finance
Excess Returns is dedicated to making you a better long-term investor and making complex investing topics understandable. Join Jack Forehand, Justin Carbonneau and Matt Zeigler as they sit down with some of the most interesting names in finance to discuss topics like macroeconomics, value investing, factor investing, and more. Subscribe to learn along with us.
Mike Contopilis and John Kirchner of Janice Henderson argue that most investors' bond portfolios haven't adapted to new market regimes, leading to underperformance. They highlight that traditional bond thinking, focused on long duration and coupon payments, was disrupted in 2022 and needs a rethink.
Mike Contopilis believes the market is shifting towards a secular environment of inflationary pressures, driven by deglobalization, labor market changes, and a lack of productive capacity. This contrasts with the disinflationary era of the past 40 years.
John Kirchner explains that the US aggregate bond index, heavily weighted towards Treasuries and mortgages, has a six-year duration and approximately 5% yield, creating significant interest rate risk without substantial yield. He suggests investors are not getting what they want from these funds.
Mike Contopilis draws a parallel between current cyclical forces and the 1960s 'guns and butter' era, citing increased global defense spending and fiscal initiatives like the CHIPS Act and Inflation Reduction Act. He argues these factors, combined with low unemployment and accelerating money velocity, put upward pressure on interest rates.
John Kirchner and Mike Contopilis of Janice Henderson assert that investors have options beyond traditional, underperforming bond indexes. They developed a report and offer various products designed to address the challenges of the current fixed income landscape, suggesting a need for more sophisticated approaches.
Jared Dillian argues that while investing all savings in the S&P 500 index fund has worked for the past 20 years, it's a fundamentally flawed strategy due to excessive volatility. He suggests this approach is akin to being a 'crazy gambler' and that Americans' reliance on stocks is unusual compared to other global markets.
Jared Dillian proposes his 'Awesome Portfolio' as an alternative to the S&P 500 strategy, designed to reduce volatility and investor unhappiness. The portfolio consists of 20% each in stocks, bonds, gold, cash, and real estate.
Jared Dillian explains that his 'Awesome Portfolio' is an evolution of Harry Brown's Permanent Portfolio. The key difference is the inclusion of real estate, which Dillian believes significantly improves the risk-adjusted returns and reduces volatility compared to the original 25% allocation across stocks, gold, bonds, and cash.
Jared Dillian discusses how volatility in investment portfolios can negatively impact an investor's psychology, leading to poor decision-making. He notes that checking a volatile portfolio daily increases the chance of experiencing negative news, which can cause stress and lead to suboptimal actions.
Jared Dillian points out that many individuals overlook their primary residence as a significant component of their investment portfolio. He highlights that for a typical middle-class person, their home equity can represent a substantial portion of their total assets, often exceeding allocations in stocks or other investments.
A significant portion of Gen Z investors, 26%, view sports betting as a deliberate and ongoing part of their long-term financial strategy. This is according to a Betterment survey, which also found that 52% of Gen Z investors redirected money from traditional investing towards sports betting in the past year. These findings align with anecdotal evidence from financial planners.
Financial planners are increasingly encountering clients, particularly younger ones, who present with gains from cryptocurrency or gambling. These clients often view themselves as winners, but their newfound wealth creates new financial planning problems, such as managing taxes and understanding long-term implications. This trend necessitates a shift in how financial advisors approach client conversations.
The current investment landscape, characterized by 'yolo-ness' and rapid market recoveries, mirrors gambling due to underlying behavioral biases like overconfidence and the underestimation of luck. Experts suggest that the psychological experience of quick recoveries, unlike the prolonged downturns of the 2000s, is preventing a necessary sentiment reset. This speculative behavior persists even after significant drawdowns.
Unlike the dramatic, single-event losses that can shock investors into caution, the problem with sports betting lies in its subtle, grinding nature. Many participants slowly lose money over time through frequent, smaller bets, creating a 'grinding despair' that is harder to recover from than a single large mistake. This gradual financial erosion may not provide the sharp learning moment needed for behavioral change.
Dave Nadig describes the insidious nature of sports betting as a potential financial strategy, noting that it's often not a single large loss but a slow erosion of capital through consistent betting. He likens this to a 'grinding tax on math literacy' because it doesn't provide the clear negative feedback loop that might deter such behavior. Nadig also points out that this habit can become problematic when it's a percentage of income without assets accumulating behind it, or worse, when assets are withdrawn to fund the habit.
Cameron Dawson notes that unlike the 2000s, where market downturns created a generation of risk-averse investors, recent rapid market recoveries have fostered a continued appetite for speculative gains. This psychological difference, where new highs are reached much faster after corrections, fuels behaviors that resemble gambling. Dawson questions what it would take to reverse this trend, acknowledging that a protracted bear market, while painful, might be necessary for a sentiment reset.
Dan Niles, founder of Niles Investment Management, believes we are in an AI revolution that will reshape the world. However, he cautions that this could lead to over-investment and a significant pullback in semiconductor stocks, potentially in the range of 30% to 50%. He notes that current valuations are not as extreme as during the dot-com bubble.
Dan Niles is closely monitoring two key factors for AI growth: the number of tokens being produced and the price per token. Since May, the price of AI tokens has dropped by 50% due to the rise of open-source models. However, the volume of tokens produced has more than doubled in the same period, suggesting a potential offset.
Dan Niles highlighted that the three major public cloud vendors—Amazon Web Services, Microsoft Azure, and Google Cloud—experienced accelerating revenue growth in the second quarter. More significantly, their operating margins expanded by approximately two percentage points, indicating improved profitability alongside increased revenue.
Dan Niles identified a significant negative development for AI growth: increasing political opposition to data centers. He cited a Gallup poll showing strong public opposition to data centers, with bipartisan agreement against them, even in states like Texas. This political risk, he believes, could hinder AI development.
Ben Hunt argues that the credibility of both the Federal Reserve and the Treasury has been significantly damaged due to inconsistent messaging and actions. He likens this to breaking a teacup, which, even when repaired, is never the same.
Ben Hunt outlines four significant problems that he believes will make the next few months challenging for markets. These include issues within the shadow banking system, crowding out effects from government and AI capital needs, rising interest rates, and a stretched consumer.
Ben Hunt highlights potential risks in the shadow banking system, particularly concerning captive insurance organizations. He cites Mark Walters' purchase of sports teams as an example of how these entities can be used for funding, with potential for significant losses.
Ben Hunt explains the crowding-out effect in the capital markets, where the immense funding needs of AI companies and governments will drive up the cost of money. He states that this situation creates a one-way bet on higher interest rates.
Ben Hunt links rising oil prices due to the Iran conflict to increased inflation and higher short-term interest rates. He also notes that the US consumer is again in trouble, with savings depleted and stimulus fading, exacerbating economic concerns.
Ben Hunt believes the Federal Reserve will need to significantly raise interest rates, contrary to market expectations of a single 25 basis point hike. He anticipates a rally in short-term bonds (2-5 year Treasuries) with at least a 100 basis point gain.
Ben Hunt predicts that inflation will be higher than the market is currently pricing in for next year. He suggests this will lead to a rally in the long end of the bond market, specifically recommending investment in 30-year Treasuries.
Ben Hunt believes the market is underestimating the probability of a recession. He predicts that this increased risk will lead to a significant rally in gold prices, projecting a potential increase of at least 20%.
The Federal Reserve's move away from forward guidance is expected to increase volatility in the short-term bond and stock markets. This shift means that investors will have less certainty about future Fed actions, leading to more unpredictable market reactions.
Kevin Mure suggests that midterm election volatility is currently underpriced in the market. He points to seasonal trends where September often sees increased volatility and argues that implied volatility for midterms is not fully priced in.
There's a discussion about the Federal Reserve's potential shift away from forward guidance. This change could mean that market participants will have to rely less on explicit Fed communication and more on market signals.
There's skepticism about whether government officials will maintain their resolve when faced with market pressure. The speaker suggests that historically, officials tend to cave and do whatever is necessary to support the market.
Kevin Muir discusses the current state of the bond market, noting that while it feels volatile, its actual ranges have remained relatively stable. He attributes the perceived volatility to factors like a rise in nominal GDP, elevated deficits, and significant corporate bond issuance driven by the AI build-out, alongside global fiscal stimulus efforts.
The discussion touches on Scott Bessent's proposed 'liquidity buyback' strategy, which aims to encourage liquidity in specific parts of the yield curve by buying back off-the-run bonds and issuing more liquid ones. There's a debate on whether this is a form of quantitative easing (QE) or an 'operation twist'.
During the conversation, there's a humorous interjection about Stanley Druckenmiller's direct approach to using AI, with one speaker humorously stating they don't pay for sex and don't let AI write their stuff. The guest (Kevin Muir) expresses a preference for Druckenmiller to write his own material, while the host (Matt Ziggler) finds Druckenmiller's audacity in using AI noteworthy.
A complex potential mechanism for debt monetization is discussed, involving the Treasury buying back longer-dated securities and replacing them with near-dated T-bills. This could overwhelm the market for T-bills, leading primary dealers to buy them, thus reducing system reserves and increasing front-end funding costs, potentially forcing the Fed into reserve management purchases.
Kevin Muir highlights the current global fiscal environment, noting that unlike in the past when the US had a higher deficit-to-GDP ratio than other developed nations, now many countries are increasing fiscal stimulus. This shift, partly attributed to geopolitical positioning, contributes to the overall supply in bond markets.
Dan Rasmussen, founder of Verdad Advisors, argues that private equity markets are experiencing a "train wreck" due to an over-reliance on consensus trades and inflated asset prices. He notes that a massive backlog of unsellable assets, acquired at peak multiples, is forcing firms into complex financing maneuvers to avoid liquidating at significant losses.
Despite the significant criticism private credit is receiving, Dan Rasmussen believes it may perform better than private equity over the next five years. He points out that private credit is at least receiving cash flow back at high interest rates, making it difficult for the equity in those capital structures to survive and grow.
Dan Rasmussen estimates that by 2021, software and healthcare technology comprised over 40% of private equity investments, with deals done at "crazy prices." He questions the intangible value of many of these sub-scale software businesses, suggesting they might be generic rather than possessing strong IP moats.
Jim Paulson believes economic growth will slow more than currently appreciated, with a greater concern for the consumer side of the equation. He anticipates a sentiment shift from inflation fears to growth fears and predicts the Fed will begin easing policy before the year ends.
Jim Paulson suggests the technology sector, which has already seen volatility, may experience further weakness. He believes the current excitement around AI, while here to stay, has led to over-discounting of future prospects, potentially causing a significant correction in tech and communications stocks.
Jim Paulson highlights a significant downturn in the US labor force, noting it has been flat since 2024 and showing a decline in participation rates, particularly among 25-54 year olds. He also points to weak payroll reports and a high average duration of unemployment as indicators of broader economic weakness tied to the consumer.
Paulson expresses concern over the consumer's situation, citing eroding real purchasing power, a negative attitude towards economic conditions, and record-low personal savings rates. He notes that while some higher-income groups may be accessing stock portfolios, the majority of consumers lack such options, making them vulnerable to weakening wages and income.
Jim Paulson observes that the ISM Services index, representing a larger part of the economy, has recently rolled over after a slight increase. He notes that the index remains at historically low levels, which is rare during an expansionary period, further supporting his concerns about economic growth.
Jim Paulson points out that retail sales, as indicated by the Johnson Red Book index, saw a jump early in the year likely due to inflation boosting nominal sales figures. However, with moderating price increases, sales have returned to levels seen in previous years, showing little real growth and aligning with weak job market data.
According to Jim Paulson, the residential real estate market shows no signs of activity, with the affordability index at record lows, making home buying less affordable than before the 2008 crisis. This lack of affordability is reflected in the market statistics, contributing to the overall weakness for consumers.
Dom Rizziolan, portfolio manager for T. Rowe Price's Global Technology Equity Strategy, likens the current market volatility to the 1998 tech sell-off, suggesting it could be a similar buying opportunity. He notes similarities in high momentum factor, geopolitical shocks, and hedge fund issues, but highlights a key difference in the semiconductor industry's revenue growth.
Dom Rizziolan believes the current AI spending cycle is only about halfway complete, drawing a parallel to the Nasdaq's performance from Netscape's launch. He notes that the launch of ChatGPT roughly three years ago marks a similar point in the current AI cycle.
Dom Rizziolan forecasts that hyperscalers' capital expenditure will accelerate into 2025, potentially reaching $1.5 to $1.6 trillion. This projection comes despite an expected moderate pricing environment for memory, driven by the attractive return on capital for these companies.
Dom Rizziolan highlighted Amazon's clear articulation of the return on investment for its AI infrastructure, noting that short-lifecycle assets break even in two to three years. He pointed to AWS's accelerating growth and margin expansion as evidence of strong ROI.
Dom Rizziolan identifies a potential long-term pitfall for hyperscalers: the rapid growth of AI labs like OpenAI and Anthropic could eventually put pressure on them. However, he believes this scenario is likely several years away, and in the short term, cloud company fundamentals remain strong.
Dom Rizziolan explains that Meta's significant AI investments are aimed at enhancing its core business, which is already showing acceleration. He contrasts this with AWS and Azure, where AI is seen as a more direct growth driver, positioning AI as an existential platform for Meta's future strength.
Dom Rizziolan argues that companies must invest in AI due to the structural capital intensity of this platform shift, emphasizing that the returns on this spending are proving to be extremely high. He highlights that this investment is not optional but a necessity for future strength.
David Rosenberg and Richard Bernstein reflect on their experiences and lessons learned during the financial crisis, with Rosenberg stating it was a "great training ground" and Bernstein describing it as a learning experience that highlighted the recurring nature of bubbles. Both speakers emphasized the importance of resolve and balancing conviction with the willingness to admit when a call is wrong.
Richard Bernstein argues that the Federal Reserve has deviated from the principles of the Taylor rule, a benchmark for monetary policy. He points out that various versions of the Taylor rule consistently suggest the Fed should be hiking rates, yet policy has often been the opposite.
David Rosenberg expressed disagreement with the Federal Reserve hiking rates, despite indicators like the Taylor rule suggesting it. He believes the rule's assumptions are subject to guesswork, leading to significant deviations between the rule's recommendations and actual policy over decades.
David Rosenberg shared a personal anecdote about John Paulson during the 2008 financial crisis, noting that while Rosenberg and his then-colleague Rich Bernstein had their reputations on the line, Paulson, who was shorting mortgage-backed securities, was on the verge of going out of business before becoming a billionaire.
Chan Yang of Vaydia Perception emphasizes that in the age of abundant data, the key is not just access but how data is creatively used and, crucially, what is omitted. He believes in focusing on data with first-principles causal reasoning rather than just what backtests well.
Chan Yang defines leading indicators as data points that shift ahead of major economic events, such as building permits anticipating construction activity. He contrasts these with coincident indicators like GDP or inflation, which are only apparent after the fact.
Chan Yang explains that the importance of leading indicators is dynamic and context-dependent, with Vaydia Perception curating about a thousand global inputs. He notes that consumer sentiment's predictive power has diminished due to shifts in economic drivers like inflation, making alternative consumer measures more relevant.
Chan Yang describes their Macro Risk Indicator as an abstraction of macroeconomics into four key dimensions: growth, inflation, policy, and liquidity. The indicator is constructed using decision trees that analyze various indicators within these dimensions to produce a single score from 0 to 100, intended to guide risk exposure.
Chan Yang notes that AI-driven capital expenditures, particularly in cloud infrastructure, data centers, and semiconductors, are significant drivers of both productivity growth and inflation. He highlights that demand for these components is also influenced by other factors like EVs and 5G, creating a pull in the same direction.
Chan Yang discusses the concept of 'building headwinds versus tailwinds' in analyzing leading indicators. Headwinds include restrictive monetary policy, high interest rates, inflation, and geopolitical tensions, while tailwinds encompass technological innovation, strong consumer demand, and fiscal stimulus.
Chan Yang explains that the recent decline in the macro risk indicator, from around 70 to 40, is attributed to policy tightening and economic slowing. He views this trend as a normalization of the market, leading to a potentially more balanced and resilient market going forward.
Chan Yang highlights a divergence between the Federal Reserve's policy stance and market expectations regarding a recession versus a soft landing. He likens the dynamic to a dance where the Fed leads, but the market attempts to anticipate its moves, leading to differing pricing of scenarios.
Chan Yang observes that correlations between various economic indicators and the S&P 500 are breaking down, suggesting a shift towards a new market paradigm. He notes that these correlations are not static and evolve with the market and economy.
Ben Hunt states that the United States is set to spend as much on AI capital expenditure and data center build-outs as it did on World War II, adjusted for inflation. He projects that this AI CapEx will be a marginal driver of economic activity, contributing half of the projected 2% GDP growth in 2026.
Ben Hunt warns that the market's heavy reliance on AI capital expenditures could lead to a systemic financial crisis if this trend falters. He attributes the current market multiples to this AI CapEx story and suggests that private equity, private credit, and alternative asset managers have heavily invested in this build-out.
Ben Hunt highlights Google's financial strain, stating the company is experiencing negative free cash flow and is resorting to raising equity and debt. He argues this is indicative of companies struggling to finance themselves through cash flow, a trend he sees as widespread.
Ben Hunt describes a significant 'crowding out effect' due to the massive investment in AI CapEx, leading to a dearth of capital across various sectors. He notes that this has resulted in underinvestment in other parts of the market and economy, and is reflected in rising interest rates and the cost of capital.
Rupert Mitchell discusses his portfolio strategy, noting a shift from high cash positions to increasing exposure in energy equities and agricultural commodities like wheat and cotton. He also details his holdings in precious metals, primarily gold, and his current views on their performance and potential.
Despite a recent punishing week for oil prices, Rupert Mitchell maintains a positive outlook, believing the numbers do not add up for current price levels. He holds a significant position, though he describes it as not yet overly concerning.
Rupert Mitchell expresses a long-standing aversion to bonds, citing a lack of diversification benefits due to the apparent positive correlation between stocks and bonds. He believes this trend will continue, driven by his view that inflation is pervasive.
Rupert Mitchell believes that despite potential short-term pain for precious metals if the Fed hikes rates, the market may soon be ready to increase exposure to gold. He sees gold as offering valuable defensive characteristics to a portfolio.
Author Robert Hagstrom discusses the 25th anniversary edition of his book, "The Warren Buffett Portfolio." He reflects on the enduring relevance of Buffett's investment philosophy and contrasts it with the academic definitions of risk.
Robert Hagstrom argues that modern portfolio theory's definition of risk as variance is flawed, contrasting it with Warren Buffett's view that permanent loss of capital is the true risk. He notes that academic theories often overlook the underlying business fundamentals.
Robert Hagstrom highlights Warren Buffett's focus on understanding the underlying business rather than just looking at financial statements. He contrasts this with a 'grade B' intelligence that relies solely on numbers, emphasizing that 'grade A' intelligence involves a deep comprehension of the business itself.
Harry Markowitz, a key figure in modern portfolio theory, developed his influential ideas on risk as variance while studying at the University of Chicago. His dissertation, initially voted down by Milton Friedman, gained traction later in the 1960s with the work of Bill Sharpe.
Showing the latest 15 of 22 covered episodes.