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Investing in the Great Lockdown
May 2020
Read Time: 10 min
This transcript is based on a podcast taped on April 23, 2020.

How would you characterize your current market views in late April 2020?

There is the economy and there are markets.

As far as the economy is concerned, the picture is bleak near term and possibly into the years ahead, depending on the economic damage.

  • Record numbers of people are losing their jobs. Let’s just start and end there.
  • The consumer is roughly two-thirds of the economy. That was viewed as good news last year. It’s very bad news this year. If people can’t cover the cost of their car breaking down in good times, what happens now? The human impact is enormous.
  • As a result, while one can reasonably debate the pros and cons of lockdowns versus alternative approaches to managing the surge in COVID-19 cases, the stimulus is effectively nationwide disaster relief, because we are facing a public health crisis and an economic meltdown.


Oil is at the intersection of the economy and capital markets. Current oil prices—with the front end of the curve dipping into severely negative territory for a while and being substantially below $20—tell us the economy is in neutral. Not surprising, really, since nobody is driving or flying, and we are running out of places to store crude so that production has to come offline altogether in some corners of Shale Country.

Equity markets appear out of sync with what’s happening on Main Street. The US market rebounded from its March low. On what? Yes, we’ve avoided the horror of millions of Americans extremely ill and dying because of the diligence of our friends and neighbors, but jobs and earnings and the whole economic machine are in the ditch. Recently, the equity market appears to have moved up because oil isn’t negative anymore and there’s a little more money in the till for small business aid.

But looking closer, does it make sense that a handful of tech companies make up about 20% of the S&P 500 and that they are driving the rebound? Does it make sense that valuation discounts between value and growth companies are the highest ever? Value companies are now priced for Armageddon, and growth companies are priced for blue skies forever. That’s directionally intuitive yes, but the order of magnitude makes it highly improbable to sustain and sets the stage for mean reversion in a big way.

Where would you invest 10-year-or-longer money today?

Our expected return models—which cover over 130 asset classes around the world with an outlook of 10 years—show that US equities are still expensive; they are priced to deliver about a 1.5% annualized real return over the next decade, plus or minus 3–4%. Not great. US Treasuries are set up to offer even more disappointment. So, given a very plausible return of inflation over the medium to long term, we would recommend looking at stealth inflation fighters with reasonable to great return prospects: REITs, EM currencies, and EM equities, in particular.

To be clear, we are facing abnormal levels of uncertainty around the extent of the economic damage and the hit to corporate earnings and defaults, among other concerns. As a result, the numerical point estimates of our return models are almost certainly less accurate than usual, but the data remain a valuable gauge of opportunities from a relative perspective across asset classes.

How do you think consumer behavior will change post-COVID-19?

It’s hard to know and is very dependent on what the new world looks like in terms of forward-looking health risk and economic damage. My guess is we want to return to normal, but it is not clear that the future will look like the past. We humans have survived the plague and the ravages of WWII, and we will still likely want to go out to restaurants, but will we return to traditional shopping malls? We’ve been hearing about Neiman Marcus and JC Penney following in the footsteps of Sears.

How quickly will we get back to traveling freely for business or to visit friends and family on the other side of country or the world? The retrenchment could be large, particularly because of the economic hit. Our use of space will be different. But… the march of human progress is more human connectivity and a more global economy. We’ve recovered from worse, but getting back to normal could take a long while.

What do you mean by the “passive bubble”?

The standard business model of active management is under substantial pressure: having to deliver value for clients is a tall order in competitive capital markets when you have a high cost of manufacturing and high fees. But the swing to the other side of the spectrum is easily overdone. We often hear that everyone is going pure passive index investing based on 50 years of academic wisdom and a 10-year proof statement that “dumb money is rich money” after the bull market that just ended.

In reality, the last 10 years are very unlikely to repeat. It’s going to prove very hard to deliver the type of returns passive investors have gotten accustomed to with cap indices in which 4 to 5 expensive companies are 20% of the index. So, there is a bubble within passive indices, but there is also a bubble in passive investing. My suspicion is that the moment of reckoning could be coming. People will come to realize that reasonably priced and well-crafted investment strategies that aren’t purely passive have a place in their portfolios. It’s about value for money.

How do you think about cash in investing?

As an options theorist, I think of cash as the ultimate option. That’s why people talk about dry powder, and that’s why Buffett and Munger are sitting on a pile of cash. When uncertainty goes up, optionality becomes more valuable: basically, you want cash in down-market states to scoop up bargains. The real problem is that cash, like all options, has decay. In this case, it’s called inflation. We are entering an era, not the next year or two, but after this recession, when inflation could shoot up, so cash is king now, but it could prove to be a pauper quickly. The reward will belong to those who aren’t too early in deploying cash, but also aren’t too late.

How do you think this crisis is different from the financial crisis?

I was in New York in 2008. I am in Newport Beach, CA, now. I recognize my experience could be biased by that reality, but the global financial crisis was a very raw and human experience we could see play out. It was understandable. The overly simplified story was that bad people did bad things, the economy suffered, and you could walk around and see the negative repercussions, such as stores closed on very valuable real estate, like Madison Avenue. I remember being in my office on the 14th floor of our building on Park Avenue and when it got dark at 5:00pm in the late fall, you could look across the street to another hedge fund and see everyone at their desk working. Then, the next day they were all gone, the people at their computers, everything was gone. You could see it.

Our experience today is very different. The threat is hard to conceptualize, but we were all told to go to our respective bunkers, and then basically a bomb went off. But no one is bearing witness to the destruction. I think that’s very hard for people to get their heads around. A month ago, I used to think of this crisis as a hurricane; models are telling us it’s coming, but outside the window, the sky is blue. Today, I think of this as the aftermath of a nuclear bomb drop. The animals are out there reclaiming the land, literally, in some cases, but we haven’t stepped out of the fallout shelter yet. We’re left wondering what the world looks like on the outside, which creates more uncertainty.

What would cause you to change your current outlook?

Valuations are baked in, but economically, it’s simple: testing, tracing, and ultimately a vaccine.

You and Meb Faber talked about the “top dogs” recently, which showed that “since 1980, typically only 2 of the top 10 companies in the market remain among the largest companies 10 years later.” How does this inform your asset allocation thoughts?

Top dogs are companies that were top of the charts by market capitalization at the end of a decade. Think Japanese companies at the end of the 1980s, tech stocks at the end of the 1990s, and so on. Those stocks usually turn out to be a major drag on returns over the next decade. Eighty percent underperform their own sectors, producing an average shortfall that nears 9–10%.

To avoid that return drag, a solution is to not be a cap-weighted investor. That then takes you down the path either of active management or of our strategies, which are smart beta strategies that sidestep the pitfalls of market capitalization by weighting companies by their fundamental weight in the economy.

What’s the worst piece of advice you hear given by financial advisors or experts?

I’ll give you two: The first one is the 100-minus-age allocation to equities. How is that possibly the answer for everyone all the time? Different people have different risk tolerances and risk exposures via their human capital, and capital markets do not offer constant return opportunities. It’s just too naïve an answer.

Second is to go for the cheapest investment option out there. When is that the right answer? Buy the cheapest car? Buy the cheapest house? Buy the cheapest food or clothes? There has to be a trade-off. It’s about the best value for money. Cheap is a nihilist position: If it’s all garbage, then pay as little as possible. But I don’t believe it’s all garbage. Yes, there are people who don’t know the trade of investing, and what’s worse is that some of them don’t know it about themselves, but there is craft and talent in the trade of investing.

What is a low-cost, or even free, tool for your business (technology, software, even a process) that others may not know of? (not Twitter)

Our Asset Allocation Interactive and Smart Beta Interactive sites are available to all on the Research Affiliates homepage ( listed under Interactive Tools. These tools will give you access to expected returns, portfolio creation tools across asset classes, and sensible trade-offs in systematic equity smart beta strategies.


This conversation was with Ben Phillips on the 10 Minutes 10 Answers podcast, taped April 23, 2020.


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