Hosted by Director of Financial Education, Jonathan Clements and President, Peter Mallouk, this month’s podcast explores the recent shift in stock market pricing and what is on the mind of many Creative Planning clients. Is the market too expensive to join now? Included is a review of why investing only in what you know might hurt you in the long run.
Plus, you won’t want to miss each of their monthly tips!
Join us as we explore how Jack Bogle changed the industry and lessons to improve your own investing strategies!
Time Stamps
0:00 – Welcome to Down the Middle
1:15 – What is on the mind of Creative Planning clients; what are they worrying about?
1:54 – Recent market shifts. What’s going on here?
3:49 – Are stocks too expensive?
7:18 – Why is my portfolio not invested in all US Large Cap stocks?
12:37 – Jack Bogle
18:00 – Peter Mallouk Monthly Tip
18:52 – Jonathan Clements Monthly Tip
Transcript:
Jonathan Clements: This is Jonathan Clements, Director of Financial Education at Creative Planning in Overland Park, Kansas. And I’m sitting here with Peter Mallouk, President of the firm and we are Down the Middle. So Peter, we’re calling this podcast Down the Middle. This is the inaugural edition, why Down the Middle?
Peter Mallouk: Okay. First, before we dive into that, I’ve got to say that I read you for many years in the Wall Street Journal was very excited to meet you a few years ago. We met for the first time-
Jonathan: And now disappointment is set in.
Peter: No. No. No. Then, I heard you talk and I was surprised by the accent. And so, I bet there are thousands of people that have read your column for years and years and years. And weren’t aware of that. How often do you get that or am I the only person that has brought that up?
Jonathan: Only a couple times a day.
Peter: Oh really? All right.
Jonathan: I’ve been accused of being Australian, I’ve been accused of being South African, but I was actually born in London, but my parents moved to the United States when I was age three. So, I actually grew up speaking with an American accent. And then when I was 10, I was packed off to boarding school in England and there they beat the American accent out of me and this is what I ended up with.
Peter: Perfect. That makes great sense. It’s good background for everybody to know as it was for me.
Jonathan: So, Peter, you talk to clients all the time. What are you hearing from customers these days? What are they worrying about?
Peter: I think if you look at the last few years, the main questions we get are, the market doesn’t make any sense because they look at December huge drop and January huge gain. So, they think that means the market’s irrational. And how can you invest in something that’s irrational? And the second component is, why do I own anything besides large US stocks? And those are really questions that come primarily from newer clients. I mean the clients that have been with us for a while, understand, I think the market’s a little bit better and understand how their investments match their goals. They tend to be a little bit more patient.
Jonathan: So, let’s go to the markets. We had a terrible, fourth quarter of 2018 and then suddenly January, February and everything’s heading upwards.
Peter: Right.
Jonathan: What’s going on here?
Peter: Well, I think to me, that’s evidence the market is rational. So, if you look at what was happening in December, the federal reserve had raised rates now nine times that there was no end in sight, they’d indicated they were going to continue to raised rates. We weren’t at the table with China, that tariffs were getting worse and the market was looking at that and saying, “Hey, if interest rates are going to be higher and we’re not going to work out a deal with China, probably earnings will be lower in the future.” And it adjusted accordingly. Well, what happened is right after Christmas, we got an after Christmas gift and the Federal Reserve indicated it probably was done raising interest rates for a while. And we got back to the table with China and the market said, “well, maybe there’s a little bit more room to run here.”
And so, to me, the lessons in that, are the market is pricing things in very, very quickly. It doesn’t take months or years to price things in it. It prices them in instantly. And second, it’s going to price them in quicker than you can react to them. And so, if you try to move to cash to be safe or move into the market to extremely aggressively, take advantage of something most likely this is not going to work out. Well for you, that you really, it reinforces for me. You need to have a strategic long-term based approach where your investments are matched to the goals. Hey, if I need money in 10 years, it can be in stocks.
And I don’t care what happens in December or January. I need that 98% chance that stocks are going to be considerably higher over 10 years. And that’s the way people should be approaching things and I think that’s why we did disconnect between our… When you say what our clients are asking, longer term clients aren’t asking anything.
Jonathan: Right.
Peter: They just are unfazed by almost everything. And the people that started in November and then they saw what happened in December. They’re asking a lot of questions about, “My goodness, what’s going on with the markets?”
Jonathan: One of the things that’s fascinating to me about the markets right now is we went through this long period where everybody said, “Stocks are expensive. Stocks are expensive.” And now, as of early 2019, what do we have? We have stocks that if they hang at current levels, we’ll finish the year at about 17 and half times reported earnings. That’s very close to the long run average. The long run average for stocks over the past 100 years is about 16 times earnings and the 50-year average, it’s actually 19 times earnings.
And we have a very low interest rate environment. We’ve had an economy that’s been grown really strongly plus of course we had the corporate tax cut. And the result of that is that suddenly, almost surprisingly so, we have a stock market that looks reasonably priced. And people who are venturing into the market, that should be comforting.
Peter: Yes. So, I think that if you’re going to the market now and you believe in regression, over time. And I think whether you look at people from Bogle to people into whole another end of the spectrum, that seems to be a common theme we can all agree on is the market always finds a way to return to its historic average.
If stocks have earned 30% in one year, they’re not going to earn 34% forever. If they go down 7% the next, they’re not going to go down 7% forever. We know we’re going to get some reasonably mid to high single digit rate of return for the market over a long period of time probably, right? And I think when we look at the PE ratio, which is one way to value the markets or another that you referenced which is how it compares to interest rates, which I know is one of Warren Buffet’s favorite ways of looking at it which is, “Hey, what’s my alternative to investing in the stock market.” Yeah. The stock market’s paying 2% dividend but if bonds are at 3% well, that’s pretty darn attractive. If bonds were paying six, maybe not so much, the valuations are very reasonable. And so, for somebody who was complaining, it was too expensive before well, this is the golden opportunity. If you forward looking PE ratio’s about 15 and a half and that starts to get really reasonable.
Jonathan: Yeah. And just before we leave this topic, one of the things that I take comfort in this, we went through the fourth quarter of 2018. Everybody who had a worry, had a chance to express it, right? All the bears finally got a little bit of air time on the TV, to go on and say how awful things are and how it’s going to get worse. And we all heard those concerns and yet the stock market didn’t collapse.
Peter: Right.
Jonathan: We heard all those fears, and we didn’t end up with the market down 30 or 40%. In fact, people looked at the market and said, “Hey, shares are now reasonably valued.” And they bit them back up again. Anybody who’s coming into the market, I think should take comfort in that fact that the market reflects all those worries and yet it’s still arising.
Peter: I agree. I think, I like to having that little bear and I wish it went down another 1% because the stock market went down 19.8% from top to bottom. So now, we’re debating that we have a bear and are we still in the longest bull market and I’m tired of that conversation. And I think it’s just healthy to have a cleansing every now, and then. It’s important for people to understand there is risk in the market in the sense that there is volatility.
We had 2017 where every single month the stock market went up. I don’t believe that had ever happened before and I don’t think that’s a healthy environment either. That’s what encourages a lot of excess speculation. So, it was a nice reminder that things can change very quickly in the short run but it presented a tremendous opportunity for a smart investor too.
Jonathan: So, you said there were two things that investors were worrying about. One was the volatility that we saw in the fourth quarter. And then second, what about everything other than large cap US stocks, why isn’t every part of my portfolio doing well? So, what do you say to those folks?
Peter: It was interesting when we finally had the FANG stocks, Facebook, Apple, Netflix, Google really get crushed. That was a real eye opener for people because they’d been on this just amazing run. And we went from a few years period of, “Why do I have anything overseas?” To “Why do I have not just anything overseas?” In the US, “Why do I have anything but large stocks?” Then it became, “Why do I have anything except large tech stocks?”
And when this is going on for three years to the typical investor, that seems like forever. I mean, 1000 plus days of in general, large US tech stocks doing better than everything else. It seems pointless to diversify. And I think that’s a concern for somebody who’s just invested in the very short run because they look at it and they get confused.
Now obviously, if you’re a student of the market, you know that over the long run, that’s not how it works out. The US international wide up in the same place. They trade places a lot, different parts of the world are priced differently. They carry different sets of risks. I know you, in a lot of your writing and speaking reference Japan and that, and what’s happened to that stock market, the importance of avoiding home bias, which is having all your eggs in the economy that you happen to live in.
But the US is 40% of the global economy. At Creative Planning, we still have it as a majority of the portfolio but you can’t have it beat everything in the portfolio. You have to have your eggs in different baskets. If you look at 2000, 2010, which is the most recent example of why you would want to do that. 2000, 2010, large US stocks, worst performing major asset class in the world, 0% rate of return. Mid-cap US, small-cap US were very positive. Bonds, great decade. International emerging markets, amazing decade. Real estate, energy, great decade. And that’s the importance. If you think a couple of years of the US outperforming international for concern, look at that decade of international outperforming the United States.
Jonathan: Yeah. I think part of the problem is how we think about portfolio construction. And I must confess, I used to think this way, I’d say, “all right. The US stocks, they’re my portfolio. And my portfolio’s engine of growth. Either that’s my starting point now, What am I going to buy in order to make owning US stocks palatable?” And then you start saying, “Okay. I’m going to add some bonds and I’m put in some alternatives, I’m going to put some money into foreign stocks to lower the volatility of the portfolio.”
But in recent years, I come to realize that’s really the wrong way to think about building a portfolio. What you should do is look at the global market portfolio, which is roughly four parts. It’s US stocks, foreign stocks, US bonds, foreign bonds and then say, all right, what am I going to subtract? And I think a lot of people reach the same conclusion. I reach which is, I don’t really want any foreign bonds because I don’t want that excessive currency exposure-
Peter: The currency exposure, are more expensive and the least contributory asset class of the ones that you mentioned, right?
Jonathan: But then from there, I think the decisions become much tougher. I mean, do you really want to have lessen foreign markets than you have in the US? Given what you mentioned the Japan problem? Given that we’ve had decade long periods when foreign stocks have outperformed US stock? And to my mind, having roughly a market waiting seems to make sense. And then in terms of the US bond portion, that’s really about your risk tolerance and where you are in your life cycle.
Peter: Yes. Agreed. I think that if you take those asset classes and you say, “Okay. I’m going to get rid of that home bias.” And you figure out when you need money, you can then back into how much of each of those asset classes you should have. And a lot of investors, I think do it based on age or risk and I think those are very big mistakes even though that’s how most of the industry works. I really think you need to look and say, “Okay. If I’m going to own this global portfolio, starting that dividing line between bonds and stocks should be, what do I need in the short run versus what do I need in the long run?”
Now, as long as we’ve got the short run covered, you can play with the long run. If you’re a very conservative person that’s going to lose sleep if your portfolio fluctuates and you can be in great shape if you’re 80% bonds, well God bless you. You have 80% bonds. If you’re somebody that’s saying, “I want to leave the most wealth possible to a charity or my children 30 years from now. I’m not fazed by market volatility. I want to be the best steward possible of my wealth.” Then you have enough to meet your short intermediate-term needs and bonds and your long-term needs, you got to start to look to that global portfolio you’re referencing.
Jonathan: So, when we talk about this global portfolio, what I always tell people is this amazing how many different asset classes you can invest in today compared to say, the early 1990s. You go back to the early 1990s and only the biggest institutional investors could invest the way the average investor can invest today. And the average investor today can invest at the expenses that only large institutions could get back in the early 1990s. And a big reason for that has been the proliferation of not only index mutual funds but also Exchange-Traded index Funds.
I mean, you can now invest in pretty much any class you imagine using an ETF or using an index mutual fund and maybe he’s not entirely thrilled with this legacy, but a big reason is the late great, Jack Bogle. Who died earlier this year. Jack was the father of the Index Mutual Fund and he launched this revolution and both of us were hugely influenced by Jack.
Peter: Right.
Jonathan: So, why don’t you talk to me about how Jack influenced you?
Peter: Well, I’ll throw one other thing that’s made a difference from the ’90s today besides the proliferation of index funds is technology. And technology has really made it a lot easier to access all of these things very cost-effectively and obviously the Internet’s made it a lot easier to implement as well.
I mean the first book I read that really was an eye opener for me with investing was, Common Sense on Mutual Funds. And when creative planning really got going in 2004, we really started the way that we invest today. I remember our Vanguard contact telling us we were the largest holder of ETFs in the country, maybe five years later of all the independent firms. And certainly, the were the largest folder of Vanguard ETFs, at the time. I remember when we were starting, I was having to explain to clients what an ETF was, what an index was.
And in fact, at that time, John Bogle was speaking out against Exchange-Traded Funds. Vanguard I think, I might have this wrong but I think they called their ETFs Vipers back then. And Bogle had called them weapons of financial mass destruction. And so, it’s interesting to watch his legacy for me to divert for Vanguard but his idea of you want to get broad representation to a marketplace in a cost efficient way and quit try to beat that market and focus on what markets you should be in.
That is the primary philosophy of the way that we approach which asset classes we’re going to own and how we’re going to invest in them. Now, I would say it’s been very interesting for us at creative planning is one of the largest holders of Vanguard, ETFs and ETFs from other firms. We use iShares and SPDRs and various companies wherever we can find the lowest cost.
One, which I think is an interesting deal today too, is Vanguard’s no longer the lowest cost provider in most spaces. But I look at Bogle and I look at Vanguard and I see a couple pretty big differences. Bogle did not like Exchange-Traded Funds. He thought you should just have a mutual fund. Vanguard, big proponent of Exchange-Traded Funds. Bogle believed in a very big home bias. Vanguard very much believes in global investing with a huge international allocation to their models.
What’s interesting is I’ve view Jack and Vanguard have had really diverged, especially in the last decade of Jack’s life. And if you look at Jack Bogle, he was very much a proponent for a heavy home bias towards the United States. But Vanguard is a huge proponent of a very large waiting to overseas investments, much more than most other fund companies in their personal, allocation portfolios.
Jack was a huge proponent of the mutual fund. And Vanguard was one of the first firms to release Exchange-Traded Funds they called them Vipers, which sounded, really scary as they’ve since thankfully changed the name. And he really argued against ETFs. I think it drove Vanguard crazy calling them weapons of financial mass destruction and he felt they were unnecessary. And then also, if you look at Vanguard, Vanguard is very much an active shop who supports active investing. They released a white paper saying we believe in active investing in Bogle and in the last decade, I didn’t hear him talk about any of that. His advice universally was just by a couple of index funds. And so, it’s interesting to watch over the years.
I don’t think it’s Jack’s Vanguard anymore. I think, it’s Jack’s industry. So I think if you look at the industry now, in Fidelity with the zero cost mutual funds and you look at State Street with their low cost ETFs in many cases, lower than Vanguard at iShares with their low cost ETFs in many cases lower than Vanguard, I think his true legacy is that he reshaped the entire industry.
You see, indexing’s very prevalent now. It’s a large part of stock market investing, not just for institutions but for individual investors. You see low-cost investing and low-cost indexing across companies. And really Vanguard is no different than these other places. In many cases, being outdone, because when you get to an index fund, all you care about is cost and liquidity. And there are other places that are providing like State Street, iShares and Fidelity, lower cost and pretty soon to be equal or in some cases more liquidity. I think that’s his true legacy and I think that history we’ll be reading about that 10 years from now.
Jonathan: Yeah. I first met Jack in 1987. I was at Forbes Magazine and I was a cub reporter covering mutual funds. And I ran into Jack, many times over the years but particularly in those early years and people don’t remember he was a pride in the mutual fund industry. As a reporter covering mutual funds for first Forbes and then for the Wall Street Journal, I used to go down to the investment company Institute, annual meeting in Washington. It was the big annual shindig. All the senior executives from the fund companies were there and Jack would hang out in the press room because nobody else wanted to talk to him other than journalists.
Peter: I believe that. Yeah.
Jonathan: Yeah. I always thought so, like a journalist, he definitely had that ankle biter mentality. He enjoyed tweaking people. He enjoyed getting into a little bit of a brawl. He enjoyed being outspoken and of course you mentioned his book. He could also write pretty well.
Peter: Really good writer. Yes.
Jonathan: But yeah. He was the earliest. He was a special person. And even though I don’t believe he was right about everything, I certainly don’t think he was right about International investing. Clearly, he was wrong about ETFs and how powerful ETFs have been in changing the business. And indeed, Vanguard came late to the ETF business and been any later, it might have been a big problem for the company. I mean, they’ve been playing catch up for the first 10 years of their time in the ETF business because iShares was so far ahead of them. But with all that, I mean, we all have floors. So, many more than Jack, he did have a tremendous influence and as people have commented, he probably saved the typical American investor more money than anybody else in the history of the business.
Peter: For sure. Yeah. Absolutely. In many direct and indirect ways. Yeah. His core beliefs, the core thing he brought to the table was overwhelmingly positive. And it’s going to impact people for generations.
Jonathan: So, regret coming to the end of our podcast and one of the things that we said we would try to do each time is to give one tip for the month ahead. One small takeaway, something people can put into action. So, what would that be for you, Peter?
Peter: Well for me, is this we just wrote a newsletter about this. It’s a pretty easy deal. It sounds like a big deal. My mom was like, “What is dual-factor authentication? I don’t understand that. That sounds complicated.” Really simple. Any service you have where you can sign up for it, you sign up for it. And before you log into your account, they just text you a code and you type in the code and it makes everything much more secure. And it’s a very easy thing to implement. So, any account you have that offers dual-factor authentication, convince yourself, promise yourself that from here on out, you’re going to take advantage of that.
Jonathan: Okay. My tip for the month ahead, it is February. We are in Kansas and it is miserable. There is snow on the ground outside. We’ve had this deep, freeze down the middle of the country. My advice is book your summer vacation now. And not simply because it’s good to think about hot weather when it’s so cold but also we know from the research, one of the best parts of spending money is the anticipation. The earlier you book that summer vacation, the longer the period of anticipation you’re going to have and in all likelihood, it will turn out to be the best part of the vacation. So, this is Jonathan Clements here with Peter Mallouk, and we are Down the Middle and at the conclusion. Thank you very much.
Peter: Thank you.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed to be reliable but is not guaranteed.
