Transcript: James Montier
The transcript from this week’s, MiB: Jame Montier, GMO, is below.
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VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast I know I say I have an extra special guest all the time, but I really have an extra special guest. His name is James Montier. You know him from his years as partners with Albert Edwards at both Dresdner and Societe Generale. He is currently on the Asset Allocation Team at GMO. And I know James in passing for many years, and I have been chasing him down to come into the studio to record one of our little chats.
And he is so difficult to pin down. He is located in the hinterlands of the U.K. He’s not even in London. He’s hiding in an undisclosed location north of — north of the city. And he is in and out of Boston and New York so frequently, it’s tough to grab him. But since we’re all sheltering in place and he has nowhere to go, I was able to pin him down for the better part of an hour and got to ask him about half of the questions I want to.
James is really a fascinating thinker. He describes that, as his job, he gets paid to sit and think about the difficult questions that other people don’t want to think about. He also has written pretty extensively not only about behavioral investing and finance, but about some of the challenges of — of being a value investor and looking at markets from a perspective of having a margin of safety. Regardless, you will find this to be an absolutely fascinating conversation. He is a really thoughtful intriguing guy and he did not hold back at all.
So with no further ado, my conversation with GMO’s James Montier.
VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My extra special guest this week is James Montier. He is a member of the Investment Committee for GMO, the famed investment firm headed by Jeremy Grantham. Previously, he worked at Dresdner as well as Societe Generale as a Market Strategist. He has an ardent reputation on Wall Street. He has been named “Best Strategist” a number of years and has a reputation as both a bear and a value manager.
James Montier, welcome to a shelter-in-place edition of Masters in Business.
MONTIER: Thank you very much, Barry. It’s a delight to be here.
RITHOLTZ: Let’s talk a little bit about your current gig. You’re working at GMO where you’ve been for a couple years. But before you started at GMO, you were at Societe Generale. Tell us a little bit about your role there.
MONTIER: Sure. So I’ve done a lot of things over the years and it’s incredible. I’ve been at GMO for — for over a decade now, which is — is startling and testament to how time flies when you’re actually enjoying yourself.
So what I do at GMO is essentially ask the questions that people don’t want to be asked. My — I finally found a — a job that I am perfectly suited for. My job is to think about all the places we could be wrong, whether that’s in — in kind of the micro level or indeed at the macro level. So I spend all of my time worrying about what the models are missing part of my job. And then the other part of my job is — is really something to table when — when things get cheap.
So when I joined GMO, Jeremy said to me, “Look, one of the things that we really want you to do is — is when you think things are cheap, really, really scream and shout and make sure that we’re not missing out.” I’ve only had to do that a couple of times, which is a — a sad reflection on the state of the markets that I’ve — I’ve had to sit through for the last decade or so. But it is — it’s — it’s a kind of perfect job.
There are essentially two jobs at GMO you would love and one that you — you really wouldn’t want. The — the two that you would love are the one that Jeremy has as Chief Strategist and the one that I have, which is effectively minister without portfolio. The one you really wouldn’t want to have is — is poor old Ben — Ben Inker, the Head of Asset Allocation because he gets to sit there and has to kind of listen to Jeremy and listen to me, and then try and build that into a real portfolio. So his is a job you — you definitely wouldn’t want. Mine is — is a — is a pretty sweet gig.
RITHOLTZ: So part of your description is to pound the table when things get cheap. Markets just dropped 35 percent last month. Was there any table pounding going on at GMO or did they not get cheap enough?
MONTIER: That –that — there was — there was indeed some table pounding going on. I was getting very, very excited about particularly non-U.S-based equities. The U.S. didn’t get cheap enough for my particular brand of value, but emerging markets were looking really, really cheap. And a lot of the international markets, Europe was — was looking pretty, pretty damn exciting as well, so there was a — a fair amount of — of table pounding. And hence the reason I — I actually put pen-to-paper a couple of weeks ago and wrote a piece on fear and the psychology of bear markets bam to — to try and galvanize people to — to action because it — it struck me that this was one of those opportunities where — where prices and fundamentals were potentially getting dislocated.
RITHOLTZ: So let’s talk about the prior time prices really got cheap. You and your partner over at SocGen and Dresdner, Albert Edwards, were famously bearish heading into the ‘08, ‘09 crisis. What were you looking at that had made you that negative on equities prior to the great financial crisis?
MONTIER: So I think from — from our perspective there are a kind of a number of events that were going on that — that really kind of triggered our caution, but the most obvious one was kind of the immense housing bubble that — that we’ve been talking about for, in fairness, a couple of years before the GSE (ph). So as usual with most of my work, I — I find it it’s best to read it, then put in a drawer and forget about it for two years, and then take it out and — and actually act on it because they seem to take about that long for — for my — my sense of timing to come good.
But it was — it was really the housing market and the — the economic imbalances that was so obvious to anyone who have kind of studied the flow of funds, who — who looked at the sectoral balances for the U.S. There — there were just such obvious glaring imbalances that — that were unsustainable and as ever an unsustainable process, can’t go on forever, but it dimly goes on for longer than one imagines. And that was one of the — the things that we were really battling with was — was the kind of when. And it’s every time when — when we get bearish, it’s the — the when is always the problem.
But the — the economic imbalances were just so marked, it was — it was hard not to be bearish. Couple that with what was a pretty damn expensive market on, yeah, a simple Shiller-style valuation, a cyclically adjusted P/E. And it — it led us to be — yeah, as bearish as — as I think we’d probably ever been.
RITHOLTZ: Yeah, that — that timing issue is always problematic because as we’ve seen over various cycles, expensive stocks can get much more expensive, and cheap stocks can get much cheaper. It — is it really just a two year lag? How do you deal with — I guess, we could call that the momentum issue when you’re looking at either cheap or pricey stocks?
MONTIER: Yeah, it is — it is a momentum issue. You’re absolutely right, and it is both momentum in — in terms of the movement of prices, more so momentum in — in terms of the underlying economics of the situation as well on occasion.
And I think the — the way I’ve been forced to reconcile is to say, look, I simply don’t know. I — I never know when something is going to — to unravel. I can often see the — the — the unsustainable nature of what is happening, but it doesn’t tell me anything about timing.
And I think that’s one of the things that — that really helps back to some of the writings of Ben Graham. You know, Ben Graham said there were two ways of thinking about investing in the market — the way of timing and the way of pricing. The way of timing was trying to effectively guess what was going to happen, and that is essentially next to impossible as far as I am concerned. I think there are potentially people who can do it, I just know that I am definitely not one of them.
And on the other hand, there is the way of pricing. And on the way of pricing, you — you simply follow the rules evaluation. Now if you’re going to do that, you’re going to need to have a long time horizon. And that is one of the most important, if not the most important corollary of being a value-based investor is you’re going to have to be long-term. And the problem is, of course, as — as we well know, everybody starts off as a long-term investor, but as soon as they hit a — a patch of poor performance, they become rather too short-term. And that is why I think so many people struggle with the whole staying true to being a value-based investor over any length of time.
RITHOLTZ: Sounds like the Mike Tyson quote, “Everybody has a plan until they get punched in the face.” You’re saying …
MONTIER: Right, exactly, right.
RITHOLTZ: … the best laid plans of — of investors work great until there’s a little volatility and turbulence like we’ve seen earlier this year.
MONTIER: Exactly right. It’s — it’s precisely that. It’s — it’s easy to have a plan. It’s the discipline of speaking to that plan. And it’s one of the reasons that I — I — I enjoy my time at GMO so much is because we have a discipline. We have a — a series of valuation-based forecasts that help us anchor. And in psychology, as you know, I — I have a — a great interest in psychology. There is an expression, which is if you cannot debias then rebias. And what that really means is it’s incredibly hard to stop people being people. It is our very nature.
So instead of trying to stop them being people, the — the best thing to do is to try and knowing they’re going to fall into these behavioral pitfalls is to design a process that will actually allow them to benefit from those same behavioral pitfalls. It’s kind of like nudge if you like. And — and the — the way that we do it is to have that valuation discipline. So when the world is falling apart, our value models are — all else being equal — going to be saying, “Hey, look, things are getting cheap. You should be buying,” that we are just as much human as everybody else and are likely to sit around and go, well, you know, what (inaudible) the models, you know, why — what happens if the world does end tomorrow, that kind of thing. But having that conversation is at least that step in the right direction and seeing those numbers when you’re seeing you have double-digit rates through a prospective return. You have to be really, really sure, you know, something the — the model doesn’t in order to override it.
RITHOLTZ: Let’s talk about behavior and valuation. I love this quote of yours, “Leaving the trees could have been our first mistake. Our minds are suited to solving problems related to our survival rather than being optimized for investing decisions.” Explain that if you would.
MONTIER: Of course. So I think it’s — it’s kind of important that we acknowledge that — that we are the way we are because of evolution. Evolution has — has designed us to work, but evolution is, in essence, a glacial process. It does not reflect the world we live in.
You know, we are really designed for the African savanna of 150,000 years ago, not certainly the — the industrial age of 100 years ago, let alone the information age in which we find ourselves drowning today. So I think that the — the brain is a — a product of those same evolutionary reinforces that have designed us in every other regard. And that means our brains are not well-adapted to the problems we’re trying to solve.
And so if we think about fear as a really good example of this, in evolutionary terms, the cost of getting it wrong is — is pretty terrible. So if you see a — a — a tweak and you — you think it’s a snake, that’s fine, right? It — you’d step out the way, you took a — a slightly wider part, but it was fine. Get that wrong and the downside is — is potentially pretty, pretty terrible.
If you think you could tweak and you step on it, it turns out it was a snake and it bites you, you are evolutionary toast (ph). And so the brain is — is designed to work in a certain way. And when it comes to fear, it’s designed to — to make very short quick decisions that will keep us alive.
Now the problem is that when it comes to investing and let’s say markets are falling as they obviously have been over the last month or so, then what we’re doing is — is we’re triggering that fear response. There was a wonderful behavior experiment by Shivin (ph) and some co-authors who — who looked at the impact of — of fear on investment decision-making. And they — they — they set-up a really simple game where you got to choose over 20 rounds each round whether you wanted to invest. And they wanted to see if you suffered a loss in the previous round, would it impact your decision to invest in the next round? And obviously it shouldn’t if you are rational.
What they found was for — for normal people, people like you and I, that actually did it when you lost money in the previous round, they were much, much less likely to invest in the next round. That wasn’t true for a subset of people they examined, and that subset were very unusual they had a specific form of brain damage, which meant that they could no longer feel fear, their amygdala, which is one of the brain center of fear being irreparably damaged.
And so they behave much more like a model of rationality. They invested irrespective of the outcome in the previous round. So our brains are — are designed by this process of evolution to work in certain ways that keep us alive, but don’t give us necessarily the correct outcome when it comes to the world in which we’re trying to — to think today in investing.
RITHOLTZ: So the secret to good investing is really just a modest amount of brain damage.
MONTIER: I — I’m standing by that, and that I’m pretty sure most of my friends would attest to that.
RITHOLTZ: I can’t say — I can’t say I disagree with that. So — so — or — or if not brain damage, at least a little bit of behavior control that doesn’t look like the typical normal human being and is a little more in bracing of risk than our evolutionary history might imply.
MONTIER: Absolutely, absolutely.
RITHOLTZ: So — so let’s talk a little bit about how some of these behavioral biases manifest themselves among investors. When I look around the world and — and I look at some of the areas that you have described as cheap emerging markets, Europe elsewhere, especially away from the United States, investors seem to really hate those areas and have voted with their dollars. How much of this is a rational response to problems in E.M. and problems in Europe? And how much of this is just being too fearful for attractively priced stocks?
MONTIER: Yeah, that is the — the — the pertinent and perennial question that one has to ask. And the answer is we — we can never be sure or at least anyone who says they’re sure is probably a liar or a fool or some linear combination of the two because you can’t know. And so all you can do is say have I got sufficient margin of safety. And it goes back to gold old Ben Graham, and I know I sound like a broken record, always quoting Ben Graham.
But to me, he really is one of the most insightful all of history’s examples of great investors because he always said you have to operate with a margin safety because you know that if you’re dealing with something like E.M., yes, they have much lower legal standards, much poorer corporate governance than — than say the U. S. does, but we don’t know that. And that’s already in the price. And so if those things then look really cheap, you’re like, well, look, let’s take cash problem as an example, the — the — the Russian energy company.
It trades on a — a P/E of about two times, which is pretty ludicrous. Nobody thinks the gas problem is worth two. It’s either worth zero because Putin thinks it belongs to him or it’s worth a lot more than two, but it trades on two. And you’re like, well, look, I am being paid a lot to take on that risk. Now push comes to shove, I will probably lose because Putin owns tanks and I won bits of paper, and his tanks will trump my bits of paper.
But I — every year that I — I get that carry-on on gas problem, it’s paying out a dividend yield of — of six, seven percent. That’s a very nice return to taking that degree of risk every year without any worry about anything else. And ultimately, you know, as long as you size a position like that appropriately, I think it — it just makes a great deal of sense because your margin of safety is so high.
RITHOLTZ: So what are the credible reasons for this ongoing gap in valuations between a country like the United States that arguably still has the rule of law and countries like Russia us that have been described as, you know, a criminal organization with a standing Army? How can an investor confidently put money at risk in a place like China, like Russia where you never know how the rules are going to change from quarter-to-quarter, month-to-month?
MONTIER: It’s — that is — that is why they — they trade cheap, right? You’re absolutely right. You — you — you have a lower degree of confidence, and you have to scale your positions appropriately. So you — you don’t put everything into Russia and put everything into China. You build a diversified portfolio across any number of — of countries ranging from — yeah, the — the ones with the greatest corporate governance risk — China and Russia — up to — to places that have considerably less — Taiwan, Korea. They’re not perfect by any means, but you are being compensated an awful lot for the risks involved right now at least. Not always the case, but right now that is the — the — the — the return you are getting, I think, way outweighs the — the — the risks you are undertaking.
And so to me, the — the arithmetic of the situation says, “Look, size it appropriately and invest with a degree of — of confidence, but acknowledge the fact that, yes, you are taking on more risk and, therefore, you — you want that greater return. That’s why these things are priced at discount even on the normal times. Now right now, that discount is way wider than normal times, so your margin of safety is — is much greater than — than average, which is why these things, to me, look very attractive.
RITHOLTZ: So — so speaking of that giant spread between E.M. and developed nations, especially the U.S., I’m assuming you’re predicating some of this on the concept of mean reversion that eventually stocks that are expensive will come down in price, stocks that are cheap will rise in price and things will revert to normal. But we’ve seen like a decade of E.M. underperform in the U.S. Are you counting on mean reversion to — to shift this or is something more fundamental happening that’s kept the spread as wide as it’s been for as long as it’s been?
MONTIER: Well, it — it’s exactly the debate that we have had internally interestingly. The — they — strangely enough given how wrong we have been on the U.S., it is — it is certainly the — the question that we have spent an inordinate amount of time trying to understand is how — how can we do wrong? What could stop mean reversion? What are — what are the — the — the rational reasons for the U.S. having such a — a premium valuation relative to the rest of the world?
And, unfortunately, when — when we’ve done that, I’ve — I’ve — personally I have found most of the explanation as to be very wanting. So, you know, one of the most common ones, low interest rates, just doesn’t cut the mustard on — on multiple different levels. First, there is no provable relationship between interest rates and valuation. Second, there are any number of other countries that have low interest rates — Europe, Japan forever, yet they haven’t enjoyed high multiples. So you — you — you automatically begin to question the transparency of — of that statement that — that low rates are the — the justification for high multiples. I think the one where I have perhaps the — the most sympathy, but still not — I — I don’t find overwhelmingly compelling is that the U.S. has higher quality companies.
And I think that is, in essence, true. There are some exceptional businesses that happened to be domiciled in the U.S., but I — I simply don’t think it justifies the degree of the premium that — that we witness. And so I come down still on the side of mean reversion. Yes, it’s — it’s taking a long time, and that’s how you end up with cheap markets, right, or expensive markets is if they go on for a long time and really doing but I always used to say these things go on for longer than you expected and — and faster than you expect.” And they certainly fulfilled the first part of that over — over the last decade where emerging has got cheaper and cheaper, and the U.S. has become more and more expensive. So certainly our — our — our face has been well and truly tested. But as of yet, I haven’t found a compelling sensible explanation that explains that differential.
RITHOLTZ: I think it was at SocGen you penned a piece that I’ve always really liked called “The Seven Immutable Laws of Investing.” That’s got to be at least a decade old, right?
MONTIER: That one was — yeah, I think I wrote that for GMO actually, so it’s about a decade-old.
RITHOLTZ: Tell us how you assemble that list. It’s a nice run of seven different bullet points. We’ll — we’ll go over some of them. But what was the process like of putting that list together?
MONTIER: It was — it was really a — a — an exercise in — in trying to distill the experience of — of myself and — and many others into something that was easily digestible. And as I realized, as I described that, I — I’ve committed what — one of the sins I — I hate, which is kind of the great dumbing down of — of everything. The — the reduction of — of anything important to 240 characters drives me to — to distraction. And I suddenly struck that the seven immutable laws is an attempt to do exactly that, which is somewhat embarrassing.
But it was really about trying to distill the wisdom of a great deal of — of investors’ past who I had respected — Ben Graham, John Maynard Keynes, Sir John Templeton, Warren Buffett obviously, numerous others, and — and really come down to a list of — of things that I withheld to be always true that if I had to — to kind of pass this on to my kids without ever being able to talk to them again, what would I tell them whether the kind of the rules they had to follow in order to — to make sensible investment decisions?
RITHOLTZ: So you’ve mentioned always insist on a margin of safety, which I associate with both Ben Graham and Seth Klarman who had a book of the same name. Let — let’s talk about rule number two, which I’m going to assume is channeling John Templeton, “This time is never different.” Explain the thinking behind that.
MONTIER: Right. So I think that that was really born out of thinking about our experience of bubbles. I’m particularly talking with my — my former colleague and — and very good friend Edward Chancellor, who wrote a wonderful book called “Devil Take the Hindmost,” which is an extraordinary history of speculative mania.
And it struck me that looking at his work, looking at Charles Kindleberger’s “Maniacs, Panics and Crashes,” there were an awful lot of — of similarities to our experience with manias, bubbles and — and these kinds of environments because the details are always different, but actually there is a — a core of rhyming within each of these experiences that is always true. And therefore, it was indeed so John Templeton who said the — the four most dangerous words is “This time is never different,” probably five most dangerous words in investment, “This time is never different.”
Jeremy Grantham takes a — a slightly different view and — and says from a value manager’s perspective that the most dangerous words are, “This time is — is — is — is — is never different in — in a slightly different way.” He points out that he — we constantly assume mean reversion and perhaps that — that can be an error sometimes so that they become pretty, pretty dangerous whereas everybody seems to believe to me that this time is different is the — the usual explanation. So the tech bubble was the prime example.
Going through the tech bubble, oh, you don’t understand, this time is different because bang bang bang bang bang, which it — it just — it’s never been true yet. I didn’t understand that shiny phones were going to change the world back then. In fact, they — they did. The Internet did change the world in ways I couldn’t even begin to imagine, but generally not in a highly profitable fashion and certainly not the fashion that people were pricing in — in — in 1990, 2000.
So to me, remembering that this time is never different is really just reminding ourselves that human experience is — is sadly not linear, it — it tends to be more cyclical. Seth Klarman who — whose book you mentioned the “Margin of Safety” has a — a wonderful discussion about collateralized bond obligations during the — the early 1990’s, which have on parity — uncanny parallels with the experience with collateralized loan obligations in — in 2000 — 2007, 2008. And so you — you — you constantly find that the — these parallels come back.
And Galbraith had a — a nice expression which was, “The world keeps coming,” and — and we — finance is the one industry where we keep reinventing the wheel each time in a slightly more unstable fashion, which I kind of like as a — a summation of — of most of the kind of problems of finance. But remembering that this time is — is never different is just a reminder that, hey, we’ve seen most of this before, we’ve seen this movie before, we know how it ends, and it generally doesn’t end well.
RITHOLTZ: So the asset classes, and the circumstances, and the specifics may change from cycle to cycle, but it sounds like human nature itself is immutable.
MONTIER: Exactly right, precisely.
RITHOLTZ: So there’s a couple of others that — that I like, “Be patient and wait for the fat pitch.” That — that sounds like you’re channeling Warren Buffett there a bit.
MONTIER: Exactly, that — that is definitely a Buffettism, the — the fat pitch and Ted Williams. And I had to learn a lot about baseball to understand that one, which is not easy as you can tell from my accent. But once you get the hang of it, I would say, “Oh, yeah, I get it,” really about waiting for those good opportunities. You know, there are long amounts of time when doing nothing is the right thing to do. And that’s really hard because people expect their investment managers to — to be active, to be doing stuff, but there are long periods when there are no fat pitches, in which case you shouldn’t be doing stuff. Don’t — don’t do something just sit there kind of thing, and — and that can be very hard to — to justify.
But ultimately …
RITHOLTZ: Makes — makes a lot of sense.
MONTIER: … it allows you to — right, it allows you to exploit the opportunities when they do come along.
RITHOLTZ: So number four is a real challenge because I’m — I’m reminded in the scene from the Monty Python movie, “Life of Brian,” where Brian is speaking to the multitudes and says, “You’re all individuals, you’re all different.” And every one of them repeats in unison, “We are all individuals, we are all different.”
And — and number four is be a contrarian. How challenging is it to be a contrarian with so much career risk and so much peer pressure to do what the crowd is doing?
MONTIER: Absolutely. And — and it — it’s really, I think, the — the essence of investing. And you can trace that back to — to Ben Graham, to — to Maynard Keynes. They — they all have quotes. In fact, every good value investor, I think, has a quote on the importance of being contrarian.
And one of the — the contributions, I think, Jeremy Grantham has — has really made to our understanding of that is why it is so hard to do. And — and there are two different sources of — of hurdles, if you like, that we have to overcome. One is — is human nature. Human nature tells us that — that it is warmer and safer in the middle of the herd, and we should probably stay there. We don’t like to look different. We’re social animals.
And then there is on the other — the other set of hurdles are really what one would describe as the institutional imperative, and that’s really changes observation about career risk, which is obviously it is far better for reputation to fail conventionally than to succeed unconventionally. And the combination of those two that that innate human desire to be similar to other people, and then the overlay of the institutional framework really do make it incredibly hard to be a contrarian.
But ultimately, this is a Templeton quote, “If you want different results from other people, you have to do something different from other people.” And so we — we — we end up there saying, OK, you — you just have to be a contrarian.” It doesn’t mean you have to be a blind contrarian. It doesn’t mean you have to be on thinking. I — I suggest both of those are foolish, but I think ultimately, you have to be prepared to look different if you want to achieve a decent set of investment results or these different ones. And that is something that people find incredibly hard to do.
RITHOLTZ: So you wrote these in 2011. They’re published on the GMO site. If you were rewriting this list today, would you change any? Would you shift the order around? How has a decade altered your perception of this list of seven immutable laws of investing?
MONTIER: I’m — I’m — I’m kind of dire to say I wouldn’t rewrite any of them. I — I — I’m glad to say the immutable part is still true. I — I never really thought about the order. They — they were just kind of I didn’t write them in any specific order of importance, and so I think all seven of them are — are probably as true today as — as they were when I wrote them. But I’m — I’m glad to say I — I definitely wouldn’t rewrite any of them.
RITHOLTZ: Let’s talk a little bit about your role at GMO. What does being on the asset allocation team there entail?
MONTIER: So it’s — it’s — my role is — is a research role, and — and that’s one that I — I — I thrive on. I enjoy — enjoy solving puzzles. And to me, investing is perhaps the ultimate puzzle. It’s never exactly the same, and there are always uncertainties. And really my job is — is to sit there and — and think.
My — my children asked me. My daughter turned around to me and said, “What do you do for a living, Dad?” I said, “Well, I think,” and — and she was, I don’t think, enormously enamored with that answer, but it is essentially what I am paid to do. I — I’m paid to sit here and think about life, the universe and everything, and really understand as much of that as I can, and make sure that — that we are investing in a way that — that kind of makes sense.
RITHOLTZ: That reference sounded like a Douglas Adams title. So — so let me …
RITHOLTZ: … have you — let me have you think about something that I — I find — a puzzle that I find quite fascinating and challenging, and it has to do with valuations. And the question is this, the world has changed over the past century. Does it make sense to compare valuations of today with those in the 1930’s and 40’s or the 1980’s and 90’s? How has the inherent capital structure of companies, what they need in terms of labor and material changed from five, 10 decades ago versus today’s fast, light, two — two founders and a laptop and — and the Amazon cloud versus tons and tons of steel, and factories, and thousands of employees? Do we really have the same valuation metrics today that we had early last century?
MONTIER: It’s a — it’s an extraordinary good question. I think that there is — there is a — another Ben Graham quote, which is effectively that the — the only constant is change, and it is certainly true, right? And I — I totally understand that when one is comparing long runs of data that say looking at a Shiller CAPE P/E, in the 1880’s that reflected an environment which was essentially mainly railroads. Today, that does not seem like a terribly useful proxy for anything of any interest.
However, I think it is worth pointing out that in the 1880’s, railroads were — were cutting-edge, right? They were — the railroad booms of the 1840’s and 1870’s were — were the cutting-edge of technology. And so I think the stock market, obviously, evolves over time. Its composition evolves over time, but it is often with a strong technological bias.
There’s a wonderful book by a friend of mine called Sandy — his name is Sandy Nairn. The book is called “The Engines That Move Markets.” He — he actually worked as the Head of Research for Templeton a long time ago. And in that book he traces all of these waves of technological innovation from the railroads through — through the telegraphs, to — to the radio, to the television, to the automobiles, et cetera.
And the one thing they all have in common is they start off generating enormous returns. People will then drive the prices up to a bubble or something that approximates the bubble that they effectively extrapolate profitability into prices. And eventually that bubble unwinds because the gains of that technology end up with the consumers not the produces. And to me, that is why I think that we get this — this kind of historical echoes, and it makes some sense to say, “Hey, look, there are some constant evaluation.” That isn’t to say every valuation metric is perfect, it isn’t.
Price to book is a really good example. Price to book gets distorted by things like buybacks, and so you end up with companies with negative book value, which is essentially economically meaningless. And so you — you have to kind of — you can’t take the — these things at face value and say, “Hey, look, yes, McDonald’s is trading on a negative book value, yes, because it’s done enormous amount of buybacks.” And so I think you do have to — to apply some — some thought.
And –and Ben Inker, my boss, said to me the other day, we were having a discussion in a group, and — and he said, “We always reserve the right to use our brains.” And I think that is a sound — a piece of advice. As I can imagine, we should always reserve the right to use our brains. And there will be times when you — you want to question stuff.
The role of the stock market itself has changed. The stock market used to be a method of — of financing companies. That hasn’t been true since really the mid-1980’s. Companies do not, in general, come to the market to — to — to raise capital in the inequities unless they’re IPO. Everybody else doesn’t. And so the amount of buybacks far outstrips the amount of — of IPOs. And so what we actually see is negative issuance.
So there are differences that it’s important to recognize. And one does have to think carefully about the valuation metrics the one chooses to use, but I think a lot of them and the — the higher the aggregate level, the — the more they make sense. So looking at a — a Shiller or CAPE P/E for the aggregate market, I think is — is a lot more sensible than trying to look at Apple or Google or Amazon’s Shiller P/E, which I think is — is pretty meaningless. So I think it does depend on — on the level of the analysis and the — the particular specifics of the analysis. So using one’s brain is — is highly recommended.
RITHOLTZ: I can’t say argue with any of that. Let — let me have you use your brain on another issue that — that I’ve been — and I think a lot of people have been perplexed by, and that’s the issue of negative interest rates at a lot of industrialized nations.
We — we briefly source some short-term treasuries go negative in the United States. What does it mean to see so much of the world dabbling with negative interest rates? And are we going to see this in the United States?
MONTIER: It’s fascinating, right, because people who had central banks when they — when they take rate negative, I — I genuinely don’t understand what they’re thinking. I can get why you want rates low if you’re a central banker. I do not understand negative interest rates because those negative interest rates are attacks on banks.
Now don’t get me wrong, I — I perfectly happy to tax banks. But from a — a policy response to effectively trying to create an economic stimulus, one of things I do remember from economics is that the taxes are a — a leakage that will break on — on economics, not — not — not a stimulus. And so therefore, relying on negative interest rates to try and boost activity, I think, is — is kind of weird. I don’t think it makes a great deal with economic sense. I think it also kind of blows up a lot of people’s models because an awful lot of — of modern-day asset pricing, for better or worse, takes its — its cue from — from the — the interest rates.
Now much as I don’t think that’s particularly sensible. I do acknowledge that a lot of people behave that way, and it does strike me that the negative interest rates could potentially mock up quite a lot of — of — of that approach. And so I — I think it’s a — it’s an old policy with unknown consequences, which I — I do not think should be pursued lightly.
As to whether the U.S. is — is ever going to get there, I have absolutely no idea. If I — if I go back 20 years, I — I — I used to be one of those people who said our interest rates can’t go below zero because it seems so unthinkable, and yet the approach you have to go back and hold the decade, right, two decades for me to have been saying that. But fast-forward then there we are, we — we’ve seen them. So never say never, I guess.
RITHOLTZ: Right. It — it ain’t called the zero bound for nothing, although I guess maybe it was.
RITHOLTZ: So — so let me ask you a …
MONTIER: Yeah, right, exactly.
RITHOLTZ: … let — let me ask you a different policy question. You seem to be somewhat enamored of modern monetary theory, which basically says stop freaking out over deficits. If the government issues currency and its — its — has control over its own currency and can issue debt that people want to buy, deficits aren’t the end of the world. Tell us a little bit in this election year what you think about modern monetary theory, and what it means for how we should be assessing how governments will be interacting with markets.
MONTIER: Yeah, I think MMT, modern monetary theory, is — is that — that very — that — that label tends to — to get people’s hackles rising, right? It’s — you know, it doesn’t matter whether it’s — it’s on the right or the left and — and people get very upset and very passionate and start throwing Zimbabwe around that hyperinflation, Venezuela and those sorts of things.
But actually, I — I think it — that the core of what I perceive as monetary — modern monetary theory is a — a descriptive model of how the world actually works. And it says that effectively governments don’t have to finance their — their deficit if — if, as you say, they are weak or monetarily sovereign, i.e., they — they issue bonds in a currency which they control. So it is absolutely a — a description of the U.S., Japan, the U.K. It is absolutely not a description of the eurozone where the — the country has obviously issue debt in euros, which they — they don’t control. That’s in the hands of — of the ECB.
So I think there is this — this kind of common belief that governments are — are really like households. They have to live within their means. And I think that’s just fundamentally false as a paradigm. And I think when you begin to understand the way that governments spend and — and potentially the reason why even money exists, it’s — it’s — really this is a form of debt settlement, and that is through pretty much as far back as anybody can go. (Inaudible) is the word for — for guilt and obligation, which is — is the — the — the historical form of money.
And so I think it’s — to my mind, MMT is a much more accurate description of the way the world works and, therefore, understanding how the world works, which is ultimately kind of my aim in life is — is goes back to the topic we were on earlier I’m — I’m paid to sit and think and trying to understand the world. Well, MMT, to me, offers a much better framework for understanding the way the world works than a lot of — of other economics.
And it does lead one to — to say that, look, budget deficits are — are not nearly as problematic as — as people believe. You know, there’s a school of thought that they lead to incredibly high interest rates. Well, just look at the evidence. That’s not the case right now and it hasn’t been the case in Japan for a very, very long time where they’ve run very low interest rates and — and very big government deficits. And quite rightly, they’ve had to do that.
But it — it — certainly, those deficits haven’t led to high interest rates, then you get people turning around and saying, “Oh, well, printing money to — to finance budget deficits is an inflation rate.” You’re like, “Really? What is the evidence for that?”
First of all, governments don’t actually worry about printing money, it’s how they’ve always acted. You have to print money in order to — to spend it and to get into circulation before people can even pay their taxes. So there’s kind of a — a whole series of myths that people have that are — are very much caught up with the — the analogy of — of governments and households.
And it’s certainly true for households, they cannot live sustainably beyond their means, but it is not the case for government. They can — they can — as long as they meet the criteria we — we talked about earlier, they — they are absolutely capable of going out and spending it. It’s very interesting that today we see a much broader acceptance of that in the response to the various corona outbreaks around the world.
And here in the U.K., we — with — government is underwriting 80 percent of people’s wages, and — and that would have been unthinkable probably is the …
RITHOLTZ: You know, we saw the …
MONTIER: … conservative government.
RITHOLTZ: Right. We — we saw it happened post financial crisis when the austerians were in control and were more focused about balancing budgets than helping the economy recover. That didn’t end especially well in the U.K. or the United States, did it?
MONTIER: No, exactly right. In the U.S. you have the — the — the slowest and weakest recovery ever, and then the U.K. was a total disaster. We — we essentially didn’t have any recovery. And so the — the austerians and — and the — the kind of advocates of sound finance, which is the balance — you must balance the budget, et cetera, I think (inaudible) with sensible evidence-based economics. And — and I’m a big fan of evidence-based anything, evidence-based medicine, evidence-based investing, evidence-based economics. One should always mark one’s beliefs to — to market, check the — the real world, see how it looks.
RITHOLTZ: So last quote of yours before we get to our speed rounds, and I want you to expound on this. Don’t equate happiness with money. Materialistic pursuits are not a path to sustainable happiness. Explain.
MONTIER: So, yeah, a long time ago, I — I wrote a couple of notes on — on how to be happy, and then it just struck me as something that I — I spent a long time working at investment banks at that stage. And I — I kind of was — was slightly worried that I looked into people’s eyes and it was like staring through zombie’s eyes. The — the — the lights were on, but nobody was home, and they seem dead on the inside.
And I — I really couldn’t fathom how that could happen. And I — I began to — to do some research on — on happiness and — and the science of happiness. And it turns out that there are a number of people who have — have thought about happiness.
And one of the — the big difficult is — is that people tend to associate happiness with — with wealth or — or income. And don’t get me wrong, a certain level of income is necessary. But — but beyond that level of kind of that threshold, it really isn’t obvious that the greater increases in wealth and income leads people to be happy. So the vast majority of people trapped in poverty, of course, an improvement in their income would help them.
But let’s say, you know, the top 10 percent of the population increasing their material worth is — is probably not going to have a great deal of impact on — on their happiness. And I think that the problem a lot of people have is what we called “hedonic adaptation,” which is you get used to stuff very quickly.
So you get a new car and you really love it and it feels great, but within six — three, six, 12 months, whatever it might be, it’s just your car, right? Your kids are in the back. They’ve scuffed up the backseats. They put their muddy boots on it; the dog’s peed in the boot. And it’s really not a new car, and it’s — it’s — it’s devalued quite a lot in your own eyes, let alone its — its economic worth.
And so we — we — we’re on this what they call the “hedonic treadmill” that we — we adapt very fast to our environment, our material ownership. And this rang through with me because when I was young I spent a long time traveling the world. And some of the poorest people were amongst the — the happiest I’ve ever met.
I was traveling in — in Thailand, and they were people who essentially had very, very little and yet they were absolutely some of the nicest, friendliest people I ever met, and they were willing to share what little they had with me, a stranger just traveling through their village. And I started reading both science and then the Dalai Lama on — on happiness. And — and the Dalai Lama is an interesting man because he’s very — obviously a very spiritual individual, but one who is absolutely certain that if science proved something that he believes to be wrong that he will update his beliefs.
And there I found a — a — a lot of wisdom about the — the way to be happy is — is not surrounding oneself with materialistic possessions but experiences. And, to me, that — that really rings true. And I think too many people focus far too much on — on — on money and materialistic pursuits rather than thinking about what might make them a happier individual.
RITHOLTZ: Tom Gilovich, I know, has written some research that echoes exactly what you’re saying — experiences are far more lasting in social than mere objects. So I know I only have you for a limited …
MONTIER: Exactly, right.
RITHOLTZ: … yep, I know I only have you for a limited amount of time. Let’s jump to our speed around. Normally these are 10 questions, but given our circumstances, we’re going to keep them to five. Tell us what you are watching today. What are you streaming on Netflix or any other service? What are you podcasting or listening to?
MONTIER: I am something of a Luddite, I confess. I’m probably much more likely to be found reading a book than — than I am watching television. But I have to say, on Netflix, I did thoroughly enjoyed Stranger Things. That, to me, was a — a very well-made and entertaining program.
RITHOLTZ: If you like Stranger Things, let me recommend Electric Dreams. I think that’s Amazon Prime, but it’s a similar concept. We’ll — we’ll see if you like that.
MONTIER: OK, I’m going to have a look at that.
RITHOLTZ: Early mentors — early mentors? Who influenced your career?
MONTIER: Albert Edwards above and beyond all else. My — my — we spent nearly 18 years working together, I think. And he had a — a huge impact on the — from when I — I just joined the team he was on when I was junior economist way back out all those years ago. I’m watching the way that Albert work and thought, really did define the way that today I — I work and think.
RITHOLTZ: Quite interesting. You mentioned you’re spending a lot of time reading. Tell us some of your favorite books, fiction, nonfiction, finance or anything else. What have you been enjoying and what are you looking forward to reading?
MONTIER: I — I tried to read fairly widely. I — I think one can often find insights into all sorts of problems from — from very different perspectives. But I think my favorite investment book is probably Seth Klarman’s “Margin of Safety,” which we’ve — we’ve mentioned earlier. I think there is a tremendous amount of value in there.
Outside of that I’m currently reading a book on biomechanics. I — I — my big passion outside of investing is — is taekwondo. And I was fortunate enough last week to take part in a seminar with one of the — the Russian grandmasters, Grand Master Kang. And he’s a — a big exponent of — of understanding biomechanics to — to improve our taekwondo performance, and so I’m trying to understand how physics applies to the human body right now.
RITHOLTZ: Give us one other. What else are you reading and enjoying?
MONTIER: What else am I reading and enjoying? I actually enjoy — really my guilty pleasure is airport thrillers. I will read almost any airport thriller. When I’m stuck on a plane, I — I will quite happily dig into pretty much any thriller. So the lower brow, the better.
RITHOLTZ: Give us an author’s name of these lowbrow thrillers.
MONTIER: Me, I — I kind of — I — I do like Mark Billingham. He — he writes a series of — of detective novels that I find most enjoyable.
RITHOLTZ: What sort of advice would you give a recent college grad who is thinking about going into the investment field?
MONTIER: Don’t do it.
Go and do something useful with your life instead.
RITHOLTZ: And why?
MONTIER: No, I — no, I think that — that investing needs bright, sensible people, but I kind of think there’s an awful lot else that we need in this world, and investing is — is probably not the — the highest and best pursuit. I think far too many people who are going to investing are kind of blinded by the dollars. And so I think come become a doctor or an engineer or something that might actually help humanity.
RITHOLTZ: And our final question, what do you know about your chosen field of investing today that you wish you knew 30 years ago when you were first getting started?
MONTIER: Oh, man, that’s such a good question. I think I — I wish I knew not to be so confident. My — my — my very first job was as a — an F.X. Strategist, and I had an incredibly humbling lesson where I — I recommended a position that was short on Swedish krona based on some very bad economic analysis that I’ve done. It turned out eventually to be correct. But in the first week that we had that trade on, the — the head of the Forex Division told me we lost more money in that — on that trade that I made in — in an entire year.
Now I was a graduate, didn’t make huge amount, but it was an incredibly humbling experience. And I think the older I get, the — the less certain I am about almost everything, which is — is I’m not sure it’s a good thing or not, but certainly I wish the younger me had not been quite as arrogant and confident as — as I was.
RITHOLTZ: We have been speaking with James Montier. He is the — he is a member of the GMO Asset Allocation Team. He is the author of such books as “Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance,” “The Little Book of Behavioral Investing,” and “Value Investing: Tools and Techniques for Intelligent Management.”
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I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.