So all in all, how do you view the market right now?
We’re about where valuations were in 2003. We’ve bounced back a little bit. Stocks are certainly not cheap by any definition. We’re looking at low expected returns in just about every asset class you’d want to own. So what does a smart person do? You diversify and own a big slug of both stocks and bonds. It’s not rocket science. We can’t predict the future, so we diversify.
What is your sense about emerging markets these days? Are they overcooked?
One of the basic rules of thumb of investing is that when everyone thinks something is less risky and is going to have higher returns, it’s almost always wrong. The time to buy an asset class is when it can’t be given away. The wonderful thing about emerging markets is that they can get terribly cheap from time to time. That sure happened a year ago, but they’ve now doubled in price and they’re no longer cheap. This asset class has lost two-thirds of its value twice in the past decade-and-a-half.
The one thing I absolutely don’t buy is that because these countries have high growth rates, they’re going to have high equity returns. There’s a great big disconnect between those two concepts. One problem is share dilution and another is outright theft by the controlling owners. A country that doesn’t protect its own children from lead-painted toys cannot be expected to protect the interests of minority shareholders.
What are your thoughts about what’s going on the indexing industry, given how hot ETFs are?
I’m basically in Jack Bogle’s school of thought, which is that in theory the ETF is a great idea. You’ve got all these vehicles out there that have low cost. But in practice, they’re being used as speculative tools. Some of them are silly, some are dangerou, and some, such as inverse and leveraged ETFs, are downright criminal. These are devices which, because of their huge variance drag, have an expected return in a flat but volatile market of something like negative 70 or 80 percent a year.
So you’re broadly in support of the SEC putting the brakes on approval of any exemptive relief filings for companies wanting to offer leveraged ETFs?
I don’t think they’re being vigorous enough. I think criminal and civil charges against some of the providers are in order. I mean, what is this concept that an investment can only be used for one day? This is not an investment. Who has the predictive power of knowing which way the market is going to go on one day?
If leveraged and inverse funds are emblematic about what’s wrong with indexing, what makes you smile about the world of ETFs?
I don’t know that any of it makes me smile, because I don’t really know how any of them are being used. I’m agnostic on the position. To the extent that people are using them more for speculation than for long-term investment, it’s a horrible thing.
What would be your advice to young investors, kids just getting out of college and in their first jobs?
Take your time and use that time to inform yourself. Read John Bogle, read Burton Malkiel; learn about the mendacity of the financial-services industry and learn about the basics of asset allocation. Get your feet wet very slowly, and encounter your first bear market with a relatively low equity allocation, say 30 or 40 percent. Then, slowly through your young adulthood raise your allocation to where your real risk tolerance is. You become a lean, disciplined investor that way.
But that’s not the way most people approach it. The worst thing you can do is to invest all your 401(k) assets at age 20 into the best-performing equity fund in your plan and then five years later watch that $30,000 get cut in half. You’ll swear off stocks for the rest of your life.
Young people aren’t terribly risk tolerant. There’s a wonderful expression that Navy pilots use to describe their first landing on an aircraft carrier: It’s like losing your virginity and being in a car crash at the same time. In the same way, your first experience with a bear market is something you’ll never forget.