:48
  Speaker 2: because of weather conditions. And also it's correlated across the country.
• 6:52
  Speaker 2: So it could be sunny in New York, but cloudy
• 6:55
  Speaker 2: in Chicago. And maybe it's Chicago fund managers who are
• 6:58
  Speaker 2: making the trade, so New York weather should be irrelevant.
• 7:02
  Speaker 2: This is why I looked at international football rather than
• 7:04
  Speaker 2: the Premier League, because if England lose, the whole of
• 7:06
  Speaker 2: England is depressed, and this may drive the market down.
• 7:09
  Speaker 1: There's another bit, a bit later in the book, that
• 7:11
  Speaker 1: I looked at, and it was about watching traders when
• 7:14
  Speaker 1: they're watching the Fed to see what an interest rate
• 7:17
  Speaker 1: decision is going to be, for example, and what happens
• 7:19
  Speaker 1: to their body. And it shows that their hormones, you
• 7:22
  Speaker 1: look at cortisol, a couple of other things. So their
• 7:24
  Speaker 1: bodies change. And the phrase you used was that they're
• 7:27
  Speaker 1: like a predator waiting for a kill.
• 7:29
  Speaker 2: Yeah. And this was really surprising to me because you
• 7:31
  Speaker 2: might think is sentiment just about fluffy feelings. But no,
• 7:35
  Speaker 2: it affects the hormones that seep through your body. So
• 7:38
  Speaker 2: this was a study done by John Coates, who was
• 7:40
  Speaker 2: a trader turned neurobiologist. So he would explore traders in
• 7:44
  Speaker 2: action a bit like David Attenborough, but on the trading
• 7:47
  Speaker 2: floor rather than in Antarctica. And he would measure their
• 7:51
  Speaker 2: hormones and they would just be coursing through the body.
• 7:54
  Speaker 2: And when you have so much of, say, cortisol in
• 7:57
  Speaker 2: the system, that has to be something which affects you.
• 8:00
  Speaker 2: So just like people may have committed some crimes based
• 8:03
  Speaker 2: on some serotonin in the body or lack of serotonin,
• 8:07
  Speaker 2: it may well be that you take some pretty devastating
• 8:10
  Speaker 2: decisions based on the hormones in the system. Let's talk.
• 8:13
  Speaker 1: About some of the things you've picked up in the
• 8:15
  Speaker 1: book that explain, well, describe rather than explain how people behave.
• 8:19
  Speaker 1: So one of those is, well, actually there's loads. There's herding,
• 8:25
  Speaker 1: which is the obvious one.
• 8:26
  Speaker 2: Yes, absolutely. It's talk about herding. And behind any crazy behaviour,
• 8:30
  Speaker 2: there is a grain of truth behind it, which is
• 8:32
  Speaker 2: why such crazy behaviour can perpetuate and why even smart
• 8:36
  Speaker 2: people can exhibit this behaviour. So what is the idea
• 8:38
  Speaker 2: of herding? It's that, well, I want to be open-minded.
• 8:41
  Speaker 2: I want to listen to other opinions and maybe there's
• 8:43
  Speaker 2: some smart people and I can learn from what they do.
• 8:46
  Speaker 2: But sometimes we are learning from other people who are
• 8:49
  Speaker 2: also being based on psychology and emotions rather than fundamentals.
• 8:53
  Speaker 2: So it may be that I see that other people
• 8:55
  Speaker 2: are investing in cryptocurrency and I see that they've made
• 8:58
  Speaker 2: a lot of money. But there's a couple of issues
• 9:00
  Speaker 2: with this. Is what I'm seeing a selected sample? So
• 9:03
  Speaker 2: my five friends who've made crypto thousands, it could be
• 9:06
  Speaker 2: there were 95 other people who also invested in crypto
• 9:10
  Speaker 2: and they're keeping quiet about it. They're very quiet about that.
• 9:12
  Speaker 1: So that's a combination of hurting and extrapolation because that's
• 9:15
  Speaker 1: one thing that investors do constantly. In fact, we see
• 9:18
  Speaker 1: it all around us at the moment, don't we? Extrapolation
• 9:20
  Speaker 1: of something that's happened over the last few years. into
• 9:23
  Speaker 1: the future without thinking about whether it's really sustainable or possible.
• 9:26
  Speaker 2: Absolutely. And this is why I think these biases are
• 9:29
  Speaker 2: so difficult to shake because they are not specific to
• 9:32
  Speaker 2: financial markets. We see this all the time. So over-extrapolation
• 9:36
  Speaker 2: from little bits of data we see everywhere. Go to
• 9:39
  Speaker 2: any football stadium on the weekend, if the manager's lost
• 9:42
  Speaker 2: three games in a row, then they'll call for his head.
• 9:44
  Speaker 2: even if he's had four great seasons. Let's say there's
• 9:47
  Speaker 2: a microaggression at work or you get excluded from a meeting.
• 9:50
  Speaker 2: You think, do I quit this company? A single ghosted date.
• 9:53
  Speaker 2: You think dating is pointless. And so we exhibit this behavior.
• 9:56
  Speaker 2: Nassim Taleb wrote about this in terms of fool by randomness.
• 10:00
  Speaker 2: we over extrapolate from small trends.
• 10:02
  Speaker 1: And we're really foolish about it as well. I mean,
• 10:04
  Speaker 1: if you think back, one of the things you talk
• 10:05
  Speaker 1: about in the book is COVID and the great boom
• 10:08
  Speaker 1: then and how a bubble actually in stocks such as
• 10:11
  Speaker 1: say Zoom and Peloton. And anyone could have looked at
• 10:14
  Speaker 1: those at the time and said, you know, this will end.
• 10:17
  Speaker 1: This homeworking thing will end. This being locked up in
• 10:19
  Speaker 1: our houses, of course it's going to end. And when
• 10:22
  Speaker 1: it ends, people will go back to hanging around face
• 10:24
  Speaker 1: to face like we are now. And when it ends,
• 10:26
  Speaker 1: people might prefer to ride their bicycle, you know, actually outside.
• 10:29
  Speaker 1: These things will change. But instead of which, the valuation
• 10:32
  Speaker 1: suggested people were extrapolating Zoom usage to the moon and
• 10:36
  Speaker 1: extrapolating riding on bicycles inside until no one will ever
• 10:39
  Speaker 1: have an outside bicycle again. And this was nonsensical, but
• 10:42
  Speaker 1: it happened anyway.
• 10:44
  Speaker 2: Yes. And this is because we focus on salient information.
• 10:47
  Speaker 2: So what we can see right now, and this causes
• 10:49
  Speaker 2: us to be very short-termist. So in the pandemic, people
• 10:52
  Speaker 2: are locked down and we're having all our interactions on Zoom.
• 10:55
  Speaker 2: And so Zoom went up by 700%. Now it is
• 10:58
  Speaker 2: clear to anybody right now, and it should have been
• 11:00
  Speaker 2: clear at the time, even without hindsight, that that rivals
• 11:03
  Speaker 2: like Google Meet and Microsoft Teams would catch up, that
• 11:06
  Speaker 2: the world would open up again and people might realize
• 11:09
  Speaker 2: they do enjoy human interaction and we want to have
• 11:11
  Speaker 2: in-person conferences. But if right then you are seeing all
• 11:14
  Speaker 2: these interactions on Zoom, then you will over extrapolate. And again,
• 11:18
  Speaker 2: this is a general phenomenon which keeps repeating. Okay.
• 11:38
  Speaker 1: And connected to herding and extrapolation is this other old classic,
• 11:43
  Speaker 1: which is Overconfidence. And one of the most heartbreaking bits
• 11:47
  Speaker 1: of the book, I find, I mean, there's lots of
• 11:48
  Speaker 1: bits in here about how you can win and lose money,
• 11:50
  Speaker 1: but I always find it particularly distressing when you hear
• 11:53
  Speaker 1: about people who've made a lot of money in a
• 11:55
  Speaker 1: particularly excellent way, sportsmen in particular. You know, you've got
• 11:58
  Speaker 1: a short career, finance isn't your thing, investing isn't your thing,
• 12:01
  Speaker 1: running around is your thing. You make a pile of money.
• 12:04
  Speaker 1: And then as a result of being far too confident
• 12:06
  Speaker 1: in your abilities to either choose a wealth manager or
• 12:09
  Speaker 1: to invest yourself, it's all gone.
• 12:11
  Speaker 2: Yeah. And this is a very sad example. So it's
• 12:13
  Speaker 2: the example of the V11, which was made famous in
• 12:16
  Speaker 2: a recent BBC documentary. So you had some great footballers
• 12:19
  Speaker 2: like Brian Dean or Rod Wallace or Danny Murphy, who
• 12:23
  Speaker 2: made decent money in football, not the sums that you're
• 12:26
  Speaker 2: making right now. And they decided to invest for the future.
• 12:30
  Speaker 2: And they invested in some schemes, which end up being
• 12:32
  Speaker 2: extremely damaging. Some of them were just poor investments. And others,
• 12:37
  Speaker 2: they were said to have some tax advantages and yet
• 12:39
  Speaker 2: they didn't manifest and therefore HMRC has come after them.
• 12:43
  Speaker 2: And you might think, well, do we want to shed
• 12:45
  Speaker 2: a tear for wealthy footballers? Were they being arrogant by
• 12:49
  Speaker 2: moving into property portfolios? But no, they were doing what
• 12:53
  Speaker 2: people suggest they should be doing is, well, you want
• 12:56
  Speaker 2: to save for the future. And going into property wasn't
• 12:59
  Speaker 2: because they had an idea that I'm going to be
• 13:00
  Speaker 2: some amazing property magnate, but that might be what they know.
• 13:05
  Speaker 2: If you're a footballer, you can get onto the property
• 13:07
  Speaker 2: ladder earlier than everybody else. And they were given advice
• 13:11
  Speaker 2: that this is for the future. The asset management firm Kingsbridge,
• 13:14
  Speaker 2: the name even, gives the idea of being something reliable
• 13:18
  Speaker 2: that you can invest in, you can trust in. And
• 13:21
  Speaker 2: I think the overconfidence here was putting too much weight
• 13:23
  Speaker 2: on two things. Number one was the advisors themselves not
• 13:27
  Speaker 2: knowing their perhaps misaligned incentives. And number two, the herding
• 13:31
  Speaker 2: that we refer to. So when one footballer heard about this,
• 13:35
  Speaker 2: they started to tell their friends, again, not to scam them.
• 13:37
  Speaker 2: They were genuinely trying to help their teammates. And in
• 13:40
  Speaker 2: a sport in which trust in your teammates is everything...
• 13:45
  Speaker 2: actually to take some financial advice from somebody who seems
• 13:48
  Speaker 2: to be ahead of the curve, seems to be something reasonable,
• 13:51
  Speaker 2: which is why I wanted to highlight the danger of
• 13:52
  Speaker 2: herd behavior behind any bad decision is a grain of sensibility,
• 13:57
  Speaker 2: but make sure that you're trusting not only the person
• 14:00
  Speaker 2: you're hearing from, but who they heard it from themselves.
• 14:03
  Speaker 2: And if it's a misaligned advisor, then that is problematic.
• 14:07
  Speaker 1: And there is, as I say, read the book, but
• 14:09
  Speaker 1: there's a lengthy list of celebrities who've got things horribly wrong.
• 14:12
  Speaker 1: I was distressed to hear that Kim Basinger, too, had
• 14:14
  Speaker 1: ended up bankrupt.
• 14:15
  Speaker 2: Yes. What was her overconfidence? So she made some money
• 14:18
  Speaker 2: through real estate gains and thought, well, let's double down
• 14:21
  Speaker 2: and go down even further into this. And yet she realized, well,
• 14:24
  Speaker 2: she didn't actually have skill in investing. And this is
• 14:28
  Speaker 2: actually a more general phenomenon. is that we overestimate the
• 14:32
  Speaker 2: effect of skill and we underestimate the effect of luck.
• 14:36
  Speaker 2: So if you did well really in one year with
• 14:38
  Speaker 2: one great investment, we think, well, let's now go all
• 14:41
  Speaker 2: in because I have an act. I'm not just a
• 14:44
  Speaker 2: great actress or a great footballer. I'm also good at
• 14:46
  Speaker 2: picking stocks. But it may well be that you just
• 14:49
  Speaker 2: were in the right place in the right time. You
• 14:51
  Speaker 2: happen to invest in something high growth when growth was
• 14:54
  Speaker 2: in vogue. And it is just a behavioral tendency to
• 14:58
  Speaker 2: when things go well, we say it's down to us.
• 15:00
  Speaker 2: When things go badly, we will blame other circumstances. And again,
• 15:04
  Speaker 2: apologies for another football analogy. After a team wins, the
• 15:07
  Speaker 2: manager will say it's my team selection. After they lose,
• 15:10
  Speaker 2: they'll blame the referee. And so this is why data
• 15:13
  Speaker 2: doesn't shake us out of our overconfidence. Because you might think, well, yes,
• 15:17
  Speaker 2: people are overconfident. I accept that. But won't they learn
• 15:21
  Speaker 2: from their past trading behavior that they actually have no expertise?
• 15:24
  Speaker 2: And the reason is no, because we look at the
• 15:26
  Speaker 2: data very selectively. Number one, we may not look at
• 15:29
  Speaker 2: the benchmark. We may think we made 15% last year.
• 15:32
  Speaker 2: That's great. Not realizing that buy and hold would have
• 15:35
  Speaker 2: given us 20%. And when things go well, we might
• 15:38
  Speaker 2: just champion this and say, well, this is evidence of skill.
• 15:40
  Speaker 2: And when things go badly, we might think, OK, it
• 15:43
  Speaker 2: was the right decision at the time, but we just
• 15:45
  Speaker 2: got unlucky.
• 15:46
  Speaker 1: I think that's connected, isn't it, to all those other
• 15:48
  Speaker 1: surveys you see about the majority of people believing that
• 15:51
  Speaker 1: they are a better than average driver. And also one
• 15:53
  Speaker 1: of my favorites from years ago when people, when house
• 15:56
  Speaker 1: prices were falling back in the 90s. And everyone was
• 15:58
  Speaker 1: asked to survey about whether they thought house prices would fall.
• 16:01
  Speaker 1: And they said, well, everywhere else, yes, but not in
• 16:03
  Speaker 1: my special neighbourhood. Not in my special neighbourhood. Very hard
• 16:07
  Speaker 1: to extrapolate correctly about yourself, isn't it?
• 16:10
  Speaker 2: And again, this is extremely human. So if you survey
• 16:13
  Speaker 2: people on anything, are you above average in terms of
• 16:15
  Speaker 2: your driving ability, your sense of humour, your ability to
• 16:19
  Speaker 2: get along with others? 90% of people will say they
• 16:22
  Speaker 2: are above average, even though obviously statistically 40% of them
• 16:26
  Speaker 2: will be deluded. Now, this doesn't matter for something like driving,
• 16:30
  Speaker 2: because as long as I'm not a terrible driver, I
• 16:33
  Speaker 2: can still get home safely. Even if I'm in the
• 16:36
  Speaker 2: bottom one percentile, I will still be able to drive home.
• 16:39
  Speaker 2: But for investing, for choosing stocks, you do genuinely need
• 16:43
  Speaker 2: to be above average. And notice the average here is
• 16:46
  Speaker 2: not the average person on the street, but the average trader,
• 16:49
  Speaker 2: which involves a lot of professional fund managers. So unless
• 16:51
  Speaker 2: you genuinely think that you are above average, then maybe
• 16:55
  Speaker 2: you should be holding an index fund. And the concern
• 16:58
  Speaker 2: here is that often some of these people who are
• 17:00
  Speaker 2: trading may think, well, I am above average because I'm
• 17:02
  Speaker 2: successful in all the walks of life. But actually being
• 17:06
  Speaker 2: successful in trading is a pretty unique attribute. So just
• 17:10
  Speaker 2: because you happen to be a finance professor doesn't mean
• 17:13
  Speaker 2: you'll be a successful trader. I can. given some inputs,
• 17:16
  Speaker 2: construct an accurate valuation model, but I can't get those inputs.
• 17:20
  Speaker 2: I don't have the day-to-day contact with CEOs of companies.
• 17:24
  Speaker 2: I don't have a large team of analysts. And so
• 17:26
  Speaker 2: I myself, one of the sobering things that I've done
• 17:28
  Speaker 2: after doing this research for the past 20 years is
• 17:31
  Speaker 2: investing far fewer in single stocks.
• 17:33
  Speaker 1: Have you gone fund or handed your money over to
• 17:35
  Speaker 1: a wealth manager?
• 17:37
  Speaker 2: Yeah, so funds, nearly always funds. I will be more
• 17:40
  Speaker 2: in active funds than the average professor will advise you
• 17:44
  Speaker 2: because I do believe in active management and market inefficiencies.
• 17:47
  Speaker 2: But I believe those inefficiencies aren't so large that somebody
• 17:50
  Speaker 2: like me can take advantage of them. But they are
• 17:52
  Speaker 2: large that professional fund managers might be able to do so.
• 17:55
  Speaker 1: And we should say, by the way, that lots of
• 17:56
  Speaker 1: things that we've been talking about, like football and weather
• 17:58
  Speaker 1: and that kind of thing, the gains that you might
• 18:00
  Speaker 1: get from that are so marginal that you're unlikely to
• 18:02
  Speaker 1: cover your costs. It's more about the... the idea than
• 18:05
  Speaker 1: the practicalities. There isn't anybody out there winning a football
• 18:08
  Speaker 1: game fund.
• 18:09
  Speaker 2: Not to my knowledge. It might be coming.
• 18:11
  Speaker 1: Yes.
• 18:12
  Speaker 2: But indeed, the point of the failure, as you say, Meryn,
• 18:14
  Speaker 2: wasn't to show that I can trade on football. But
• 18:16
  Speaker 2: if the market overreacts to football, then what else might
• 18:20
  Speaker 2: it overreact to? And then that might say, yes, let's
• 18:22
  Speaker 2: go shorten a potential tech bubble or AI bubble or
• 18:25
  Speaker 2: tulip bubble. Okay.
• 18:26
  Speaker 1: So let's look at this. We started off by saying
• 18:29
  Speaker 1: there's a couple of things I want to talk about.
• 18:30
  Speaker 1: I want to go on to talk about how you
• 18:31
  Speaker 1: can get an edge in market's in a minute. But first,
• 18:34
  Speaker 1: I want to talk about the fact that in the end,
• 18:37
  Speaker 1: it is true that markets are based on fundamentals just
• 18:40
  Speaker 1: over a much longer term than most people expect. So
• 18:43
  Speaker 1: this is one of the things that you talk about
• 18:44
  Speaker 1: at the beginning of the book, that in fact, value
• 18:47
  Speaker 1: investing is the best long-term strategy, because in the end,
• 18:52
  Speaker 1: value does out and fundamentals do out, but it just
• 18:54
  Speaker 1: can take a very long time.
• 18:55
  Speaker 2: That's correct. It can take a long time. And as
• 18:58
  Speaker 2: John Maynard Keynes said, in the long run, we are
• 19:00
  Speaker 2: all dead. But I think rather than this being a
• 19:02
  Speaker 2: frustration for us, it takes so long. This is actually
• 19:05
  Speaker 2: a great opportunity.
• 19:07
  Speaker 1: Why?
• 19:08
  Speaker 2: Because it might mean that other people cannot exploit missed valuation.
• 19:12
  Speaker 2: So what do I mean by this? So let's say
• 19:13
  Speaker 2: we are at the start of 2009. We think, well,
• 19:17
  Speaker 2: equity valuations are really low here. There's the financial crisis.
• 19:20
  Speaker 2: But then you might think, well, if it was really undervalued,
• 19:23
  Speaker 2: wouldn't everybody else have bought into this? And the answer
• 19:26
  Speaker 2: is actually no, because if you're a professional fund manager,
• 19:29
  Speaker 2: you might want to not want to go all in
• 19:30
  Speaker 2: because maybe we haven't yet hit rock bottom. If the
• 19:34
  Speaker 2: market goes down even more, then the end investors will
• 19:38
  Speaker 2: see you underperforming your benchmarks and might withdraw their money.
• 19:42
  Speaker 2: So even if you're correct and the world rebounds, maybe
• 19:45
  Speaker 2: you're just not around to enjoy this because your fund
• 19:48
  Speaker 2: has been liquidated. So if you're an asset manager with
• 19:51
  Speaker 2: flighty capital, you might not be able to take advantage
• 19:54
  Speaker 2: of these mispricings. So then if you are just an
• 19:57
  Speaker 2: amateur investor like me, what I did was I put
• 20:00
  Speaker 2: significantly large chunk of my portfolio into equities at the
• 20:04
  Speaker 2: start of 2009. And not just saying this with hindsight,
• 20:06
  Speaker 2: because I actually emailed all my students at the time
• 20:09
  Speaker 2: saying this and saying this is one of the applications
• 20:12
  Speaker 2: of behavioral finance, which I was teaching in class. I
• 20:14
  Speaker 2: had a 40-year horizon back then. And even if I
• 20:17
  Speaker 2: have not got the bottom right, I do think the
• 20:20
  Speaker 2: long-term direction is correct. Much more publicly, Clare College, Cambridge,
• 20:24
  Speaker 2: they launched the 2048 fund. They said, we're investing for
• 20:28
  Speaker 2: the next 40 years for research and teaching. They borrowed
• 20:31
  Speaker 2: 15 million pounds. And 10 years later, that 15 million
• 20:35
  Speaker 2: had doubled to 30 millions in the equity market, whereas
• 20:38
  Speaker 2: the loan had only gone up to 20 million.
• 20:40
  Speaker 1: And that was early 2009, right? Fair College?
• 20:42
  Speaker 2: Correct. End of 2008, early 2009.
• 20:44
  Speaker 1: I mean, that was phenomenally brave. And as you say,
• 20:47
  Speaker 1: the kind of thing you can only do with a
• 20:49
  Speaker 1: genuinely long-term portfolio, which some of those British colleges really have.
• 20:53
  Speaker 2: And if you contrast that to some others, which over-extrapolated
• 20:57
  Speaker 2: and moved too quickly, the Boots Pension Fund, I think
• 21:00
  Speaker 2: they went out of equities because they just saw this
• 21:03
  Speaker 2: being negative. They just got cold feet and then they
• 21:05
  Speaker 2: sold out right at the bottom and not participating in
• 21:08
  Speaker 2: the future fund. increase. Gordon Brown sold out of gold
• 21:13
  Speaker 2: right at the bottom. And again, this is something which
• 21:14
  Speaker 2: has cost taxpayers billions of pounds.
• 21:26
  Speaker 1: Okay, let's talk about some of the places where it
• 21:36
  Speaker 1: might be possible to have an edge. Because one of
• 21:37
  Speaker 1: the things you talk about quite a lot in the
• 21:40
  Speaker 1: book is the intangibles that don't necessarily make it into
• 21:43
  Speaker 1: a valuation model, but nonetheless offer value. And one of
• 21:48
  Speaker 1: those things, I know you've written a lot about ESG
• 21:49
  Speaker 1: and we've talked a lot about ESG in the past,
• 21:52
  Speaker 1: but one of those things is it's simply governance, isn't it?
• 21:55
  Speaker 1: Is a company well-governed to somehow find its way into
• 21:58
  Speaker 1: your valuation model?
• 21:59
  Speaker 2: Yes. And this is one of, I think, where the
• 22:01
  Speaker 2: strongest evidence is out of the ESG trilogy. I don't
• 22:05
  Speaker 2: think those three things should belong together to begin with.
• 22:07
  Speaker 2: I think governance is fundamentally different. But it should be
• 22:11
  Speaker 2: quite natural for people to think governance does matter. We
• 22:13
  Speaker 2: do care about the executives of a company. But sometimes
• 22:16
  Speaker 2: this can be really difficult to measure. So you might
• 22:19
  Speaker 2: look at some simplistic measures such as demographic diversity on
• 22:23
  Speaker 2: the boardroom or independence. But those things don't really capture
• 22:28
  Speaker 2: how well governed a company is. So what you might
• 22:30
  Speaker 2: want to look at is diversity of expertise rather than
• 22:33
  Speaker 2: just demographics or some measures of CEO character. And some
• 22:38
  Speaker 2: of them in the book are hopefully quite entertaining, but
• 22:40
  Speaker 2: there is a big point behind them. So one of
• 22:43
  Speaker 2: them you just wrote about recently was where do you
• 22:45
  Speaker 2: hold an AGM? So every year a company has to
• 22:48
  Speaker 2: hold an annual general meeting. And a lot of this
• 22:50
  Speaker 2: is routine. You present the accounts and you have some votes.
• 22:54
  Speaker 2: But the wild card is the Q & A at
• 22:57
  Speaker 2: the end. And you can get some pretty harsh questions. Now,
• 23:00
  Speaker 2: if you are a transparent CEO, you don't mind harsh
• 23:03
  Speaker 2: questions because you then get the opportunity to set the
• 23:06
  Speaker 2: record straight. But if you're somebody who's shifty, you want
• 23:09
  Speaker 2: to avoid them. And how do you avoid them? You
• 23:11
  Speaker 2: hold the meeting in as remote location as possible. And
• 23:15
  Speaker 2: we can be quite creative about this. So there was
• 23:17
  Speaker 2: a car company based in Detroit in Michigan, which held
• 23:20
  Speaker 2: its meeting in McAllen, Texas. Most people would have never
• 23:24
  Speaker 2: heard of McAllen. You might have heard of Houston. You
• 23:26
  Speaker 2: could fly to Houston and then drive 300 miles to
• 23:29
  Speaker 2: get there. Really painful for the CEO. So the only
• 23:33
  Speaker 2: reason he or she would do that is if they
• 23:36
  Speaker 2: wanted to make shareholders make the trip as well to
• 23:39
  Speaker 2: make sure that they don't actually scrutinize him or her.
• 23:42
  Speaker 2: And you don't even need to stay within the US.
• 23:44
  Speaker 2: There was a CEO of a US company which held
• 23:46
  Speaker 2: a meeting in Lahore, Pakistan at the time of terrorist threats.
• 23:50
  Speaker 2: So be very careful if you want to ask me
• 23:52
  Speaker 2: a question. That was feisty. And so I think this
• 23:54
  Speaker 2: is great because while this might seem entertaining, there's a
• 23:57
  Speaker 2: big point behind it, which is we want the equivalent.
• 24:01
  Speaker 2: of a poker tell, which is something that the CEO gives, says,
• 24:06
  Speaker 2: or does, which gives away what they truly think about
• 24:09
  Speaker 2: their company. And yes, CEOs say upbeat statements, but if
• 24:13
  Speaker 2: you're choosing to be shifty, then that is something which
• 24:15
  Speaker 2: is a sign of poor governance and may well be
• 24:17
  Speaker 2: a sell signal.
• 24:18
  Speaker 1: Yeah, and one of the other interesting things you picked
• 24:19
  Speaker 1: up there was that companies that may have more trouble
• 24:23
  Speaker 1: than they're immediately admitting to in an analyst call will
• 24:25
  Speaker 1: only take questions from the people who they know are
• 24:27
  Speaker 1: the most bullish. That's quite a tell.
• 24:30
  Speaker 2: Yeah, so that was another really, really clever paper. So
• 24:32
  Speaker 2: what they looked at was who is speaking in the
• 24:36
  Speaker 2: analyst conference calls, and they could see whether they had
• 24:38
  Speaker 2: given a strong buy or strong sell recommendation. And again,
• 24:41
  Speaker 2: notice that it might be to your advantage to call
• 24:44
  Speaker 2: on the strong sell analyst, because if you have a rebuttal,
• 24:47
  Speaker 2: You want to be able to set the record straight.
• 24:49
  Speaker 2: But if you were just cherry-picking the people who are
• 24:51
  Speaker 2: asking you questions, then that suggests you don't want to
• 24:54
  Speaker 2: take bad questions because you don't have good answers. And
• 24:57
  Speaker 2: this was something which took place not just in the US.
• 24:59
  Speaker 2: It was replicated around the world. Sell if indeed the
• 25:02
  Speaker 2: CEO is cherry-picking the most positive analysts.
• 25:05
  Speaker 1: The other things that you talked about in terms of governance,
• 25:07
  Speaker 1: and I was really interested in the Costco case study
• 25:10
  Speaker 1: where you talked about very, very high minimum wage there.
• 25:13
  Speaker 1: And some people will look at Costco, not minimum wage,
• 25:15
  Speaker 1: but average wage, should I say, Hourly wage. And some
• 25:19
  Speaker 1: people look at that and go, well, every penny that
• 25:20
  Speaker 1: goes to the employees doesn't go to the shareholders and
• 25:22
  Speaker 1: this balance is wrong. But in fact, it's been a
• 25:25
  Speaker 1: huge boon to Costco. Very, very low stock turnover, et cetera.
• 25:28
  Speaker 2: That's correct. And this was one of my own studies,
• 25:30
  Speaker 2: which I wrote about 20 years ago, way before ESG
• 25:33
  Speaker 2: was popular. And I never saw this as an ESG paper,
• 25:36
  Speaker 2: but just a paper on human capital. So what is
• 25:38
  Speaker 2: the idea? Again, when I was at MIT, people were
• 25:41
  Speaker 2: looking at bricks and mortar and tangibles and sales and revenues.
• 25:45
  Speaker 2: But I knew that the most important asset within a
• 25:47
  Speaker 2: company was human capital. So I looked at, are companies
• 25:50
  Speaker 2: that are great places to work, are they ones that
• 25:53
  Speaker 2: are going to outperform? And what I found over a
• 25:56
  Speaker 2: 28-year period was that companies which were in the 100
• 25:59
  Speaker 2: best companies to work for in America delivered shareholder returns
• 26:02
  Speaker 2: that beat their peers by 2.3% to 3.8% per year.
• 26:08
  Speaker 2: that's 89 to 184% compounded. And I can control for
• 26:11
  Speaker 2: recent performance and get around causality correlation issues. But why
• 26:16
  Speaker 2: is that surprising? Because you might think, shouldn't everybody know
• 26:20
  Speaker 2: that an employee-friendly company is good? As soon as a
• 26:22
  Speaker 2: company gets added to this list, should it not be
• 26:25
  Speaker 2: stuff enjoying a big price increase? And the answer's no
• 26:29
  Speaker 2: for a couple of reasons. So number one, it may
• 26:31
  Speaker 2: well be people have what you described earlier, Maren, this
• 26:34
  Speaker 2: pie-splitting mentality that if my employees are being treated too well,
• 26:39
  Speaker 2: then I'm overpaying them or underworking them. Indeed, when I
• 26:41
  Speaker 2: was at Morgan Stanley, one day the vice president caught
• 26:44
  Speaker 2: me laughing and he said, Alex, do not laugh because
• 26:47
  Speaker 2: my boss, the managing director, will think I'm not a
• 26:50
  Speaker 2: good VP for not working you hard enough. And even
• 26:53
  Speaker 2: though that was a bit tongue-in-cheek, there was a little
• 26:56
  Speaker 2: bit of truth behind this, was a great boss was
• 26:58
  Speaker 2: one who squeezed as much as possible out of you.
• 27:00
  Speaker 2: And the second reason why people might not take this
• 27:03
  Speaker 2: into account is even if they accept that employee satisfaction
• 27:07
  Speaker 2: and corporate culture is important, what do I do with this?
• 27:11
  Speaker 2: So if sales were 5% higher than I thought, I
• 27:14
  Speaker 2: can increase every sale in my spreadsheet by 5%. But
• 27:18
  Speaker 2: if I know that employees are happy and motivated, how
• 27:20
  Speaker 2: do I change cell C23? And again, just like your
• 27:24
  Speaker 2: earlier question, this is something which is not just in finance.
• 27:27
  Speaker 2: We see this pervasively across all decisions. Which job do
• 27:30
  Speaker 2: I take? I know deep down I care about more
• 27:33
  Speaker 2: than just the salary. I care about do I like
• 27:35
  Speaker 2: the people and the commute and the purpose of the
• 27:37
  Speaker 2: organization and the camaraderie of the colleagues, but I will
• 27:40
  Speaker 2: default to salary because it's something which is quantitative. Yeah. Okay.
• 27:44
  Speaker 1: Interesting. Um, So here's the big question then. All the
• 27:49
  Speaker 1: things that you write about in the book, all the
• 27:50
  Speaker 1: things that we've just discussed, all the things that are ridiculous,
• 27:54
  Speaker 1: the thing that leads to bubble, the failure to focus
• 27:56
  Speaker 1: on value, all the intangibles that we've discussed, you write
• 27:59
  Speaker 1: about them brilliantly. But again, as you say, these are
• 28:01
  Speaker 1: studies you've written before, other people have written before. This
• 28:04
  Speaker 1: is not, you've put it together gorgeously, but it's not
• 28:07
  Speaker 1: necessarily new information. Fund managers know all this, but they
• 28:12
  Speaker 1: continue to make the same mistakes.
• 28:14
  Speaker 2: Yeah, so there is a puzzle here. So why is
• 28:16
  Speaker 2: it not that after you see these papers published in
• 28:18
  Speaker 2: the top journals that you don't just act on this
• 28:21
  Speaker 2: and then the alpha disappears? And I think there's a
• 28:23
  Speaker 2: couple of reasons. And number one is actually it could
• 28:26
  Speaker 2: be rational for fund managers to ignore all of this
• 28:29
  Speaker 2: great investment advice. Why? Because fund managers might not be
• 28:33
  Speaker 2: trying to maximise return. And that might seem crazy, and
• 28:35
  Speaker 2: maybe I'm going to get a lot of tomatoes thrown
• 28:37
  Speaker 2: against me for this, but why? You are concerned about
• 28:40
  Speaker 2: your clients, and you are in an industry where there's
• 28:43
  Speaker 2: flighty capital. Again, if I was to short right now
• 28:47
  Speaker 2: in the AI bubble, thinking it's a bubble, what if
• 28:49
  Speaker 2: I'm wrong? What if it continues to inflate? If my
• 28:52
  Speaker 2: peers are still in AI, and then I'm underperforming, then
• 28:56
  Speaker 2: my investors are going to liquidate me. And this is
• 28:59
  Speaker 2: what happened to Julian Robertson, who did the smart decision.
• 29:02
  Speaker 2: A tiger. at Tiger to exit from tech. And he
• 29:05
  Speaker 2: was correct, but he was just early. And if you're
• 29:07
  Speaker 2: early and right, you are plain wrong.
• 29:10
  Speaker 1: And he liquidated about 10 minutes before it all crashed
• 29:12
  Speaker 1: around him, right?
• 29:13
  Speaker 2: Exactly. So almost on cue, almost immediately after his fun
• 29:17
  Speaker 2: collapsed in March 2000, then the tech bubble collapsed, but
• 29:20
  Speaker 2: he was just not around to enjoy the victory. I
• 29:23
  Speaker 2: think the second issue here is a bit more behavioural.
• 29:25
  Speaker 2: It's that sometimes exploiting these mistakes just goes against what
• 29:30
  Speaker 2: human psychology tells us. So let's think about momentum, which
• 29:33
  Speaker 2: is another very pervasive trading strategy. The idea that if
• 29:37
  Speaker 2: we look in the short term, short term winners... keep winning,
• 29:41
  Speaker 2: short term losers continue to sink. So what this tells
• 29:43
  Speaker 2: you is that I should sell my losers and I
• 29:47
  Speaker 2: should ride my winners. But in fact, we see the
• 29:49
  Speaker 2: opposite behavior. It's really difficult to take a loss. If
• 29:52
  Speaker 2: I bought a stock at 100, it's gone down to 80.
• 29:55
  Speaker 2: I tell myself it should bounce back. And again, behind
• 29:59
  Speaker 2: any bad behavior, there's a grain of sensibility. Don't I
• 30:02
  Speaker 2: tell myself investing is about being patient, looking to the
• 30:05
  Speaker 2: long run, trying to ignore the short-term fluctuation? But in fact,
• 30:09
  Speaker 2: if the future path is down, then it'd be much
• 30:11
  Speaker 2: better for me to sell. It's just so hard for
• 30:14
  Speaker 2: me to take a loss.
• 30:15
  Speaker 1: And the last part of the book is the self-help bit.
• 30:18
  Speaker 1: It's the bit that hopefully will help some fund managers
• 30:20
  Speaker 1: through this. And you give, I think it's 18 different
• 30:23
  Speaker 1: things that one should think about and do. Can we
• 30:25
  Speaker 1: just pick out maybe the two or three most important
• 30:28
  Speaker 1: for an ordinary retail investor? What are the couple of
• 30:30
  Speaker 1: things that they should pick out behaviorally to make sure
• 30:32
  Speaker 1: they really definitely do?
• 30:35
  Speaker 2: Absolutely. Actually, I'll preface this by saying your introductory remarks
• 30:38
  Speaker 2: were fantastic about why the book, it's not clear which
• 30:40
  Speaker 2: section to put it into, is self-help or investing. And
• 30:43
  Speaker 2: this is actually one of the motivations for the book,
• 30:45
  Speaker 2: because before, who was it who invested? Professional fund managers,
• 30:48
  Speaker 2: wealthy people. Who is it who invests now? Everybody. Because
• 30:51
  Speaker 2: we've democratized investing. We've given the power to invest in
• 30:54
  Speaker 2: everybody's pocket or smartphone. So this is something that everybody
• 30:58
  Speaker 2: may be affected by overconfidence and herding. So what are
• 31:01
  Speaker 2: the tips that we can put into practice? One of
• 31:02
  Speaker 2: them is to know your edge. So if you're going
• 31:06
  Speaker 2: to do something other than holding index funds, you need
• 31:10
  Speaker 2: to have a good reason for why you're deviating. Do
• 31:12
  Speaker 2: you genuinely have more knowledge about the future of AI
• 31:16
  Speaker 2: than other people? Maybe I'm a doctor. I think this
• 31:19
  Speaker 2: company is making beta blockers and I can understand them.
• 31:22
  Speaker 2: And I know that high blood pressure is going to
• 31:24
  Speaker 2: be a phenomenon in the future. But do I know
• 31:26
  Speaker 2: what the marketing spend is or what the pricing will
• 31:29
  Speaker 2: be or what regulatory headwinds and tailwinds will be? If
• 31:32
  Speaker 2: I don't have that edge, maybe I should be holding
• 31:34
  Speaker 2: index funds. But maybe you do have a different edge,
• 31:37
  Speaker 2: which is I have just more patience and endurance. I
• 31:40
  Speaker 2: am not suffering from flighty capital. And that might allow
• 31:43
  Speaker 2: me to make this contrarian value play that you've talked
• 31:46
  Speaker 2: about a lot in your prior episodes. So that's one,
• 31:49
  Speaker 2: which is know your edge. Second is know your objective.
• 31:52
  Speaker 2: We talk about this being a great fund or a
• 31:55
  Speaker 2: great stock. But whether it's great for you depends on
• 31:58
  Speaker 2: your investment objectives. And so for me, I actually have
• 32:01
  Speaker 2: a very short horizon objective right now, despite my age. Why?
• 32:05
  Speaker 2: Because I bought a house four years ago with a
• 32:07
  Speaker 2: five-year mortgage. And when I refinance it next year, it's
• 32:10
  Speaker 2: going to have a much higher interest rate than what
• 32:12
  Speaker 2: I bought. This is going to hurt.
• 32:13
  Speaker 1: This is going to hurt. Thank God you put all
• 32:15
  Speaker 1: that money in in 2009. You're going to be fine.
• 32:17
  Speaker 2: I'm not going to worry about you. Yes. And so
• 32:19
  Speaker 2: that's why for me, I actually reduced my tech exposure
• 32:23
  Speaker 2: quite a lot six to nine months ago, because even
• 32:25
  Speaker 2: though maybe I might miss the top, I wanted to
• 32:27
  Speaker 2: lock in those gains. And number three is to look
• 32:31
  Speaker 2: at your whole portfolio. So not to narrow frame, we
• 32:34
  Speaker 2: typically will say, oh, This is going to be on
• 32:36
  Speaker 2: my ISA pick, and this is what's in my pension,
• 32:38
  Speaker 2: and this is for my discretionary fund account. But our
• 32:42
  Speaker 2: whole portfolio should be seen as one, including our human
• 32:44
  Speaker 2: capital and including our house. Okay, those are great tips.
• 32:48
  Speaker 1: Now, listen, one of the other things that you mention
• 32:52
  Speaker 1: a bit in the book, and I'm sure we can
• 32:54
  Speaker 1: go into more detail another time, we'll do a whole
• 32:55
  Speaker 1: other podcast on this, is why does it matter? in
• 32:58
  Speaker 1: that a lot of people will say, well, the market
• 33:00
  Speaker 1: is the market.
• 33:00
  Speaker 2: It's different.
• 33:01
  Speaker 1: The fundamental economy continues regardless of what happens in the market.
• 33:04
  Speaker 1: Because that's not really true. As we've been taught over
• 33:07
  Speaker 1: and over and over again, the market can affect the
• 33:09
  Speaker 1: economy and the other way around. So that, I mean,
• 33:12
  Speaker 1: for example, one of the things you point out is
• 33:13
  Speaker 1: that when stock prices are very high for particular companies,
• 33:16
  Speaker 1: they might overinvest. It's too easy for them to raise
• 33:19
  Speaker 1: money for them both to borrow and to issue equity.
• 33:21
  Speaker 1: So perhaps they will overinvest and that will lead to
• 33:23
  Speaker 1: overcapacity to supply problems and And crashes not just in
• 33:27
  Speaker 1: the financial economy, but also in the real economy. I
• 33:31
  Speaker 1: know you know where I'm going with this.
• 33:32
  Speaker 2: Yes, absolutely. Is there a sector right now which is
• 33:36
  Speaker 2: very highly valued and might be spending a lot?
• 33:39
  Speaker 1: Perhaps it's showing us an example of market madness that
• 33:42
  Speaker 1: with the knowledge from the book, we can avoid.
• 33:46
  Speaker 2: I don't think this is really important. So we often think,
• 33:48
  Speaker 2: is the market just a zero-sum game? If some people
• 33:50
  Speaker 2: are winning and other people are losing, do we really care?
• 33:53
  Speaker 2: They're choosing to play the market voluntarily, so just allow
• 33:56
  Speaker 2: them to do their stuff. But no, because it affects
• 33:58
  Speaker 2: the stock price, and the stock price is a useful signal.
• 34:01
  Speaker 2: So when prices are high, number one, it's really easy
• 34:04
  Speaker 2: to raise equity. And number two, even if you are
• 34:07
  Speaker 2: not raising capital because you're sitting on a lot of cash,
• 34:10
  Speaker 2: that's just a signal that the market loves you. You
• 34:13
  Speaker 2: should be investing more and doing more of what you're doing.
• 34:15
  Speaker 2: And again, we've seen this time and again. So in
• 34:17
  Speaker 2: the 2010s, there was the shale oil boom, where I
• 34:20
  Speaker 2: think about $ 300 billion was spent on exploration because the
• 34:24
  Speaker 2: prices were high. In the tech bubble, a lot of
• 34:26
  Speaker 2: companies went public because they were dot-coms and invested a
• 34:29
  Speaker 2: lot of money in something which was not actually fundamentally
• 34:32
  Speaker 2: that strong. So we use prices as a signal. It
• 34:36
  Speaker 2: matters whether the price is correct. And then this means
• 34:39
  Speaker 2: that any force that corrects overvaluation, rather than chastising them,
• 34:44
  Speaker 2: we should welcome them.
• 34:44
  Speaker 1: That's an AI bubble. There's a bubble in hyperscalers. There's
• 34:47
  Speaker 1: a bubble in CapEx. And retail investors should really be
• 34:50
  Speaker 1: careful now. Now is the time to pull back, not
• 34:51
  Speaker 1: put in.
• 34:52
  Speaker 2: Yeah, so I am cautious, but more quietly cautious than
• 34:56
  Speaker 2: I might have been in other bubbles. So when you
• 34:58
  Speaker 2: go back to Cisco, there you could have looked at
• 35:01
  Speaker 2: the price earnings ratio. And even without the benefit of hindsight,
• 35:04
  Speaker 2: you could say, well, that's 190 compared to Microsoft itself,
• 35:07
  Speaker 2: I think three times Microsoft and four times Intel. So
• 35:10
  Speaker 2: that's just a massive valuation. Right now, the price earnings ratios,
• 35:14
  Speaker 2: depending on what AI stocks or index you look at,
• 35:16
  Speaker 2: they don't, on the face of it, look to be
• 35:19
  Speaker 2: that high, about 25 to 30. On the face of it. Now,
• 35:23
  Speaker 2: on the face of it. So why might they actually
• 35:25
  Speaker 2: be not so high? Because what is the denominator? The
• 35:27
  Speaker 2: denominator is earnings. And those earnings may be unsustainable. So
• 35:31
  Speaker 2: they could be huge capital expenditure from the hyperscalers and
• 35:35
  Speaker 2: maybe meta. They're under pressure themselves not to spend so much.
• 35:38
  Speaker 2: In some cases, some of those earnings might be high
• 35:40
  Speaker 2: because they are on unrealized gain from their own AI investments.
• 35:44
  Speaker 2: So Microsoft owns stakes in OpenAI and Anthropic. And so
• 35:48
  Speaker 2: we think, well, those earnings are temporarily inflated, then the
• 35:53
  Speaker 2: true price earnings ratio is much higher than one might think.
• 35:56
  Speaker 2: But because it's not so clear cut as in 2000
• 36:00
  Speaker 2: when there was a 190 valuation, it would be hard
• 36:03
  Speaker 2: for me to say it's a definitive bubble. I myself
• 36:06
  Speaker 2: have chosen to reduce my weighting in tech more generally,
• 36:12
  Speaker 2: partly because I do think it's slightly overvalued, but also
• 36:15
  Speaker 2: partly because of my refinancing needs and my objectives in
• 36:18
  Speaker 2: a year from now.
• 36:19
  Speaker 1: And if you were looking at the market and thinking, well,
• 36:21
  Speaker 1: there is a sector that is too cheap because everyone
• 36:24
  Speaker 1: is so carried away with herd behavior and stories and
• 36:27
  Speaker 1: is missing out on one sector. one area? Is there
• 36:32
  Speaker 1: anything that you can look at and say, well, I
• 36:33
  Speaker 1: think that's it?
• 36:35
  Speaker 2: For me, I don't think it would be a sector
• 36:36
  Speaker 2: in terms of an industry, but a type of firm,
• 36:38
  Speaker 2: which is an intangible intensive firm in terms of something
• 36:41
  Speaker 2: with strong corporate cultures or strong other types of intangibles.
• 36:46
  Speaker 1: Excellent. There is one you mentioned in the book actually
• 36:47
  Speaker 1: called the Sparkline Intangible ETF, wasn't it, which basically picks
• 36:50
  Speaker 1: up on a lot of the intangible themes that we've
• 36:53
  Speaker 1: been talking about.
• 36:53
  Speaker 2: Correct. So it goes back to value investing. You might
• 36:56
  Speaker 2: think I'm a foolhardy person for mentioning value investing because
• 36:59
  Speaker 2: isn't value dead? And what he claims is no, value
• 37:02
  Speaker 2: is not dead if you actually correctly define the value
• 37:04
  Speaker 2: of a company of not just its balance sheet, but
• 37:07
  Speaker 2: also those intangibles. And then you do want to invest
• 37:10
  Speaker 2: in value companies which have high total value, including intangible
• 37:14
  Speaker 2: value compared to its stock price. Okay, brilliant.
• 37:17
  Speaker 1: Alex, thank you very much. I think we're pretty clear
• 37:18
  Speaker 1: here that the madness of markets is just going to
• 37:20
  Speaker 1: go on and on, isn't it?
• 37:21
  Speaker 2: Always a pleasure to listen to your podcast. Even more
• 37:24
  Speaker 2: of a pleasure to be on it. Thanks so much, Mary.
• 37:25
  Speaker 2: Thanks for joining us.
• 37:34
  Speaker 1: Thanks for listening to this week's Merrin Talks Money. If
• 37:36
  Speaker 1: you like our show, rate, review and subscribe wherever you
• 37:39
  Speaker 1: listen to your podcasts and keep sending questions or comments
• 37:41
  Speaker 1: to merrinmoney at bloomberg.net. You can also follow me and
• 37:44
  Speaker 1: John on Twitter or X. I'm at Merrin S.W. and
• 37:47
  Speaker 1: John is John underscore Stepak. This episode was hosted by me,
• 37:51
  Speaker 1: Merrin Somerset Webb. It's produced by Sam Asadi and Moses Andam.
• 37:55
  Speaker 1: Sound design by Blake Maples. And special thanks, of course,
• 37:57
  Speaker 1: to Alex Edmonds.