The Colossal Mistake | Richard Bernstein on the Risks of Tariffs and Passive Investing

[00:00:00] Certainly I'm not going to be too far away. The biggest tax on the consumer, certainly that we've seen in our professional careers, 2024's stock market was the most narrow stock market we had seen since the Great Depression. If you're investing in an index fund or you're investing in a growth index fund, I think you're making a colossal mistake. My joke used to be we're seeing unprecedented use of the word unprecedented. Now we're seeing unprecedented use of the word uncertainty.

[00:00:27] If you were another country and you didn't like the tariff that was being placed on you, the biggest threat you could offer the United States back is not I'm going to tariff you, it's that I'm going to puke your treasuries. You're watching Excess Returns. I'm Matt Ziegler, co-hosting today with me Justin Carbono and of course our esteemed guest CEO and Chief Investment Officer of Richard Bernstein Advisors. It's Richard Bernstein himself. Welcome to the show, Rich.

[00:00:57] Thank you. Thanks for the invitation. So, got to be honest, I'm a little uncomfortable with this. I remember 2008 sometime, I was at Merrill, you were in Merrill too, in a prominent role, and you were telling me about how you really should be avoiding those financial stocks. The market could hit 666 if things go awry. And that was like a year in the future.

[00:01:21] And I remember you saying that, and I remember registering my head. I was new in the business at the time. But I have never forgotten neither that call, nor just what it felt like in that environment. Do you see anything today that rhymes with the financial crisis in any way, shape, or form? I need to ask this for myself, if nothing else.

[00:01:38] Yeah, I think, Matt, I think this is obviously a very different construction, right? In 2008, it was centered, as the name would imply, the global financial crisis. It was centered on the financial sector. And the financial sector, especially the major banks around the world, are obviously key to the economy, right? Capital formation, savings, lending, all these things, very key to the economy.

[00:02:04] And also, it also affected housing. And housing is a very high multiplier industry. So that was the construction then. Today, the construction is a little bit different. I'm not sure I can say it's better or worse yet, to be honest. But this is really what we're feeling right now is probably the biggest tax, maybe in history, in the United States history. I'm not sure about that, but it's certainly I'm not going to be too far away.

[00:02:34] The biggest tax on the consumer, certainly that we've seen in our professional careers. And given that the United States is 70%, 65% a consumer-oriented economy, having that kind of tax on the bulk of the economy, I think that's what we're feeling right now in the volatility of the markets.

[00:02:54] You also, something I learned just following your work all those years ago was what you called style investing and thinking about sectors and just this approach to how these things stack up and then tacking it back to broad market indices, which is insanely useful for any active manager. I'm curious what you're seeing, kind of like you saw in underweighting financials back then. Are there any sectors right now we should be thinking about?

[00:03:19] Yeah. So, Matt, one of the things that I think investors always have to remember, it's fun to be a momentum investor. I would actually call that more trading than investing. But it's always fun to do that. But the problem is with momentum investing, it's sort of like Wile E. Coyote, right? You just keep running and running and all of a sudden there's nothing there. And then whoosh! And then you get a little puff of smoke at the bottom of the canyon.

[00:03:46] That's what momentum investing is all about, is that you kind of just, you know, you're the first lemming going over the cliff type thing. And that's when you're a momentum investor, buying things is not where success comes from. It's actually knowing when to sell. And I think momentum investors always forget that. It's always, you know, what am I going to buy? What am I going to buy? It's always so exciting. And they forget that that's not really the key to momentum investing.

[00:04:10] And so, we all know that the market got very, very narrow. There's no value in my saying that. Everybody knows that with the magnificent seven or the, you know, top 10 or whatever phrase you want to use. But I don't think investors realized what a pessimistic view of the future that was to have such incredibly narrow leadership.

[00:04:32] Now, what do I mean by that? So, Goldman Sachs, giving credit where credit's due, Goldman Sachs pointed out that 2024's stock market was the most narrow stock market we had seen since the Great Depression.

[00:04:46] Now, in the Great Depression, it makes sense to see a narrow market, right? Because companies are trying, forget growth, companies are trying to stay alive. And the companies that can grow were like a handful. And so, you had very narrow leadership during the Great Depression. Makes perfect economic sense.

[00:05:03] Now, we could argue all day long how strong or weak the economy was in 2023 and 2024. But unless I missed it, we didn't have a depression. So, it was very hard to argue that this was really a fundamentally driven market that we saw. And our argument was that people were missing all these other growth opportunities that were going on around the world, not just the United States.

[00:05:28] And I think, so where am I going with this relative to your question? What I'm saying is that I think right now that if you're investing in an index fund or you're investing in a growth index fund, I think you're making a colossal mistake. Because those index fund, because those index fund are dominated by those seven or 10 names. And those seven or 10 names may not do very well because there's tons of growth opportunities all around the world in a much broader universe.

[00:05:54] And the market will eventually understand that and rotate towards that broader universe. So, I think the unfortunate reality right now is that growth investing, the way it has been defined in recent periods, is very, very, very dominated by those seven or 10 or 20 companies. And so, I think that right now, if you're an investor, not a day trader, but if you're an investor, there are a bazillion reasons to err on the side of value over growth.

[00:06:24] So, important follow-up question. If momentum investors are Wile E. Coyote, who's Roadrunner? Who's Roadrunner? I'm not sure. I haven't thought about that one out. I can, you know, I'm ready for the tortoise and hare type thing, but I wasn't ready for Roadrunner. I want to know who's painting the fake tunnel. Can we at least figure that out? Exactly. I'm not sure who that is. And an idea is running through my head, but I'm not sure I want to share it with everybody.

[00:06:53] Well, I'll give you a much easier question to answer. If we're not going to say who's painting tunnels on walls, let's talk about tariffs. Let's just talk about how do we even start to think about these? How do we start to think about their impact? And forget unknown tariffs. If we start to think about them as a construct, how can we put something to work here? So, Matt, the idea of the re-industrialization of America is a very worthy goal.

[00:07:19] In fact, we started writing about this, I think, you know, the first time I seriously wrote about this was in an op-ed in the Financial Times in 2011. So, that's now, what, 14 years ago, right? This is a real theme that we've been investing for for more than a decade, and we think it's a necessary theme. It's such a nice theme. It's a necessary theme for the United States to regain some element of our economic independence. We're not going back to the 50s and 60s. I think that's a pipe dream.

[00:07:47] To think that we're going to be the manufacturing powerhouse, that's ridiculous. I think that's really a silly idea. But on the margin, can we regain some element of manufacturing independence? Yes, and we should be doing that. And so, I think the goal is a very worthy goal. Personal opinion here for a second, I think the way we are going about this with tariffs is about the most ham-handed way we could possibly have designed a way to achieve this goal. You know, the reality is that tariffs are near-term.

[00:08:16] Capital spending, as we all know, is a long-term phenomenon. You don't just buy new equipment. You don't build a new factory in a quarter. This takes years. So, we've got this mismatch of pain versus reward. You know, there's plenty of better ways to achieve this goal without hurting the U.S. consumer and placing this massive tax on the U.S. consumer. So, the goal, I think, is very worthy. I don't think anybody should argue against the goal.

[00:08:45] I realize politicians are going to say, oh, you know, right and left, all this kind of... I don't think there's any reason to argue against the goal, but I do think that the policies that we're... The policy path that we're following right now is really not a very wise one. I think that's why the markets are reacting the way they are. Inside of the market reaction, which is the injection of this type of uncertainty, what about inflation? Tariffs and inflation, how should we process that? Well, I mean, I've been unequivocal on this point.

[00:09:12] I think that tariffs, deglobalization, first of all, just the process of deglobalization is inherently inflationary. And the reason why was that globalization, whether you like it or not, I mean, I'm not passing judgment on that one, but globalization was inherently disinflationary. Because all globalization did was increase competition.

[00:09:35] And everybody that's listening to this podcast knows that when you increase competition, you put downward pressure on prices. That is not PhD type stuff, right? Well, what deglobalization does is it starts reducing competition. And we all know when you reduce competition, you get upward pressure on prices. And therefore, deglobalization is inherently inflationary. It's a very simple construct. So on top of that, we now have tariffs.

[00:10:03] Tariffs exacerbate that inherently inflationary force. Why? Because the United States does not have the excess capacity to provide goods to substitute for the tariffed goods. So here's a way to think about it. Here's the example I give everybody. Matt, is anything in, and Justin too, is anything you guys are wearing right now made in the United States? No, no. There's no way that anything you're wearing is made in the United States.

[00:10:31] In the last 30 years, the United States has lost, depending on how you measure it, up to 90% of our textile manufacturing capacity. So if the administration puts a 15% or 20% or 25% or 125% tariff on clothes, we have a very simple choice as consumers. We can run around naked or we can pay 10% or 15% or 125% more for clothes because there's no alternative. There is nothing else we can do.

[00:11:00] And so that's why tariffs are inherently inflationary on top of the secular deglobalization, which is inflationary too. Now, one thing just to add to that real quick. When I say that it's inherently inflationary, people go, you know, but this is a hair and fire environment, right? So everybody goes, oh, you know, do you mean like 8%, 10%? How much inflation is going to be there? Well, remember the Fed is still using this 2% inflation goal. And that seems incredibly antiquated to us at RBA.

[00:11:28] And so maybe instead of 2%, the Fed should be using 3% to 4%, something like that. I think that's a reasonable secular outlook for inflation. It totally makes sense. And I just want to point out, I think Wile E. Coyote and Roadrunner both ran around naked. So they might have been on the side. They actually did. Yeah, I don't think maybe a necktie or something somewhere. One more thing on tariffs, the negotiating strategy for tariffs. Is there a smarter way to roll out a policy like this?

[00:11:56] Understanding we're reversing some of the globalization trend. This is always going to be a messy process. Other ways to do this. Yeah, I think, look, the argument that I made, you know, a decade ago was that, you know, this is, and forgive me on this one. I'm going to get a little kind of professorial. There's two classic inputs of production, capital and labor. The United States cannot compete on labor, right?

[00:12:24] We're not going to put children in the mines. We're not going to, you know, child labor is not going to happen here in the United States. You know, that's just not going to happen. So we can't compete on the cost of labor. So what we have to do is compete on the cost of capital and specifically the after tax cost of capital.

[00:12:42] And what I tried to outline in my earlier reports and commentaries was that the United States, we should treat the United States as a giant enterprise zone, right? So that we reward good behavior, but there's no government expenditure. There's no damage to the economy. Nothing changes unless corporations do good things and we reward them for their good things.

[00:13:10] You'd say, well, why don't you just cut corporate taxes? That's part of the problem as to where we are today. So not picking on Apple as any one company, but I think it's one that everybody knows. Apple got a corporate tax cut and then they built plants in China. That doesn't work. That defeats the purpose. Why would the United States finance, effectively finance China's expansion? That's ridiculous.

[00:13:33] So what we should have done was said, Apple, if you build a plant here in the United States, it will be, I don't know, tax advantaged forever. You know, I mean, make up whatever numbers you want to make up here. But as opposed to just saying, here's money, go do what you think is right. What we should have said was, we want you to do this. If you don't want to do it, you don't have to do it. But if you do it, there's going to be a huge incentive to do it. That doesn't blow out the budget. We don't run a bigger budget deficit. Nothing like that happens. And the return on investment becomes very measurable.

[00:14:03] Rich, I know from following you all these years, you have a humility when it comes to forecasting. But with that being said, I feel like you're probably one of the more accurate people that I've listened to over the years. But I wanted to get your take on kind of forecasting in this type of environment where you have these massive changes happening rapidly. It's kind of one decision maker supposedly making the decisions.

[00:14:28] You know, you can't really rely on the economic data that you would usually look at. So just, you know, generally what's your take on that? And if you want to tie in, you wrote a piece for the Financial Times. The title of that was certainty is now a scarcity in the market. So that I think plays into this. Exactly. So, so, Justin, first of all, thank you for the for saying what you said. You're grossly overstating my ability to forecast, but that's fine. I'll take it for this situation. I'm happy to accept that.

[00:14:59] But, but yeah, I think the point that I tried to make in that in that opinion piece was the uncertainty is growing. And, you know, it used to be with my joke used to be we were seeing unprecedented use of the word unprecedented. Now we're seeing unprecedented use of the word uncertainty. Right. And, and what a change in six months for that.

[00:15:20] And so the range of outcomes, this uncertainty that we're all faced with now, the market is dealing with that in terms of just increasing the risk premium. If you have a riskier asset, say a junk bond relative to a treasury bond, junk bonds carry higher yields because they are riskier. The uncertainty is greater. You know, is the company going to go bankrupt? Will they make their payments? Will they go up in, in credit quality?

[00:15:47] And, and maybe that could happen, but the range of outcomes for a junk bond is greater than the range of outcomes for a treasury. And so with that uncertainty comes a higher yield. Well, in the United States, as we have become more uncertain, what you found is that the market has begun to reprice the risk premium on U.S. assets. It's a very simple story.

[00:16:11] And so you're seeing that and that we've knocked off about five or six multiple points off the S&P's valuation, despite the fact that earnings have actually been reasonably healthy. Right. That's not what should happen in this environment. That's the repricing of U.S. assets. People have been shocked that treasury bonds aren't rallying like crazy into, and interest rates aren't falling like crazy into this, into this volatility that we're seeing. It's the repricing of U.S. assets. It all kind of works its way together.

[00:16:40] And so if that's true, and if we're right in that assumption that we're in an uncertain environment where risk premium are being reevaluated, to your point, what you said before, certainty becomes the scarcity in the marketplace. And so in our portfolios, what we're trying to do is we're trying to increase the certainty. What does that mean?

[00:17:02] We're looking for higher quality companies, because that's obviously been very speculative, but higher quality balance sheets that are non-tech. We are looking at dividends more and more, right? Because of the certainty to the cash flow that you get as an investor. And we're discounting these lofty growth stories where the range of outcomes is now spreading exponentially, right? You have no idea what's going to happen over the next three, five, 10 years.

[00:17:30] And so even in our fixed income portfolios, we've been reducing what little credit quality we had. We were already underway credit, but we've been reducing credit quality even more now in that respect. And people are wondering, like, why is gold performing well? Well, there's a fantastic correlation between gold and the small business surveys, the NFIB small business survey.

[00:17:55] They have a component that's called the uncertainty index, and there's a tremendous correlation between gold and the uncertainty index. So, of course, we have had and continue to have gold in our portfolios as well. So the way to think about it is if certainty is the scarcity, you want to buy that scarcity. And that's basically what we're trying to do. So two things, earnings and stock picking.

[00:18:21] So do you, I don't know at a firm level if you forecast S&P 500 earnings, but I know you guys look at individual company earnings. So the first question is, is, you know, what type of effect do you think this tariffs are going to have on earnings?

[00:18:38] And then B, it would seem to me like this would be a good environment for roll up your sleeves, sort of due diligence on individual companies and like active stock selection. Because I feel like there's certain companies that are going to be affected more or less to your point about the certainty thing. So just on those two, those two. Sure. Sure. Sure.

[00:19:01] So in terms of the second one first, we don't really spend a lot of time on individual stocks. We're more of a macro firm. But there's, from a macro perspective, the spreads, the valuation spreads are obviously widening and widening pretty dramatically. But they're not enough yet to say like, wow, this is the time to go buy, you know, individual companies. There's a normal process. That normal process is underway.

[00:19:29] It has not yet hit an extreme. I know that's disappointing to a lot of people given the level of volatility, but it hasn't yet hit that kind of extreme yet. But we're working our way there. We are. There's definitely some effects that are going on. And then, forgive me, now I'm going to show my age. What was the first part of your question? Oh, it was the earnings, Ford earnings. Oh, earnings. Okay. So let's talk about earnings pre-tariff, pre-liberation day, all this kind of stuff.

[00:19:58] Before all that even occurred, our forecast was that the profit cycle was going to peak out roughly about mid-year. Roughly about, let's say, somewhere between June and September. Let's say the summer, to be imprecise. Somewhere around the summer that the profit cycle in the United States was going to peak out. That was before.

[00:20:16] I think now it's obviously a boatload more nebulous, very difficult to figure out whether this is, you know, how quickly and dramatically this is going to occur because there's no certainty. Again, you know, things are changing right and left and very capriciously. But it certainly is not going to make the profit cycle stronger. Let's put it that way.

[00:20:40] So I think in terms of, you know, the normal story for us would have been that as we move through the year this year, and we wrote about this at the beginning of the year, we expected our portfolios to move from something more cyclical to something more quality and defensive oriented. I think that process is speeding up a little bit. You had mentioned before that one of the goals of the tariffs is to bring manufacturing back to America.

[00:21:08] But I think that, you know, what's confused the market here is it seems like there's a number of maybe other goals with the tariffs. And it seems like one of those is to bring the 10-year down. So, you know, it used to be the belief that Trump focused on the stock market. Now it's like the 10-year yield. So can you just talk about why that would be important to them and maybe the impact of, if that's true, switching from, you know, focusing on the stock market to the bond market?

[00:21:36] So it's important to the administration to have lower long-term interest rates because of the effect that that has on very high multiplier industries like housing, right? I mean, that was one of the problems we talked about before in 2008 that housing got hit. And housing is about the biggest high multiplier industry. What do I mean by high multiplier?

[00:21:59] I mean that if you think about this, when you build a house, you employ people, you're using a lot of building materials, lots of stuff that goes in there. Person or family moves into the house. You're buying all new furnishings. You're, you know, all this kind of stuff. And so, you know, there's a lot of spending that ripples through the economy in an economist sense. It's called a multiplier effect. And housing is about as high a multiplier as you can get in the economy.

[00:22:25] And we all know that housing is very sensitive to mortgage rates and mortgage rates are very sensitive to the 10-year note. So if 10-year yields start going up and going up dramatically, that's going to have an impact on the mortgage market. Mortgage market is therefore going to impact the housing market. You start increasing your risk of recession. And so that's number one.

[00:22:51] Number two is the administration is concerned because, you know, one of the things that we do export, export in quotes, it's not something we really export, is treasuries. And everybody around the world owns treasuries. And so if you wanted, if you were another country and you didn't like the tariff that was being placed on you, the biggest threat you could offer the United States back is not I'm going to tariff you. It's that I'm going to puke your treasuries.

[00:23:21] That's the biggest risk that's out there. And so when they started seeing rates going up, they started worrying that foreign buyers were selling treasuries. And if that happens, then we kind of lose control of our own economy to some extent. And so there's a fine line here. I would dispute the notion that the trade hand we have been dealt is quite as strong as the administration is making it out to be.

[00:23:48] I really don't think we have a very strong hand here. What do you think about the level of debt that we have as a country? I think we're roughly I think our debt to GDP ratio, and correct me if I'm wrong here, is around 120 percent, something like that. Yeah, yeah, yeah. Is that something that we should be concerned about or is there a tipping point somewhere? What is your feeling on that? So we should all be tremendously concerned about that.

[00:24:13] There is nothing good to say about debt to GDP and the debt levels of the United States. I'm amazed that people like somehow try to twist this into something that's positive. I can't figure that one out. There's nothing. I mean, think about this if it was your own personal finances and you were levered up the schnoz. You know, would that be good? Would we all say that's a smart thing to do? Probably not. If we had a company that was levered up the schnoz, would we say that's good for the company? No, we wouldn't do that.

[00:24:42] And we've learned in the past that when hedge funds or Korean companies, if you want to go back to the 1980s, 1990s, you know, levered themselves excessively, it led to tremendous volatility in their earnings streams and everything else. So I don't think there's anything good to say about this. However, I'm not sure people kind of have this notion that there's going to be a day of reckoning, right? We're going to wake up tomorrow and we're going to be an emerging market and nobody's going to want to own our assets.

[00:25:12] And it's going to be this sudden thing, like all of a sudden the lights are turned on. And I love when people say that, one, because it's like, you know, we're so smart and the markets are stupid. I mean, that's a huge statement to make, right? That we're all smarter than the market. The markets don't realize this. The markets realize it, I can assure you. And the second thing is that it's not like we're going to wake up and there's going to be a day of reckoning. Rather, it's a slow bleed.

[00:25:37] And that slow bleed has been going on for really 10 or 15 years already. What do I mean by that? So you might remember that in, I think it was 2011, the spring of 2011, U.S. treasuries got downgraded for the first time from AAA. Okay. Now, let's again go back, take a step back. If I had a corporate bond and it was downgraded from AAA to AA, would it trade similarly to other AAA rated bonds? No, it would not.

[00:26:06] It would start trading like AA rated bonds and there would be a little risk premium attached to that yield. Now, if going from AA to AAA, that might be small, but still it would not trade with AAA anymore, right? Okay. So the U.S. debt gets downgraded in 2011. Prior to that downgrade, U.S. treasuries trade pretty much in tandem with other AAA rated sovereign debt around the world. Sometimes we yield a little more. Sometimes they do. We do. They do.

[00:26:32] Back and forth, back and forth, back and forth, depending on what was going on around the world. Then we get downgraded. And I'm going to exaggerate here, but almost to the day that U.S. debt gets downgraded, U.S. treasuries have sold at a risk premium yield relative to other AAA rated sovereign debt. And that spread has just continued to grow through time. It's come down a little bit in the last several years, but it's still, I mean, the chart relative to history is something to see.

[00:27:02] It's like you can tell exactly when we were downgraded. Now, why is that important? It's important because we know that everything in all debt in the United States basically trades off the 10-year. We know that mortgages do. We know the corporate loans do. You know, all this kind of stuff. And municipal bonds, everything trades off that. So what's happened is because the United States has already been penalized with this risk premium, that penalty has translated through to all debt in the United States.

[00:27:31] And so it's not like we're going to wake up and be penalized. We've already been penalized with higher interest costs for being a riskier country. Why hasn't anybody noticed that? Because the absolute rate of interest was so low. Nobody cared. Right. They missed the point that it should have been lower. Right. But we were being penalized. And so part of our lack of competitiveness is already being felt in that spread that's hindering our ability to raise capital at a cheaper price relative to other nations.

[00:28:02] I have two questions about the Fed. And the first one is more about, I guess, narrative. It seemed like, and this is true, I think, in the markets in general, that, you know, maybe like a year ago, all that anyone was talking about was the Federal Reserve. And you get these times in the market where I think investors become laser focused on something. Now, the Fed is obviously important and I get why.

[00:28:29] But I'm just wondering, like, how do you or how should an investor, would it be true to say that if you're hearing something too much, it's like it might not matter as much as you think? And I'm thinking about the Business Week, you know, cover story of, you know, Warren Buffett, you know, not. And then all of a sudden Buffett goes on a great 10 or 20 year run.

[00:28:51] Just it's like some perspective on like narratives in the market and how, you know, you when you see something, what gets you either concerned or what gets you look one and two deeper. Right. Is there a question in that? No, I get it. I get it. So first, let me let me preface this by saying I don't envy the Fed. Fed, I'm about to be very critical of them, but I think it's real easy to be an armchair Fed watcher than it is to be the Fed itself.

[00:29:17] And I admire them for their guts and gumption, even though I don't agree with a lot of things they do. You know, it's two kind of two separate issues there. So I don't want anybody to think that this is that, you know, they have an easy job. They certainly don't. That being said, a couple of things. I used to teach in the grad school at NYU. And one of the things we used to talk a lot about was leading, lagging and coincident indicators. So a leading indicator is one that actually leads GDP.

[00:29:45] A coincident indicator moves in tandem with GDP and a lagging indicator moves after GDP. And so what we do, what I always used to try to point out to the students was that investors, for some reason, have an amazing fascination with lagging indicators. I just don't get this. I mean, it's one of the things that that when we go out as a firm and we market to people, we talk about the importance of leading indicators and we follow them, blah, blah, blah, blah, blah. And, but everybody talks about lagging indicators.

[00:30:15] So what are kind of lagging indicators? Well, the CPI is a lagging indicator. The unemployment rate is a lagging indicator. Think how much attention those two get. And they're lagging indicators. What's another lagging indicator? The Fed. The Fed is a lagging indicator. And Janet Yellen used to talk about this. She used to say, we're going to become data dependent. Now, I always love that phrase because what were they before?

[00:30:41] Were they just winging it and all of a sudden this is something new and now they're data dependent? You know, no, they were always data dependent. But what that statement really means is that they were going to get the data, they were going to analyze the data, and then they were going to, keyword, react to the data. That's the definition of a lagging indicator.

[00:31:01] So whereas Wall Street always treats the Fed as being the initiator of something, at our firm, we've always treated them as the reactor, not the initiator. And so I think that's very important for investors to understand that, you know, maybe if you're a hedge fund in your day trading, I get the Fed announcement is going to be very important. I understand that. But from an investment point of view and a portfolio construction point of view, you cannot treat the Fed as a leading indicator. They're very much a lagging indicator.

[00:31:31] Second thing is, I think the Fed right now is kind of caught between a rock and a hard place. And that's what I was saying before. This is a tough job because the Fed was spoiled for many, many years by that deglobalization, secular disinflation, deflationary force that was put on the United States. So we all thought that, like a lot of the Fed chairmen were fantastic.

[00:31:53] It was they couldn't go wrong because even if they completely messed up, you saw this massive disinflationary force keeping inflation under check. Well, as deglobalization takes effect, the Fed's job gets harder now because now the secular trend isn't disinflation. The secular trend is inflation. So they can't play the hero anymore.

[00:32:17] In other words, they can't, you know, the whole notion of the Greenspan put and all this kind of stuff, the Fed put that people like to talk about, how when the market goes down, the Fed saves the day. The Fed can't really do that now because inflation expectations are rising. You know, secular inflation may be rising. That handcuffs them a little bit. So they're caught between a rock and a hard place in that the economy might be weakening because of might weaken rather not be weakening, but weaken because of tariffs.

[00:32:47] We may hurt the consumer on that. But at the same time, inflation expectations are going up. Which do they choose now? They have to make a choice. Do they want to fuel inflation and maybe save the consumer or do they want to fight inflation and maybe cause a recession? Now they're going to have to earn their keep. It's a much different world to be a Fed chair than it was 10 or 15 or 20 or 25 years ago. If Rich Bernstein was Fed chair, what would the Bernstein put be?

[00:33:16] Rich Bernstein is Fed chair. Number one, I can assure you that's not happening. I do not. One, I probably wouldn't do it. And two, I certainly don't have the political connections to make that happen. But what would I do in this environment? Look, I think not being cruel. I'm not trying to be cruel. Through time, historically, people have hated central bankers. And the reason people hate central bankers is they're tightwads.

[00:33:45] And they're tightwads because the most critical thing in an economy is to not allow inflation to creep into the economy. It's really not the job of the Fed to save the day. That's the job of the fiscal side of the equation, to have appropriate policies in place to alleviate pain during a recession. That's not really the Fed's point of view. Now, if the banking system gets in trouble, then, yes, the Fed should be easing and making sure there's adequate liquidity in the system.

[00:34:13] But if it's just unemployment going up and there's inflation going up, I think they have to err on the side of inflation. You can tell from that comment that my central bank hero was Paul Volcker, right? Because I think he set us on a path for long-term disinflation. And I think that's what a central banker should really try to do through time is kind of be a tightwad. Your role is not to be generous. We'll accept that as your formal submission for throwing your hat in the ring for that role.

[00:34:43] You had this great piece on your site, and we want to ask some questions. The first one, and this goes right back to the leading lagging coincident question, is a recession looming? Is that what's up next for the United States? So a couple of things on that. Number one, throughout my entire career, the consensus economic forecast has never, never correctly forecasted a recession.

[00:35:08] Recessions are always, for the consensus, recessions are always a surprise. And so the way I would think about that is how many people forecasted the 2008 financial crisis and the recession? Like nobody. One of my colleagues did, and he was like persona non grata on the street. It's usually a surprise.

[00:35:28] So if you couldn't forecast 2008, which was like the mother of all recessions in our lifetimes, I don't think we should expect the consensus to correctly forecast even a mild recession when and if it happened. So the fact that the consensus has rolled towards this recession, inevitable recession forecast is probably good news, to be honest. That being said, and I think it's hard not to feel like if there's not going to be a recession, that growth is going to be slower than people think.

[00:35:59] Right. I just don't understand that if tariffs are put in place, it is – well, let me rephrase this. We are seeing – if everything goes according to plan, we will see the most restrictive fiscal policy in our lifetimes by an order of magnitude I can't even imagine. You've got doge and all the cutbacks on fiscal spending. At the same time, you're raising tariffs, which is a tax on the consumer.

[00:36:27] To do both at the same time seems, as I used the word I used before, very ham-handed. Right? I get the point about cutting and shrinking the size of government. I get that. I can't imagine anybody would argue against that. We could argue whether it's the right programs or the wrong programs. That's a whole different story over beers. But who doesn't think that there's got to be some waste in Washington, D.C.? Of course, there has to be. How could there's waste in my little company? Right? I mean, there has to be waste in a big enterprise like that.

[00:36:54] But to do both in the magnitude they're being done at the same time is an amazing contractionary fiscal policy. And, you know, I don't see how that speeds up growth. That's kind of the way to think about it. And, you know, as we get towards mid-year, as I said before, we're going to have another one on top of that. And that is corporate profits growth is going to start rolling over. So, you know, is there going to be a recession? I don't really know. But the probability has to be going up.

[00:37:23] Or at least, if not a recession, the growth is going to be for many quarters weaker than people think. And that shows up in the market multiples and everything else, right? Absolutely. That's uncertain. Okay. Yep. All right. Well, if, you know, Elon's out of work anytime soon and he shows up at RBA looking for a job to help you crack down on those costs, we pray for you. I'm not sure that's going to happen. Well, let's turn our eyes overseas because I think this is one of the other big tariff takeaways right now.

[00:37:51] Are non-U.S. stocks finally attractive enough to warrant some investor flows? Yeah. So it's a really interesting question because one of the things I try to get our investors to understand is that we at RBA, we don't think like economists. We think like investors. And everybody goes like, well, what does that mean? Isn't it one and the same? No, it's not. So an economist would say, what's the difference between the U.S. economy and the European economy?

[00:38:19] And then you hear all the stories about slow growth and everything else is going on in Europe and all these kind of things. At RBA, we ask the question, what's the difference between the U.S. stock market and the European stock market? That's a slightly different question, subtle, but slightly different question. And the answer to that is that Europe doesn't have a big tech sector. And so if you think about what's been driving the U.S. market for the last two, three, four years, five years, it's really been tech. It hasn't been the U.S. economy.

[00:38:48] It's been tech and tech stocks that have been driving the U.S. stock market. And so we just simply said, look, if you look at the world ex-tech, whether you're looking at Europe or you're looking at emerging markets, you're looking at the equal-weighted S&P, right? You look at all these other ways that people look at the world. They're all valued very similarly, and their performance has actually been very similar.

[00:39:15] So, and this may be the if in many people's minds, if technology falls out of bed and if it becomes, if it falls out of favor and goes into, say, let's say some kind of secular doldrum, which I kind of think could happen, might these other sectors of the U.S. economy, other sectors of the global economy perform better and therefore you'd want to be diversified around the world?

[00:39:41] I mean, the simplest way to look at it is to simply say we've got seven or 10 companies and then we've got everything else in the world. So if you're going to say everything else in the world, wouldn't that include non-U.S.? My answer would be yes, it would include non-U.S. Well, speaking of seven things and then everything else in the world, you shared this chart, which was basically the top 10 wealth management stocks and their one-year beta relative to the S&P.

[00:40:09] And I don't know if it's your word or Professor Damadaran's word, but diversification turning into diversification comes to mind. Right, exactly. So let me just correct one thing you said there. That chart of the beta is the 10 largest stocks in private client portfolios, the most widely held stocks in private client portfolios. That's what's really there.

[00:40:32] And the interesting thing is if you go back to the beginning of the bull market in 2009, the secular bull market, which by definition is the period where there's the most opportunity, the beta was 0.75. Right? So a beta of one, just in case people aren't familiar, beta of one would say you're taking equal risk to the market. 0.75, you're taking considerably less risk than the market. But at the beginning of the bull market, you should be taking like boatloads of risk. But no, everybody was under their desk in the fetal position. Fine. Okay.

[00:41:01] We started writing about that, I don't know, let's say a year, two years ago when the beta hit 1.25. And we said, whoa, you know, 0.75, 1.25. They're taking as much risk now as they were not taking risk before. This is kind of interesting. And the 1.25 went to 1.4 and the 1.4 went to a totally mind-boggling 1.7. Right? And I will, you know, people are familiar. I will guarantee, you can't use that word, but I'm going to use that word.

[00:41:31] I will guarantee you, you will not find a pension endowment and foundation in the world that runs an equity beta of 1.7. That is just a massive amount of equity risk in a portfolio. But that's what private client investors were doing. Right? They were so certain that this is a sure thing. And so, you know, now I'm going to quote the renowned philosopher Mike Tyson and say, you know, everybody's got a plan until they get punched in the mouth.

[00:42:00] That 1.7 said that everybody had a plan. They thought it was easy. Right? I can trade. I know what I'm doing. And then they just got punched in the mouth. And, you know, what are the things you're supposed to do to build wealth? But one of them is diversification. But people were saying to me, a number of people said this exact word to me. Isn't diversification now diversification? That is just a lead weight on performance. And why would anybody diversify?

[00:42:26] Well, that's that 1.7 beta talking to all of us and telling us that it's easy. And but I think right now, diversification is not only a risk reduction tool, which is how it's usually thought of. But because of the extraordinarily narrow market, it actually opens the portfolio to incredible opportunities. Right? There's more than seven growth stories around the world. So just by diversifying, you open up the portfolio to all this, all these opportunities out there. And that's what we've been trying to do. Let's just take that attitude.

[00:42:54] Well, speaking of opportunities, and this is a weird one because everybody with the DCF loves to throw this one under the bus. But it's also it's also kind of ripping lately. And I want to invoke one other Mike Tyson quote, because he is the ultimate poet philosopher for times like this. Fear is like fire. If you learn to control it, it can cook for you. It can heat your house. And if you can't control it, it'll burn everything around you and destroy you. Which I think is the bull case for gold. Siblione? Yeah, that's great. I love that. You know, like who would think that we'd end up quoting Mike Tyson?

[00:43:24] Who would think we would if you're quoting Mike Tyson? Who would think we would? Right. So gold, gold's an interesting asset class. Okay. And I want to set kind of my personal opinion here first. At RBA, we're not gold bugs. Right. I'm not advocating anybody buy gold and bury coins in their backyard. You know, all these kind of extreme things. I think that's really extreme and I don't think that's the right thing to do.

[00:43:49] But the reality is that gold has been and apparently continues to be a good hedge against uncertainty. That uncertainty can arise from inflation. It can arise from geopolitics. It can arise from the combination of the two, which is kind of what we're seeing right now. And as I said before, there's a great correlation between the small business uncertainty index and gold. It really is pretty good to hedge against uncertainty.

[00:44:15] And so in our portfolios, we pretty consistently, I don't want to say like all the time because I might be overstating it, but we pretty consistently have a little bit of gold in our portfolios to work as a ballast against volatility. And I'll be damned if it's not working again, doing exactly what it's supposed to do. So, you know, you're going to get people that are talking about, are we in a new bull market on gold? Is it time to buy gold? It's like all so exciting. And now we're going to shift from the mag seven to gold. And I think that's the wrong attitude to take here.

[00:44:45] I think the right attitude is to say, look, gold's a good ballast against volatility. If you're freaked out about volatility, maybe you want to carry a little bit of gold in your portfolio to mute that through time. And that's all that we do. So, yeah, I think we're in a good environment for gold. I don't think it's an unusual environment for gold. I think we're seeing extremes of uncertainty and you're seeing gold appreciate pretty dramatically, which seems to make perfect sense to me.

[00:45:11] Do you find yourself fielding questions about crypto and your thoughts on that and how that could fit into a portfolio? Oh, Justin, you just opened the floodgate. Right. I won't go on and tell you because we'll be here for another hour if I tell you my whole story about crypto. I think and I'm going to alienate probably a good portion of the people watching this. I think crypto is the first true global financial bubble that we have seen.

[00:45:40] I think that most financial bubbles have been regional like U.S. tech. You know, if you want to go back, Dutch tulips, right? They were very localized. Crypto is now a global phenomenon. And I think it is highly speculative. Why do I say that? The number one driver of crypto prices, Bitcoin. Let's just use Bitcoin for a second. The number one driver of Bitcoin prices is financial conditions. In other words, when there's a lot of liquidity, it goes up.

[00:46:09] When there's not, it goes down. That's a perfect sign of speculation. Now, we could argue whether it's a bubble or not. That's another story. But it's certainly a highly speculative asset. And there's nothing fundamental driving it. The second thing I will point out is that I think that crypto advocates don't understand money and banking. I think there is an incredible naivete, if I can say that without sounding too aloof about this.

[00:46:37] I think there's incredible naivete about how money and banking works and what would happen if crypto really does become a true currency. So, you know, do away with the dollar. And we're all we're all using Bitcoin. There will be Bitcoin banks. There will be Bitcoin lending. Money and banking doesn't go away. It's existed no matter what the currency has been.

[00:47:01] And there's a certain naivete about the scarcity of Bitcoin that revolves around that that lack of understanding of how money and banking actually works. And so I think the valuations are overstated by as could be could be more than a factor of 10. So the easy way to think about that is and that's just based on historical money multipliers.

[00:47:29] What normally goes on in a normal economy and how much money is created, you know, relative to that. Right. Normal money multipliers would say that the that if you think of Bitcoin, it's not trading there anymore. But if it was 100000, the if you're really an optimist about this, it should be 10000. And that's that's an optimistic valuation. If you believe that this is going to happen, because decentralized finance would argue the money multiply should be even higher.

[00:47:59] Second thing I would point out is that there's a whole arsenal of people that believe that decentralized finance is fantastic. I would encourage them to understand why we have centralized finance, that the history of decentralized finance is pretty bad. This is not there's nothing unique. Nobody's come up with this smart idea out of nowhere.

[00:48:20] This has been tried many times in history and it consistently fails and fails big time, which is why you have central banks to prevent that from happening. So as you can tell, I'm not the biggest fan of cryptocurrencies. We'll get those laser eyes in the cover. Right, Justin? Oh, no. Diamond hairs. Yeah.

[00:48:42] One of the things that we've talked a lot about, specifically with Mike Green from Simplify, is the rise of passive investing and how that has influence on the largest stocks in the market. Do you have any thoughts and opinions on that? So I a couple of things. Number one, Jack Bogle was one of my heroes when I was like in business school. And I was fortunate enough to meet him a couple of times during early parts of my career.

[00:49:11] And I have an amazing amount of respect. I mean, I think he was one of the there aren't as many as people, but he was really one of the one of the forefathers of modern investing. There's no there's no doubt about that. And and however, one of the things in one of the books I wrote, one of the things I pointed out was that Jack would never tell you. He would say, go buy an index. What he would never tell you is what index to buy and when.

[00:49:37] And that's actually a pretty critical question, because, you know, if you had bought NASDAQ at the peak of the bubble, it took you 14 years to break even. But if you had bought an emerging market index fund, you would have been fantastic. You would have had a great old, great old time where you bought the energy spider. You would have had a grand old time for that decade. But if you bought an S&P index fund, you had negative returns for a decade. So to say I'm just going to hold an index fund, it doesn't quite always work that way.

[00:50:02] And and right now, when we've got such domination of of, you know, such a narrow market, buying an index fund basically gets you exposure to these tremendously overvalued stocks and doesn't get you exposure to everything else. So I think one wants to be a little careful about that. I've always taken issue with the notion that index funds drive narrow markets.

[00:50:25] I don't think that's actually right, because if you're buying an index fund, the index fund buys everything in proportion. It's not like they're buying just the mag seven and therefore the mag seven are going up relative to everything else. If you're buying an index fund, it should be neutral relative to everything's out there. And now one could argue that the less liquid companies don't know, you know, there's all kinds of ways you can argue against it.

[00:50:51] But I don't think in a grand scheme of things, that's what's actually going on. I think it is much more that that people really took a speculative liking to a very narrow universe of companies. And so I'm not against indexing. I think right now is a very bad time to hold like an S&P index fund or a growth index fund. I said that before.

[00:51:12] But, you know, if you're talking about something like an equal weighted where you're talking about emerging markets, you're talking about Europe, you're talking about ACWI, XUS, there's plenty of index-like products that you could invest in and probably get pretty good returns. So we have two standard closing questions. I can either ask you both of them or I can ask you one with the promise that you'll come back again in the future where we can ask you the other one.

[00:51:41] I'm your guest so you can set the table however you'd like. All right. So I'll do the one and hold the other one out for hopefully another future conversation because this has been great. So based on your experience in the markets, if you could teach one lesson to your average investor, what would that be? Oh, one lesson. Okay. So here's what I tell everybody. And I wrote a book about this 20 years ago or something. It was called – imagine this. This was 25 years ago.

[00:52:09] I wrote a book that was called Navigate the Noise, Get the Subtitle, Investing in the New Age of Media and Hype. That was 25 years ago. Okay. So more appropriate today than it was 25 years ago. And what the book basically argued is that building wealth is not difficult. It's actually very easy. So why don't people do it? And the answer is that there's always a siren song of something new, better, sexier, something.

[00:52:37] And to continue on the Greek mythology there. And then people go and they crash on the rocks. Right? And so why don't – we know that certain things are critical. Like we know that diversification helps you build wealth. People don't want to do it because now there's the MAG-7, something new, better. We know that compounding dividends is a fantastic way to build wealth through time. People don't do it because who wants dividends? That's so boring. Right? Why do we want dividends? You know, things like that.

[00:53:06] So I think, you know, there are – my advice to individual investors has always been to keep to the straight and narrow. Right? If you want to have a little puddle of money over here that's your more speculative play money, that's fine. I get that. I mean, we all do that. That's fine. I have mine. I'm not going to share with you the stuff that I blow up in like everybody else, but that's fine. Right?

[00:53:32] But the bulk of your wealth building should stick to the straight and narrow. And, you know, just keep it simple. Think about the rules. And I just think people don't do that. They always think there's a get-rich-quick. And there's never a get-rich-quick. It just doesn't work. I mean, that's sage-like advice. And I just have to say some of the great expressions now that I'm taking home while I wait for you to come back

[00:53:58] to answer the other closing question, the unprecedentedly ham-handed market. I think that's a good feel on this one. I love this expression of how you fight tariffs as you puke your treasuries. That's evocative. I'm going to start using levered up the schnoz more often. Yeah, that's a good one. I think levered up the schnoz really captures something almost Shakespearean. And I don't know why I didn't realize it now. Like the armchair Fed quarterback or whatever.

[00:54:26] Like the armchair Fed chair is a word that we should start using far more often as people are critical in that institution. You know? I mean, look, I know in my heart that I could be quarterback of the New York Jets, right? And I know exactly what to do and every down and everything. But somehow the Jets haven't called me yet. Maybe they should actually now that I think about it. I know. Some of that spare capacity around RVA, you could just throw that in. Get it on the CV too. I'm ready. Well, Rich Bernstein, thank you so much for joining us today.

[00:54:54] We'll put links to all the places to find you in the comments and we'll see you real soon. Thanks, guys. Much appreciated. Thanks so much for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on YouTube or your favorite podcast platform or leave a review or a comment. We appreciate it. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the participants or their clients.