The transcript from this week’s, MiB: Richard Bernstein, CEO/CIO at RBA, is below.
You can stream and download our full conversation, including any podcast extras, on iTunes, Spotify, Stitcher, Google, YouTube, and Bloomberg. All of our earlier podcasts on your favorite pod hosts can be found here.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have another extra special guest, Rich Bernstein is a legend in finance circles. He was the chief investment strategist at Merrill Lynch where he worked for more than 20 years. He launched his own firm right into the teeth of the collapse in ’09, which turned out to be quite a fortuitous time to launch an asset management shop. He is a macro top-down guy with a strong quantitative background.
If you’re at all interested in thinking about asset allocation, top-down analysis, how to think about the world of investing, not as a stock picker, but as a broad macro perspective, none better than Rich Bernstein. I found this conversation to be fascinating, and I think you will also.
With no further ado, RBA’s Richard Bernstein.
Let’s start talking a little bit about your career. You get a BA in Economics from Hamilton College. You get an MBA from NYU. You go to a few firms before you end up at Merrill Lynch in 1988, not too long after the crash.
RICHARD BERNSTEIN, CEO & CIO, RICHARD BERNSTEIN ADVISORS LLC: Correct.
RITHOLTZ: Tell us a little bit what Mother Merrill was like in the late ‘80s.
BERNSTEIN: So Merrill was a fantastic place to work. As you pointed out early in my career, I bounced around a bunch of investment banks, and what I learned through time was it was important when I interviewed the investment bank, it was for them to interview me. Each investment bank had a different corporate culture, and it was clear that some of them I liked and some of them I didn’t. And Merrill was just a fantastic corporate culture. It was Wall Street, so I don’t want to make it sound like we were all best buddies or anything. But it was a very collegial, very success-oriented culture. It was a great place to work.
RITHOLTZ: So what was your first job there? Did you start as an analyst or incumbent? What did you come in then?
BERNSTEIN: So truth be told, I actually lied about my age to get my first job —
RITHOLTZ: Get out of here.
BERNSTEIN: — because back then you could ask people how old they were.
RITHOLTZ: Right.
BERNSTEIN: And I was 29 and I knew that if I told people I was 29, they would think I was a kid. So I told them, I was 30, you know, the 29.99 thing.
RITHOLTZ: Right.
BERNSTEIN: So by the time I actually get the —
RITHOLTZ: You went the opposite direction.
BERNSTEIN: I did.
RITHOLTZ: You round it up.
BERNSTEIN: I round it up.
RITHOLTZ: That’s very fun.
BERNSTEIN: Yeah. And so by the time I got there, I was 30, but —
RITHOLTZ: To be honest, I mean, what does a 29-year-old know? By the time you’re 30, you’ve got it all figured out.
BERNSTEIN: Exactly. That’s what I figured. So I was hired to be the quantitative analyst. This was in the late ‘80s. Quantitative analysis was really starting to gain momentum and everybody thought they needed a quant of one form or another. And I’m not sure Merrill knew what a quant did back then, but they knew it was a slot that got voted on an institutional investor and they wanted an analyst —
RITHOLTZ: Right.
BERNSTEIN: — to fill the slot. And I was probably the cheapest —
RITHOLTZ: Right.
BERNSTEIN: — and that’s how I got the job.
RITHOLTZ: No empty seats at the table.
BERNSTEIN: All right. Exactly.
RITHOLTZ: I don’t know if we’re going to win, but let’s at least get nominated.
BERNSTEIN: Exactly. So, you know, I figured I was there. But what was interesting, and I think, you know, for anybody who’s listening who is starting as a young person in this industry, I think what I did learn was I took some of my experiences from business school and the business school case studies, and there were a lot of very established senior analysts at Merrill. And the question was, how was I going to make an impact, right? Who’s going to listen to the 29, 30-year-old guy, when you’ve got guys that are, you know, 50, 55, 60 men and women? They’re 50, 55, 60, have multiple cycles, tons of experience, some of the best in the industry. Why would they listen to me?
And so, I quickly figured out I couldn’t do what everybody else was doing. I had to find something different and I had to find a niche. And in the ’89, ‘90 recession, value managers did very, very poorly, and I just figured if I could help those value managers, it would solve a problem and it would create a need for my work, and that’s how I started.
RITHOLTZ: All right. So obvious question, it’s 1990, technology is about to explode, how do you help a value manager short of saying, psst, go buy growth?
BERNSTEIN: Yes. So —
RITHOLTZ: Like, what did you do?
BERNSTEIN: Yeah. So what we did was we figured out the economic rationale, the macroeconomic influences about why growth and value work at any point in time. And so, even if value managers weren’t going to outperform, they could explain to their investors what was going on and why value was out of favor, and they could point to our work as an independent source, not their own marketing people defending their work. And so, in the ‘90s, you know, the middle part of the ‘90s was kind of value-oriented. But you’re right, Barry, as we got to the late part of the ‘90s, nobody cared about value.
RITHOLTZ: That whole irrational exuberance era from ’96, from the speech to 2000, that could be the best four-year run in market history.
BERNSTEIN: It was crazy. It was really crazy. And I think, you know, the way you can tell when equities are expensive is by the investment banking activity, because nobody sells a company when it’s cheap. Everybody wants to sell a company when they get a good valuation. And so, the investment banking activity started to explode.
RITHOLTZ: Right,
BERNSTEIN: It was like mushrooming like crazy and people couldn’t get enough, and that was a pretty good warning sign as to what we were heading for.
RITHOLTZ: So you start as the head of quants, a department of one. How do you go from that to chief investment strategist? What is that career path like?
BERNSTEIN: So it wasn’t a straight line, I can assure you. I went from being the quantitative analyst to being the manager of quantitative analysis, to being the quantitative strategist, to being the chief U.S. strategist, to being the chief quantitative strategist. And you know, each step along the way —
RITHOLTZ: Same office, same department? Like, they just changed the business card?
BERNSTEIN: No. Unfortunately, I got more responsibility, bigger staff, and eventually a bigger office, yes, and everything that comes along with that. But it took a while. That’s a 20-year career, right? I mean, as I said, Merrill was a good place. If you worked hard and you did well, you were definitely rewarded at a place like Merrill.
RITHOLTZ: So you’re there for 20 years, from 1988 to 2009. And you say, you know, I think now is the time to go hang my own shingle, given this whole financial crisis we’ve just been through.
BERNSTEIN: Right.
RITHOLTZ: What was that experience like, launching a firm right into the teeth of that mess?
BERNSTEIN: Yeah. So, you know, 2009, what had happened was I was very burnt out. I mean, being a sell side strategist is a very, very difficult job.
RITHOLTZ: You’re on the road a lot.
BERNSTEIN: I was on the road 40 percent, 50 percent, 60 percent at that time —
RITHOLTZ: Wow.
BERNSTEIN: — depending on what time and year it was, or something like that, all around the world. And you know, I actually remember when this kind of hit me. I was in Taiwan for like, you know, 20th time or whatever it was, and a lot of my colleagues are going out and they said, do you want to come out? I said, no, I’m just going to watch TV. And then I’m watching TV and I realized I’m in one of the greatest cities of the world, I’m in Taipei, and all I want to do is watch TV. There’s something wrong with my life. And that’s when it kind of hit that I need to do something else.
And so the question was what was I going to do? And I just figured, yeah, this stuff I’ve been telling everybody to do for all these years, let’s see if it actually works. And I figured let’s start a firm. Now, why then? Well, I really thought and I think some of my associates thought that 2009 was a major market low. We were going to enter one of the biggest bull markets of our careers. And we simply thought, if you’re going to start a firm —
RITHOLTZ: Now is the time?
BERNSTEIN: — now is the time.
RITHOLTZ: Yeah, absolutely.
BERNSTEIN: And —
RITHOLTZ: How often in the U.S. it’s down 56 percent in equities? Not a good entry.
BERNSTEIN: Yeah.
RITHOLTZ: 29.
BERNSTEIN: Yeah.
RITHOLTZ: 32 kind of you felt the pain, but, still —
BERNSTEIN: Absolutely.
RITHOLTZ: — anytime U.S. equities are cut in half, not a bad entry.
BERNSTEIN: No.
RITHOLTZ: And people were not only figuratively, but literally under their desks in the fetal position. And when we started our firm, what was very interesting and really kind of confirmed what we were talking about was the people would refuse to invest with us because we were too bullish.
RITHOLTZ: Now, keep in mind, I know you and David Rosenberg —
BERNSTEIN: Right.
RITHOLTZ: — as the twin bears.
BERNSTEIN: Absolutely.
RITHOLTZ: Right? Rosie, who’s been on the show a couple of times and now runs Rosenberg Research, was the chief economist. You were the chief strategist.
BERNSTEIN: Correct.
RITHOLTZ: And in the mid-2000s, right, arguably a little early, but not that early —
BERNSTEIN: Yeah.
RITHOLTZ: — you guys were like Uber bears, and you were wrong, wrong, and then wildly right.
BERNSTEIN: Yup.
RITHOLTZ: So it’s funny to hear someone say, that Rich Bernstein guy, way too bullish.
BERNSTEIN: Yeah. It was shocking. I mean, it was something I didn’t expect. But people, literally, would not invest with us because we were too bullish. They wanted to hear a bear story post 2009. They wanted to be cautious. And our marketing materials, if you go back and look, our marketing materials from 2009, ’10, ’11, ‘12, you’ll see little things about what we call fire extinguishers that we’ve put in the portfolio, things you could pull off the wall in case there was an emergency, to put out the fire in the portfolio. And that was a key part of our marketing back then.
RITHOLTZ: So when you launched the firm, obviously, it was macro-focused. Also, how quantitative was it in 2009 and ’10? You’re still bringing the same tools —
BERNSTEIN: Correct.
RITHOLTZ: — the same philosophy along with you.
BERNSTEIN: Correct. So what we did, the way our firm works is that we are very much active managers. We don’t know anything about Coke versus Pepsi. You know, I don’t want to lead anybody astray who’s listening.
RITHOLTZ: You’re top-down macro, not bottom-up schedule stock selection.
BERNSTEIN: Completely, completely. We do know individual stock selection. When we form portfolios of individual stocks, we’re always forming baskets of stocks. Think of it as we’re forming our own ETF, so to speak. That’s what we’re doing. And so what we do is we combine a process-driven macro assessment with quantitative portfolio formation. So we want to know what the risks we’re taking. You know, it’s always good to say like, oh, you should go do this from a macro perspective. The question then is can you actually do it? And so —
RITHOLTZ: Meaning, can you express that investment thesis in a portfolio?
BERNSTEIN: In a portfolio, without taking ridiculous amounts of risk. And so what we do is we balance out those macro views with the risk assessment, the quantitative assessment, to form a realistic portfolio.
RITHOLTZ: And how has that been working out?
BERNSTEIN: Knock on wood, we’ve been doing okay.
RITHOLTZ: Yeah.
BERNSTEIN: I think —
RITHOLTZ: Well, 2022, clearly, was a macro investors paradise —
BERNSTEIN: Yes.
RITHOLTZ: — at least if you got it right. And it’s no fun when you’re the macro tourist in the wrong place.
BERNSTEIN: Correct.
RITHOLTZ: But you’re bringing a certain discipline and quantitative analysis. We’ll talk in depth more about your process, but it’s late ‘21, S&P up 28 percent from the previous low, from the COVID low in 2020. I think the S&P gained 68 percent to finish the year. So up 18 or 19 percent for the year, you see those spectacular numbers. What does that do to your macro perspective —
BERNSTEIN: Right.
RITHOLTZ: — heading into 2020? Oh, when inflation is ticked up through 2 percent in March —
BERNSTEIN: Correct.
RITHOLTZ: — and has begun to really move higher in ‘21.
BERNSTEIN: Right. So what people forget is going into the pandemic, the U.S. economy was actually starting to slow and slow pretty dramatically. Nobody remembers that anymore because of the pandemic, but that was starting to happen. And so we —
RITHOLTZ: Yield curve inverted?
BERNSTEIN: The yield curve inverted.
RITHOLTZ: There was some definite expectations —
BERNSTEIN: Yeah.
RITHOLTZ: — of a recession?
BERNSTEIN: Profits were slowing very dramatically. Employment growth was negative year-on-year. I mean, all these things were starting to happen. So we were calming down the risk in our portfolios, becoming more and more defensive. Obviously, when the pandemic hit, we did very well. Not that we saw the pandemic coming, but we saw the economy slowing, and so we ended up doing very well. A little bit of luck, I will readily admit on that one.
Then coming out of the pandemic, we were very defensively positioned, and we weren’t sure what was going to happen. There’s no playbook for pandemic. You can’t go back and say, like, well, how does the macro economy respond after a pandemic? There’s no cycle.
RITHOLTZ: ’19, ‘18 wasn’t a big help (ph).
BERNSTEIN: No, we couldn’t —
RITHOLTZ: No guidance set?
BERNSTEIN: No. Zero guidance. So we just decided, as a group, we said, look, if we’re going to be wrong, what’s going to benefit the most from that environment? What’s a 180 degrees away from where we are positioned right now, let’s own some of that, in case we’re completely wrong. 180 degrees away from what we were owning was energy.
RITHOLTZ: I knew you’re going to go there. Yeah.
BERNSTEIN: Right. And so —
RITHOLTZ: Which had a fabulous last year.
BERNSTEIN: Fantastic. I mean, it was incredible.
RITHOLTZ: Which is surprising given that oil was negative on year —
BERNSTEIN: Yeah.
RITHOLTZ: — which always shocks people.
BERNSTEIN: Yeah. You know, if you think about ‘21 to ’22, ’21, well, at one point, actually was priced with a negative sign in front of it. I don’t understand how anything could be priced with a negative sign, but sure enough, it did. And you know, some of the major oil companies had 8 and 10 percent dividend yields and things like that. So we just figured, okay, if we’re going to be wrong, let’s not take a lot of risk. This seems like a good opportunity. That’s played out very well over the last couple of years.
But I think, you know, for us, 2021, in general, towards the end of the year got very hard, right? We had a big speculative burst in the marketplace. You know, it was all about tech innovation, disruption, cryptocurrencies. It couldn’t be sexier, you know, that type of thing.
RITHOLTZ: Right.
BERNSTEIN: And so that’s not us. We’re not momentum investors at all. And so we lag there. But then 2022, when the momentum faded, as the Fed was tightening and monetary conditions changed, and profits began to slow, we did very, very well.
RITHOLTZ: So the question I have about that environment; you have all these conflicting crosscurrents happening at the same time. Employment is strong, but rates are going up. Margins are falling, but lots of companies seem to be able to pass along input costs to their end consumers. And the consumers had plenty of stimulus money in their wallets. They continue to spend. As a macro strategist, how do you look at all these seemingly cancelling sine waves —
BERNSTEIN: Right.
RITHOLTZ: — to get to the —
BERNSTEIN: Exactly.
RITHOLTZ: — signal amongst the noise to paraphrase —
BERNSTEIN: Absolutely.
RITHOLTZ: — your book?
BERNSTEIN: So I mean, the first thing that one has to do in the current environment is understand that the central bankers in the 1970s were not stupid, right? They were faced with varying pressures. They were faced with some of the conflicting data that you’re talking about, Barry, and obviously lots of politics involved as well. And I think the thing we ought to remember is that fighting inflation is not easy. There’s this kind of notion that, okay, the Fed has raised rates, the worst is behind us, it’s all over. Well, it will be fine. We can go right back to where we were.
History says it’s not quite the way it works. And so, I think in the current environment, you have to kind of understand that we’re reliving the past to some extent. And I’m not sure it’s an evolution. I’m not sure we’re any smarter than we were in the ‘70s, that the same pressures and the same conflicts and all that kind of data is still there. So I think that, you know, our story has been that the Fed will be tighter for longer than people think, that this tightening cycle is not going to end quickly.
And right now, I think the biggest thorn which you point out, Barry, is the labor market. That is a huge thorn in the Feds side. You know, I think if we had said this going into this, the Federal Reserve would raise interest rates more than 75 basis points, what would happen to the demand for labor? We would all say it would fall over? Well, the demand for labor has actually gotten marginally stronger. I mean, it’s crazy to think that way, but that’s kind of what’s going on. So that is a big thorn in the side of the Fed. And I think that if you think about what it means to weaken the labor market, and what that means from the political side, you can then start understanding the crosscurrents that are facing the Fed right now.
RITHOLTZ: Really interesting. Let’s talk a little bit about that model, kind of similar to what you did at Merrill. Tell us about who you work with, who your clients are.
BERNSTEIN: Right. So our clients are financial advisors and institutions, as you point out. And the methodology we use is very similar to what we originally constructed at Merrill. I mean, the original research was like the early 1990s. We’re now on sort of, you know, the fifth or sixth or seventh generation of that original research.
But, you know, my goal always, as a researcher, was to try and understand what the macro influences were on the stock market. You know, most people try to look at individual stocks, and they try to figure out why Company A is outperforming Company B, and they forget about the macro influences. And so my job has always been to try and figure out what in the macro environment is causing things to happen. And my attitude has always been if you can understand that and you can identify what the macro causes are, you can generally take advantage of that in the marketplace.
RITHOLTZ: So you describe your firm’s quantitative approach as really having three drivers; profits, liquidity, and sentiment.
BERNSTEIN: Correct.
RITHOLTZ: So let’s talk about all three. Obviously, profits, very important to company valuation —
BERNSTEIN: Absolutely.
RITHOLTZ: — growth metrics, growth, all those sort of fun things. So I don’t know how much detail we have to deal with the profits. Let’s talk a little bit about liquidity and sentiment. What do you look at when you’re looking at liquidity?
BERNSTEIN: So liquidity, Barry, we look at liquidity conditions in roughly 40 or 45 different countries around the world. Obviously, you get more detail in the United States than you wouldn’t in an emerging market, but we still look at about 40 or 45 different countries. Liquidity is really necessary for people to take risk. And so what you want, you want to look at corporate profits because you want fundamentals to be improving, of course, but then you want to have liquidity so that people can take advantage of those improving fundamentals.
And so what do we look at to gauge liquidity? Well, we look at central bank policies, of course. We look at slopes of yield curves. We look at banks’ willingness to lend. Because remember, central banks, at least in true capitalist economies, maybe not so much in a command economy, but in a true capitalist economy, the central bank can only set the table and they can’t force banks to lend or stop lending. You know, we all hear about the lags of monetary policy. That’s one of the reasons why there were lags.
So the Fed could lower interest rates, it doesn’t guarantee the banks are going to be willing to lend at the moment they lower interest rates; or they can raise interest rates, it doesn’t mean the banks are going to stop lending the second they raise interest rates. So we look at how banks are acting and the willingness of banks to lend as well.
RITHOLTZ: So I have a vivid recollection back in the days when I was on a trading desk, M3 would come out, money supply would come. I don’t even know if we report M3 anymore.
BERNSTEIN: No. It’s M2 now.
RITHOLTZ: Right. I think it’s M1, M2, M3. M3 was the narrowest? The broadest?
BERNSTEIN: The broadest.
RITHOLTZ: The broadest. Right. I don’t remember. But nobody talks about money supply anymore in those terms.
BERNSTEIN: Right.
RITHOLTZ: But that, theoretically, was liquidity that would find its way into stock markets. When you talk about liquidity, how do you think about the dollar and the availability of —
BERNSTEIN: Sure.
RITHOLTZ: — free capital?
BERNSTEIN: Sure. So, you know, it’s kind of interesting. Even relative to the last cycle where, you know, money growth, M2 growth, getting back to your question before, M2 growth got up to about 27, 28 percent, which was the highest in history that we can find. It put the United States on par with Peru at that time, just to put it in proper perspective. And given that during the pandemic, not a lot of business was going on.
RITHOLTZ: Right.
BERNSTEIN: So you had tons of liquidity going into the economy, and really no place for it to go.
RITHOLTZ: Right.
BERNSTEIN: So that means it’s going to go to savings. If it’s going to savings, where is it going to end up? It’s going to end up in the stock market. And I think that was one of the reasons why we saw the bull market develop much more quickly than people thought through the pandemic, post pandemic. Yeah.
RITHOLTZ: Makes a lot of sense. And last is sentiment. So there’s always a challenge looking at sentiment because it’s so noisy, except that extremes. How do you use sentiment in —
BERNSTEIN: Right.
RITHOLTZ: Or am I wrong? Is that the —
BERNSTEIN: No. You’re spot on that. And we tend to fade some of the more accepted sentiment indicators.
RITHOLTZ: Oh, really?
BERNSTEIN: The kind of short term, you know, put call ratios, things like that.
RITHOLTZ: Do you recall odd lots was a big deal years ago?
BERNSTEIN: Right.
RITHOLTZ: I mean, all these things just —
BERNSTEIN: Right.
RITHOLTZ: — say M3 odd lots is like a graveyard.
BERNSTEIN: Nobody talks about it anymore.
RITHOLTZ: Right?
BERNSTEIN: And the reason why is because exactly what you point out, is that they’re so volatile. And as an investor as opposed to a short-term trader, it’s questionable as to whether you get a consistent signal, so you can actually take an investment position in that. So we tend to look at sentiment a little more structurally, by looking at various measures to try to figure out how people are truly allocating their assets, not trading their assets, but literally allocating their assets.
The other thing we do, Barry, is we group valuation as a sentiment indicator. So we do a lot of valuation work. And then some people say, well, why do you consider it sentiment? Well, you can’t have an overvalued market that people hate.
RITHOLTZ: Right.
BERNSTEIN: And you can’t have an undervalued market that people love. So valuation will reflect sentiment, and so we include valuation in our sentiment work. So effectively, we think about profits, liquidity, sentiment and valuation. What we’re looking for? Places where profitability and fundamentals are improving, there’s liquidity to take advantage of it and nobody cares. Right? That’s a pretty good combination, or vice versa, fundamentals are deteriorating, liquidity is drying up and everybody loves it. That would be a warning sign.
RITHOLTZ: That’s really intriguing. Which raises the question, which is the harder environment to stand out from? I didn’t want to ask which is more challenging. Which is it harder to draw a distinction in, where rates are low, capital is free and the market is screaming higher, or where inflation is up, rates are going higher and people are a little bit cautious?
BERNSTEIN: Right. So you know, let’s talk about it from an investment point of view and a marketing point of view for a second. From an investment point of view, the extremes are always very intriguing, right? And I think our firm is relatively indifferent, whether we should be really bullish or really bearish. But they’re both kind of very interesting periods.
From a marketing point of view, Barry, remember you pointed out on the CEO and the CIO.
RITHOLTZ: Right.
BERNSTEIN: The CEO, within me, doesn’t like these extremes, because the extremes are when a firm like ours looks really stupid and people think you know nothing. So it’s a very difficult period for us to market, for us to —
RITHOLTZ: Well, you have to do that long crypto. It’s $60,000.
BERNSTEIN: Exactly right.
RITHOLTZ: How did you miss that?
BERNSTEIN: Exactly right. And so, that’s when we rely more heavily on our Investor Relations people, on our marketing people, all that, because it’s very important to be very transparent as to what you’re thinking and what you’re doing. We don’t expect everybody to agree with us all the time. But we want them to know what our thinking of is, so that there’s not a surprise, there’s nothing like, you know, they just don’t know what they’re doing.
RITHOLTZ: So tell us a little bit about the suite of services RBA offers, how do you work with advisors who say, hey, you know, I have good financial planning with my clients, but I don’t want to run the portfolios. What can Rich Bernstein do for me?
BERNSTEIN: Exactly. Well, one of the greatest things that we can do for financial advisors right now is free up their time. There is an immense amount of pressure on financial advisors, rightly or wrongly, I’m not passing judgment. But there’s a lot of pressure on financial advisors to grow assets. And so that makes it more difficult for them to manage portfolios like they used to. You know, it used to be that the financial advisor was also a portfolio manager. That’s becoming very difficult. The role that we play for a lot of financial advisors is that kind of portfolio manager, almost an outsourced CIO, if you will.
RITHOLTZ: I was about to say that.
BERNSTEIN: Yes. And so we can play that role. Obviously, there’s going to be all kinds of specialists that are going to be in that portfolio as well. But we play the role very often is kind of a core of a basic portfolio.
RITHOLTZ: So there’s a phrase in your literature that kind of cracked me up, Pactive management.
BERNSTEIN: Yes.
RITHOLTZ: What is that? Who came up with it? Is it trademarked? What is Pactive?
BERNSTEIN: Yeah. Pactive —
RITHOLTZ: I’m assuming it’s passive active.
BERNSTEIN: Yeah. It is trademarked. It is trademarked.
RITHOLTZ: Okay.
BERNSTEIN: So don’t get any bright ideas.
RITHOLTZ: All right, I will. So active.com I’ll have to give that up.
BERNSTEIN: Exactly. But Pactive is for the active management of passive investments.
RITHOLTZ: Oh, really?
BERNSTEIN: You know, if you go back to Jack Bogle and the whole idea, and always in my career, I have tremendous respect for Jack, both as a businessman and as an investor. And Jack’s whole thing was you want to be a passive investor. Okay, we could argue whether that’s right or wrong. But what Jack would never do and what no true passive investor does is they never tell you what index to buy and when.
And people can say, well, I should just hold an index fund for the long term. Well, what’s your definition of the long term? Because there are times where if you make the wrong decision, and if you’re in the wrong index at the wrong time, it can take you 5, 10, 15, in one case that we found, 17 years to break even. You know, isn’t that an important decision?
So Pactive investing is all about, yeah, look, maybe you want to be passive, but being passive is an active decision in and of itself, and that you have to decide what index to buy and when. We think we’re pretty good at that, at the Pactive side of investing.
RITHOLTZ: And I get the sense that you’re an investor, not a trader, especially given your recent research note earlier this year, Don’t Speculate On Speculation.
BERNSTEIN: Right.
RITHOLTZ: Tell us what that means.
BERNSTEIN: So it’s really our view right now, Barry, that the market is in another speculative phase, that the rally so far this year has largely been in the speculative stocks of technology —
RITHOLTZ: The worse the company was, the better to do this year, right?
BERNSTEIN: Yeah. And —
RITHOLTZ: So I think the Goldman basket of profitless stocks —
BERNSTEIN: Exactly.’
RITHOLTZ: — is one of the market labels.
BERNSTEIN: Right. And you know, somebody could say, well, that’s a fundamentally based rotation maybe from value to growth, or to more economically sensitive companies. I get that, except for one thing. Cryptocurrencies are up 30 to 50 percent.
RITHOLTZ: Yeah. Where are we? Like 23, 24 on Bitcoin?
BERNSTEIN: Yeah.
RITHOLTZ: Up from 16?
BERNSTEIN: Right.
RITHOLTZ: That’s a big move.
BERNSTEIN: It is. And now, I may offend a lot of your listeners, but I don’t believe there is anything fundamental about cryptocurrencies. So when cryptocurrencies erupt so much, at the same time that we’re seeing tech and innovation, and disruption, and profitless stocks, and meme stocks and everything go up at the same time, that says to me, this is a speculative environment. This is not fundamentally driven. And I think what that is really relating to is people’s hopes that inflation is going to subside very quickly. The Fed will go back to a period of cheap and abundant liquidity, which is a cornerstone of speculative investing.
RITHOLTZ: Right. Unfortunately, transitory is taking a lot longer than expected.
BERNSTEIN: Correct.
RITHOLTZ: Right? So given that, since you brought up the Fed, how significant is the path of rate hikes, how high they go, how long they stay that way relative to consensus expectations?
BERNSTEIN: Yeah. Well, you know, I love, Barry, that everybody has like a terminal rate. They know exactly when it’s going to be.
RITHOLTZ: And when.
BERNSTEIN: Exactly. I mean, like, I love the precision. I mean, I wish I were that smart. I’m really not that smart. You know, but I think that what we’re going to find is that that terminal rate will be higher, it will be farther in the future than people think right now. It’s just very hard to kill inflation in an economy. Inflation in our economy right now is not because of supply chain disruptions. That was an early story. But that was the early story in the ‘70s, too. We just didn’t call them supply chain disruptions. We called them oil embargoes. But they were supply chain disruptions.
RITHOLTZ: So let me push back on that a little bit.
BERNSTEIN: Okay.
RITHOLTZ: Sure, we had the oil embargo, and oil is the lifeblood of the economy. But dear Lord, everybody is stuck at home for a year.
BERNSTEIN: Right.
RITHOLTZ: You can’t get paper towels, forget bleach or, you know, Lysol or anything like that. Semiconductors are shut.
BERNSTEIN: Right.
RITHOLTZ: There’s a shortage of homes. There’s a shortage of people —
BERNSTEIN: Absolutely.
RITHOLTZ: — of workers. There’s a shortage of containers for container ships —
BERNSTEIN: Absolutely.
RITHOLTZ: — even to move goods. You know, when everybody is stuck at home, we go from a service economy to a goods economy, and you can’t ramp up goods when demand surges 20 percent.
BERNSTEIN: No.
RITHOLTZ: So you would expect some of this to legitimately be pandemic lockdown related?
BERNSTEIN: Absolutely, 100 percent.
RITHOLTZ: Maybe that’s the first year. What happens in the second?
BERNSTEIN: So what happened in the ‘70s even was that it moved from oil and from the embargoes into the general economy and then into wages. So a prominent economist recently, about a year ago, said to me, that we don’t have a wage and price spiral because wages aren’t keeping up with prices. And my answer was, okay, we don’t have a wage and price spiral, maybe we have a price and wage spiral.
RITHOLTZ: That’s right.
BERNSTEIN: I’m not sure which comes first, the chicken or the egg, the wage or the price, and does it make any difference? And so I think that now we’re in that wage portion, where wages are starting to catch up. I mean, I’m sure you saw today, one of the airlines came out with a new agreement with their pilots for, like, seven —
RITHOLTZ: The big increase.
BERNSTEIN: — seven and a half percent increase per year for the next four years.
RITHOLTZ: But to be fair, they had been cutting, freezing pilot wages.
BERNSTEIN: Absolutely.
RITHOLTZ: In fact, my big complaint about wages as a driver of inflation, hey, where were you for the past 30 years, where at least the bottom half of the wage pool was deflationary?
BERNSTEIN: Absolutely.
RITHOLTZ: Minimum wage lags everything from productivity to corporate profits, to C-suite, to inflation. The minimum wage, if it kept up with anything, would be 14, 16 BPS (ph), something like that.
BERNSTEIN: Yeah.
RITHOLTZ: So suddenly, wages finally start to catch up. Oh, my goodness, this is the end of the world, says the Fed.
BERNSTEIN: Right.
RITHOLTZ: We have to stop this.
BERNSTEIN: Yeah. Right. So first of all, you know, a little known fact about Rich Bernstein, I’m a two-time union member.
RITHOLTZ: Oh, really?
BERNSTEIN: Not only have I had my entire career on Wall Street, but I’m a two-time union member. I once worked for the International Chemical Workers Union.
RITHOLTZ: Oh, really?
BERNSTEIN: Yes.
RITHOLTZ: Doing what?
BERNSTEIN: I was a maintenance guy in a pharmaceutical plant.
RITHOLTZ: Right.
BERNSTEIN: And I also worked for the United Auto Workers when I was on the adjunct faculty at NYU.
RITHOLTZ: Oh, okay.
BERNSTEIN: We were represented by, of all things, the United Auto Workers.
RITHOLTZ: Oh, that’s great.
BERNSTEIN: So I’m a two-time union member. Believe me, I’m not anti-union. I’m not anything like that. I understand. I’ve always thought that unions were the comparable to like CEOs have lawyers and agents —
RITHOLTZ: Right.
BERNSTEIN: — and sports people have agents. For everyday folks, it’s called the union.
RITHOLTZ: Right. Well, even though people talk about the rise of Amazon (inaudible) —
BERNSTEIN: Yeah.
RITHOLTZ: — union membership is a fraction of what it was 20 years ago, 50 years ago.
BERNSTEIN: This one is very low. It’s very low. Now, it is creeping up, because as we have a very tight labor market, power is starting to revert back to the workers in some respect. And I’m not Karl Marx, don’t misunderstand the point here. I spent my entire career on Wall Street. But these are just some of the realities that are going on now in a tight labor market.
RITHOLTZ: Analysts of the world unite.
BERNSTEIN: Analysts of the world, I love that.
RITHOLTZ: That’s the Wall Street version. So let’s stick with labor a little bit because it’s kind of interesting. I was having this conversation with David Kotak of Cumberland, and he points out you have the highest level of disability, people leaving the workforce for disability —
BERNSTEIN: Absolutely.
RITHOLTZ: — over the past 20 years. Then you have all these people, you know, a million plus dying of COVID, and another depending on which study you believe, 10, 15, 20 million people with long COVID. Immigration and as much as people blame Trump, it started before him and it continued after. Legal immigration continues to trend downwards.
BERNSTEIN: It’s crazy. Right.
RITHOLTZ: If we want to get wages sort of under control, in a way that works out, don’t we need to bring a whole bunch more workers —
BERNSTEIN: Absolutely.
RITHOLTZ: — into the labor force?
BERNSTEIN: Absolutely.
RITHOLTZ: Now, I’m going to ask you a policy question which is outside of your expertise.
BERNSTEIN: Yeah. No, no, no. No problem.
RITHOLTZ: But why aren’t we bringing in more skilled labor from outside of the country?
BERNSTEIN: I think we actually have to. I think that’s been part of the story of the U.S. economy for decades and decades and decades, and I think we have to. But, Barry, you bring up a very important point. When I talk about the labor markets and the tightness of labor markets, like one reason why it has happened, it’s really a perfect storm of about four or five or six different things all coming together at the same time, and there’s no one reason. But the end result is that we do have, I would argue, the tightest labor market in our lifetimes.
RITHOLTZ: Isn’t that always the case, though? People want Jack Hughes, one simple. Here’s why everything is terrible —
BERNSTEIN: Right.
RITHOLTZ: — it’s always so much more complicated, so much more nuanced. And that makes people unhappy when the answer to what appears to be a simple question is, well, it’s really complicated and here are the 47 factors that —
BERNSTEIN: Yeah.
RITHOLTZ: But that’s just reality.
BERNSTEIN: That is reality. But I think that makes the Feds job very, very difficult right now. Because as I said before, if you think about that the Fed is trying to curtail demand for labor, if they’re trying to ease up the labor market politically, that’s not very palatable.
RITHOLTZ: So let’s talk a little bit about the challenges of being a top-down macro investor in a very conflicted environment. How dependent are you on what the Fed says, what Jerome Powell questions get asked him at a conference, the random ways people seem to misinterpret it in the morning and then reverse it in the afternoon? How crazy is it operating like this?
BERNSTEIN: So Barry, being a macro investor, one of the things that’s important for us is that we are not event-driven. We are certainly a macro firm. But as you point out, everybody wants to know, like, what’s the Fed doing? What’s happening today? And that’s not us. And we are very, very process-driven. So very often I get calls from people that say, like, you know, what do you think of the Fed? And my answer is I don’t know, you know, and that’s not satisfying (inaudible).
RITHOLTZ: They’re in D.C., right?
BERNSTEIN: Right. You’re supposed to have like a very sophisticated answer. And I think if you look at macro hedge funds and the lack of success of macro hedge funds, the reason why is because everything has become an event. Everything is a hair on fire event these days.
RITHOLTZ: Right.
BERNSTEIN: And it’s hard to figure out what is true investment information, and what is pure noise. And so, what we’ve been arguing and what I argued for my entire career has been the way to sift out the true investment information is to stick to a hard core process. No matter what happens, come hell or high water, do not deviate from that process. And as we were talking about before, for us, it’s profits, liquidity, sentiment and valuation. We never deviate from that.
So yes, we know what’s going on. We know what the Fed is doing. We know everything, and we’re aware of that, but we stick to our process and we stick to our models and to our indicators to keep the hardcore process and not just flail around every five seconds.
RITHOLTZ: So since we’re talking about the Fed and not giving a hot take, let’s take a longer term look at inflation. Where are we in the inflation cycle? Is it safe to say inflation peaked on us six or eight months ago already?
BERNSTEIN: Well, the answer I’m going to give you kind of The Economist answer. On the one hand, yes, we have probably peaked in terms of the near-term inflation. But on the other hand, and I think what’s much more important for investors, I think secular inflation has changed. I don’t think we are going back to the period that we saw for the past, you know, 30 years or so, where we could always count on secular disinflation.
I think that now the story is secular inflation. Now, what does that mean? Right? All of a sudden, you know, does that mean it’s 6, 8 percent? What does that mean? Well, most forecasts of secular inflation right now ranged between 2 and 3 percent, which makes a lot of sense because long-term inflation in United States is roughly two and a half. So you can see how the forecasts are there. So that means as an investor, you have to kind of take an over/under bet. Is it going to be less than 2, the lower end of that range, or higher than 3, above the higher end of the range?
Right now, the markets are making a huge bet, it’s going to be sub 2. In other words, going back to the period of cheap and abundant liquidity, our story is 3 percent or more. That’s it. We think that meaningfully changes the way people have to manage portfolios.
RITHOLTZ: So let’s stay with that because that’s so interesting. So the key forces that were drivers of deflation in the ‘80s, ‘90s, 2000, in the post Volker era, was we had globalization. So manufacturing went wherever it was cheapest. We had software and automation and technology that made everything more productive. And then, lastly, productivity across the board finally started showing up in the statistics after it famously was everywhere, except in the data. Have any of those things really changed materially, or have we just wrung out all of the deflationary forces from globalization, automation and productivity that —
BERNSTEIN: Right.
RITHOLTZ: — we will see in our lifetimes?
BERNSTEIN: So, Barry, I would argue that the number one factor that caused secular disinflation was globalization. Then I would suggest it started with NAFTA in the early ‘90s. And what it did was it consistently opened markets around the world. And what that meant was that we were consistently increasing competition around the world, right.
Inflation for all the fancy ways people think about, I think it’s very easy to think of inflation as when demand is greater than supply, we know prices go up. When demand is greater than supply for an extended period of time, we call that inflation. And what globalization did was it increased the supply of suppliers. In other words, it increased competition.
RITHOLTZ: So that’s the old commodity trader joke, the cure for high prices is high prices.
BERNSTEIN: Exactly. And so what happened was, as you had more and more and more suppliers, greater and greater and greater competition, you had downward pressure on prices. Well, it looks like globalization is now starting to contract. This is not going to happen in five minutes or five months. It’s been 5, 10, 15, 20 years as was NAFTA, a 30-year story, or globalization, a 30-year story. We’re now going back the other way.
Now, look, it could be that we’re all going to sit around a campfire and sing Kumbaya around the world, or like the old Coke commercial where we’re on a hill, you know, holding hands and —
RITHOLTZ: Teaching the world to sing.
BERNSTEIN: Exactly. That could happen. I’m skeptical that that’s really going to be the thing.
RITHOLTZ: So I’m glad you brought that up because I’ve heard the end of globalization story, and it smells like a lot of political noise. All right, we’ll build the semiconductor plant in Arizona.
BERNSTEIN: Absolutely.
RITHOLTZ: But the massive shift in global economy, where manufacturing has done here, and all these other countries are coming online, whether, first, it was Japan and was South Korea. Now, it’s Vietnam and Turkey and Mexico and go around the world. Are we really going to meaningfully reverse that? Is globalization going to shrink beyond low single digits?
BERNSTEIN: I don’t think, right now, we can see how that could happen. But again, I’m talking about, you know, a 10, 20, 30-year phenomenon here. I think if we had said 30 years ago, that globalization was going to cause the environment that we ended up with, people would have said, you are nuts, right? In the early 1990s, you know, Ross Perot was the one who was anti-globalization.
RITHOLTZ: The great sucking sound.
BERNSTEIN: The great sucking sound, which turned out to be, to some extent, correct. But what he didn’t allow for were the benefits to society —
RITHOLTZ: Right.
BERNSTEIN: — what globalization might do.
RITHOLTZ: Well, you lost the, you know, hosiery and furniture manufacturing —
BERNSTEIN: Oh, yeah.
RITHOLTZ: — and replaced it with software and quantitative analysis.
BERNSTEIN: Correct. Exactly right. And so our argument at our firm is that we’re going to see a slow progression back in the other direction, where we keep calling a shift from cute wiener dogs in the metaverse to real productive assets. That’s not going to happen in two weeks. But we think that’s going to happen over 3 years, 5 years, 10 years, 15 years.
RITHOLTZ: So given where we are in the broad world, it seems like the stock market in 2023 is hanging on every economic report, every CPI release, every nonfarm payroll, every FOMC meeting. Like, even when we get the FOMC notes, they’re always a month old, and yet, people wait with bated breath. Tell us what they were thinking a month ago, like that really is going to move markets, but it certainly causes some volatility. Is there too much focus on these big macro events today?
BERNSTEIN: I’m not sure there’s too much focus. But I think the minutia and the decimal point focus is not very healthy. You know, I think if you think about the CPI report, you know, the February CPI report that comes out in March, I think the consensus is for something like 0.4 for March. If you look at Bloomberg, I think that’s the consensus. And you know, I —
RITHOLTZ: Which would be under a 5 handle annualized, which is not bad.
BERNSTEIN: It would be, which is not bad. But if it comes in at 0.5 instead of 0.4 —
RITHOLTZ: Not the 6 then.
BERNSTEIN: — we know the markets are going down.
RITHOLTZ: Right.
BERNSTEIN: If it comes in 0.3 instead of 0.4, we know the markets are going up. Now —
RITHOLTZ: Well, are we in this phase where bad news is good news, because just 0.3 mean that the Fed is done? And if the market rallies, hey, hey, not so fast?
BERNSTEIN: Yeah, well, that’s —
RITHOLTZ: It seems like every time the market rallies in anticipation of the Fed ending their tightening regime, the Fed says slow your roll.
BERNSTEIN: Yeah. I think we’re definitely in that kind of environment. But the point that I was just trying to make was the decimal point precision, which is so spurious if you think about it, that 0.3 means everything is okay and 0.5 means it’s the end of the world —
RITHOLTZ: Right.
BERNSTEIN: — as we know it. That’s very silly. And to get into your question, you know, what does this mean? Are people looking at this too closely? I would say yes. I think that people should be taking a more longer term holistic view, which is kind of what we try to do with our firm.
RITHOLTZ: All right. So given all the focus on the Fed, and last year, we were talking about the end of TINA, for a long time, you know, getting no yield and bonds. Now, I think, what is it, six months, nine months, about 5 percent.
BERNSTEIN: That’s right. Yeah.
RITHOLTZ: You’re really seeing some decent yield. How do you look at the world of bonds when for the first time in a decade or longer, you’re actually getting paid to lend Uncle Sam some money?
BERNSTEIN: Yeah. So Barry, two things relative to that question. Number one is one has to remember that that’s what the Fed is trying to do. By raising short-term interest rates, so they are trying to disintermediate the economy, get liquidity out of the economy, slow the economy. And of course, you’re going to put it in short-term instruments. That’s the whole point of monetary policy.
RITHOLTZ: Right.
BERNSTEIN: And so people are saying, oh, short-term rates are competitive again. Yeah, no kidding. That’s what the Fed is wanting to happen.
RITHOLTZ: Price is on. Right.
BERNSTEIN: Right. That’s what they’re trying to do. Second thing is that I think that if we’re right, and the secular inflation backdrop is changing, I think fixed income money management will change dramatically over the next 5, 10, 15, 20 years. It’s been very —
RITHOLTZ: Meaning become a whole lot more attractive?
BERNSTEIN: It will be a lot more difficult.
RITHOLTZ: Oh, really?
BERNSTEIN: Because, look, in our careers, it’s been pretty easy to be a fixed income money manager. You could have been the worst fixed income money manager —
RITHOLTZ: Right.
BERNSTEIN: — and secular disinflation bailed you out. You could have been completely wrong —
RITHOLTZ: Right.
BERNSTEIN: — but you still made money for your client.
RITHOLTZ: Just ride the wave from when Volker took rates —
BERNSTEIN: Correct.
RITHOLTZ: — to a million percent and it’s been a 40-year bull market in bond.
BERNSTEIN: Yeah, it’s been great. It’s been great.
RITHOLTZ: Was it 81 to 21?
BERNSTEIN: Yeah.
RITHOLTZ: That’s a good run.
BERNSTEIN: That is. Now if we’re right and the inflation backdrop is changing, it means that money management or fixed income money management doesn’t have the wind at their back anymore.
RITHOLTZ: Right.
BERNSTEIN: It means you’re going to have to be more tactical. You’re going to have to constantly change duration, depending on what’s going on with interest rates. You’re going to have to change quality, depending on what’s going on with company fundamentals and earnings and things like that. And fixed income money managers have never had to be that nimble. You know, if you look at the data, they say, oh, we’re active managers, but maybe they changed duration from 92 percent of benchmark to 94 percent of benchmark duration.
RITHOLTZ: Right.
BERNSTEIN: That’s hardly being inactive manager.
RITHOLTZ: A lot of active bond managers because there’s so many more types of bonds than stocks.
BERNSTEIN: Yeah.
RITHOLTZ: Just don’t own the worst half and you’re way ahead of everybody.
BERNSTEIN: You may have.
RITHOLTZ: So let’s talk about duration. If you shorten up your duration last year, you did okay.
BERNSTEIN: Yeah.
RITHOLTZ: I mean, you didn’t do great bonds, but you didn’t do as bad as the benchmark —
BERNSTEIN: Absolutely.
RITHOLTZ: — taken into as poorly as the benchmark. So here we are, it’s first quarter of 2023, where should our duration be set with an inverted yield curve and a Fed that keeps telling us, hey, guys, higher for longer?
BERNSTEIN: Right. So, Barry, we are barbell right now on the curve. We have very short term because the Fed is raising rates. And as you pointed out before, you can get reasonable yields at the short end of the curve. But then we’ve also begun to extend duration because in every cycle, the Fed goes too far.
RITHOLTZ: Right.
BERNSTEIN: And the long end of the curve starts to rally. No, I’m not going to tell you we’re smart enough to pick that to the day. But we’re at the point in the cycle, we think it pays to start extending duration because they are going to make a mistake at some point.
RITHOLTZ: So when you say longer term, do you mean five to seven? You mean 10 to 20? Where are you —
BERNSTEIN: Yeah. So we have nothing in the middle of the curve, the belly of the curve. We’re very short term, let’s say under two years, and then we’re in 10 years plus.
RITHOLTZ: Okay.
BERNSTEIN: That’s kind of how we’re positioned.
RITHOLTZ: What’s the 10-year yielding when the six month is about four and a half, 5?
BERNSTEIN: 10-year right now is about 3.90 —
RITHOLTZ: Yeah, just sub to 4.
BERNSTEIN: Yeah, something like that.
RITHOLTZ: All right. So it always feels so weird to say, listen, I’ll give you 4 percent if you tie your money for either six months or a decade.
BERNSTEIN: Right. Right.
RITHOLTZ: And that’s just the nature of an inverted yield curve.
BERNSTEIN: Right. But the way we think about it is not so much for the yield, we think as total return investors. And maybe we’re going to get that yield. But will we get, you know, 5 or 10 percent capital provision on top of that, that makes for a pretty good total return.
RITHOLTZ: So let’s talk a little bit about the current environment, I’ve been told the 60/40 portfolio is dead. Is that true? Are we no longer looking at a balanced portfolio as a viable investment thesis, or have higher rates resurrected 60/40 back from the debt.
BERNSTEIN: So Barry, I think both the 60 and the 40, if you’re just buying indices, probably not a good idea over the next 5, 10 years. That’s probably not a good idea. However, if you’re actively managing within the 60, and you’re actively managing within the 40, I think what you buy will have a meaningful difference on performance. So I don’t think the 60/40 is dead. But I do think the traditional passive 60/40 is going to have a very tough time.
RITHOLTZ: So let’s stick with that. We have rates approaching 5 percent from the Fed, very different than where we were just two years ago when we were at zero. How does that impact your tactical allocation decisions? If inflation continues moderating and rates stay high, what sectors look attractive to you?
BERNSTEIN: Yeah. So Barry, you know, it’s kind of funny, I think I mentioned this before that we’re not really very bearish. We don’t like three sectors. We don’t like U.S. tech. We don’t like U.S. consumer discretionary, and we don’t like U.S. communications. We think those are the three very speculative bubbles. And by the way, they dominate the U.S. market. Even when their bear market, those three sectors are still about 45 percent of the U.S.
If you remove those three sectors that we think are very speculative, everything else is basically fair game. It’s almost every other sector in the United States. And the menu of global opportunities is big too because United States is very unique and that we are dominated by those three sectors. Most other developed markets are not.
RITHOLTZ: So let’s talk about that because the rest of the world has lagged the U.S. markets for 10, 15 years.
BERNSTEIN: Absolutely.
RITHOLTZ: It could be the longest period of outperformance I think in market history. So when you look around the world, since you’re active, not passive, what parts of the world do you look at? Are you looking at EM or developed ex- U.S.? And again, since you’re not passive, what particular specific countries you find appealing?
BERNSTEIN: Yeah. So first, it’s important to start this part of the conversation by saying that in 2022, 70 percent, seven, zero, 70 percent of non-U.S. markets outperformed the United States in 2022.
RITHOLTZ: That’s a big, big move.
BERNSTEIN: Even in U.S. dollar terms. So the fact that most people aren’t aware of that shows that investors have become a little geographically myopic. And why did that happen?
RITHOLTZ: Home country bias is absolutely huge.
BERNSTEIN: Absolutely huge.
RITHOLTZ: Yeah.
BERNSTEIN: It’s huge. But why did that happen? It happened because what they said before, most other markets aren’t dominated by those three sectors that were dominated by in United States; tech, consumer discretionary, communications. So what you actually had in 2022 was a global sector event, not a country event.
And one of the things that we try to do is we look at size and style, and industries and sectors, not only in the United States, but around the world. But most investors think of global investing is what country do I invest in, not as they were a global sector event or global style event going on. And I think 2022 was very much a global sector event.
RITHOLTZ: So let’s talk about a specific sector. Since the financial crisis in ’08, ’09, since you launched Rich Bernstein Associates, finance really hasn’t been much to ride home about, right?
BERNSTEIN: Yeah. No.
RITHOLTZ: It’s been a giant laggard. When does the financial sector start to see a little love from investors?
BERNSTEIN: Right. So there’s a compounding issue with the financial sector, namely the financial crisis and the increased regulation, which kind of threw them all for a loop and really constrain their business activity. I mean, one of the reasons today, the financial sector was so healthy is because of all that regulation.
RITHOLTZ: Right.
BERNSTEIN: But you had to give up all the growth that you maybe were going to get from all the leverage and everything else, but —
RITHOLTZ: To be fair, not blowing up and destroying the world economy. That’s a fair trade.
BERNSTEIN: That’s okay.
RITHOLTZ: Wait. You’re healthy and you’re still around, but you’re only growing at 5 percent instead of 10 percent.
BERNSTEIN: Right.
RITHOLTZ: It seems like a reasonable trade-off.
BERNSTEIN: Exactly. So let’s just remove that from the discussion. Historically, if you take out that period, you’ll find that the yield curve is a pretty good representation of when you want to buy financials and when you don’t. And when you have a steeper yield curve, it says that net lending margins are going to be higher; deposits are cheaper than lending, the way you’re getting on the loans; the interest rate you’re getting on the loans. And so your profitability goes up.
And when the curve inverts, not only is it a signal of recession, but the inverted curve itself starts shutting down the economy because the deposit rate is higher than the lending rate, nobody wants to lend. And so what we’ve got right now is an inverted yield curve, historically, not a great time to overweight financial stocks.
RITHOLTZ: Early. It’s too early.
BERNSTEIN: It’s too early. Yeah.
RITHOLTZ: So we have a steep curve.
BERNSTEIN: Correct.
RITHOLTZ: We want to stay away from.
BERNSTEIN: Correct. Exactly.
RITHOLTZ: Um, we’ve seen some of the utilities and defensives underperform.
BERNSTEIN: Yes.
RITHOLTZ: Also, now, some people have argued, hey, that’s suggesting the worst of the economic slowdown is behind us. How do you look at these different sectors as a foretelling of what might happen in the next quarter or two?
BERNSTEIN: Right. So we talked about early on about the importance of corporate profits and the profit cycle. And what we tend to do in our firm is look a little bit more at profit cycles as opposed to economic cycles. In the United States, we could argue whether we’re going into an economic recession, we are definitely falling into a profits recession.
RITHOLTZ: Despite 2022, having profits hold up —
BERNSTEIN: Yeah.
RITHOLTZ: — shockingly well —
BERNSTEIN: Tremendously well.
RITHOLTZ: — considering what was going on.
BERNSTEIN: Tremendously well. But now, those hard comparisons, everything are coming home to roost —
RITHOLTZ: Got you.
BERNSTEIN: — increasing labor costs, everything that we’ve been talking about.
RITHOLTZ: They had base case.
BERNSTEIN: Yeah, exactly. And so when you go into a profits recession, what tends to work defensive type sectors, because there’s kind of this ridiculously obvious statement that we’re going to make, but people forget it. The cycle by definition is determined by cyclicals. And so when you’re —
RITHOLTZ: That is cyclical.
BERNSTEIN: When you’re in a cyclical downturn, you don’t want to hold cyclical stocks. When you’re in a cyclical upturn, you do. And so we’re in a position right now we think we’re entering a profit recession, which would be a cyclical downturn. You want to be very careful about the cyclicals that you hold.
RITHOLTZ: So the profit recession in a cyclical downturn. Everybody has been focused on the landing. Is it a soft landing? Is it a hard landing? Torsten Slok of Apollo has been talking about no landing. At Thanksgiving, the question is, hey, are we going to have a recession or not?
BERNSTEIN: Right.
RITHOLTZ: So how do you look at that? Or are you less concerned with the economic recession and more focused on the earning side?
BERNSTEIN: Well, we are more focused on the earnings. But to the point about the landing, I think we’re circling the airport. I don’t think we’re landing yet. And I don’t think it’s right to say there won’t be a landing because I don’t think the Fed can effectively fight inflation without some kind of landing. Whether it’s hard or soft, to some extent in our work, it doesn’t matter. You’re going to have the same defensive strategy for landing. It’s just a question whether it’s a single, a double, a triple, a homer or grand slam as to how successful it’s going to be. But we’re not going to change our portfolios depending on the type of landing.
RITHOLTZ: Really interesting. I got a curveball question for you. You have two books which we haven’t talked about, Style Investing: Unique Insight into Equity Management.
BERNSTEIN: Right.
RITHOLTZ: The second one, I love the title, Navigate the Noise: Investing in the New Age of Media and Hype. You donate the profits from both of those books to charity.
BERNSTEIN: Right.
RITHOLTZ: Tell us where those profits go and what motivated that decision.
BERNSTEIN: So I don’t want to make it sound like they’ve been hugely profitable books.
RITHOLTZ: Millions of dollars.
BERNSTEIN: Yeah. Exactly. But with that as a realization, the profits have long gone. They’re very small now because the books have been around for a long time. But originally, they went to Doctors Without Borders.
RITHOLTZ: Oh, that’s nice.
BERNSTEIN: Yeah, that was the charity that it went to.
RITHOLTZ: That’s really interesting.
BERNSTEIN: Yeah.
RITHOLTZ: What led you to choose that particular charity?
BERNSTEIN: Well, the first book was written in 2000. I think it was in 1999, Doctors Without Borders won the Nobel Peace Prize.
RITHOLTZ: That’s right.
BERNSTEIN: And so I’ve always had a place in my heart for that organization because when I was a kid, my childhood doctor took a month off to go tend to earthquake victims in Nicaragua.
RITHOLTZ: Wow.
BERNSTEIN: And I thought that was so cool, right? Not golf on Wednesday, he actually went to help people, and so that just stayed with me. And so my wife and I have consistently donated to that charity.
RITHOLTZ: So before we get to our favorite questions, I have a couple of other things I have to throw at you. First, you could be bearish but still have a 10 percent return target for the S&P 500 every year. Discuss.
BERNSTEIN: You can be bearish, but have a 10 percent. Well, you know, it’s kind of funny, when I was at Merrill, people who always asked me for my expected returns and everything on the markets, and I would always say 8 to 10 percent, because that’s what the market did over the long term. But in any one year, it never actually did 8 to 10 percent.
RITHOLTZ: Right.
BERNSTEIN: So I used to just throw that out and people would be satisfied. I think —
RITHOLTZ: Despite your reputation as a permabear.
BERNSTEIN: Yeah, yeah, yeah.
RITHOLTZ: A permabear, 8 to 10 percent.
BERNSTEIN: I always said 8 to 10 percent, because the odds are, look, the market goes up about two-thirds to three -quarters of the time, historically.
RITHOLTZ: Yeah.
BERNSTEIN: So you know, you really don’t want to be a permabear that doesn’t really pay. But, you know, I think we all have to realize the probability of hitting 8 to 10 percent in one year is probably pretty low.
RITHOLTZ: This is one of my favorite questions. When the firmwide sell side indicator turns positive, it’s preferable to leave the firm and start your own shop and go on the call and tell everybody about the sell side indicator. Tell us about that.’
BERNSTEIN: Yeah.
RITHOLTZ: By the way, I have great research team.
BERNSTEIN: Yeah. I was going to say that’s a good one. But, no, I mean, the sell side indicator to which you refer really is a gauge of Wall Street bullish and bearish. And what it’s always shown is that when Wall Street doesn’t like equities, it’s a great time to buy equities. And you know, I described it as people being under their desk in a fetal position. In 2009, I really thought we had hit an ultimate under your desk in a fetal position, and that was probably a good time to start a firm.
RITHOLTZ: Generational load to say the least.
BERNSTEIN: Yeah.
RITHOLTZ: And finally, our last question, and this will be the big reveal. On Wall Street, a midlife crisis doesn’t have to involve a Ferrari and hair plugs. A Mini Cooper, a leather rubber and metal man bracelet will do just fine. Does that sound remotely familiar?
BERNSTEIN: I’m not quite sure about all of that.
RITHOLTZ: So Savita Subramanian’s farewell speech to you when you left the firm, and thanks to her and Josh Frankel for scaring that up.
BERNSTEIN: For digging that up.
RITHOLTZ: But a midlife crisis doesn’t always have to involve a Ferrari and hair plugs —
BERNSTEIN: Right.
RITHOLTZ: — sounds like a good approach to life.
BERNSTEIN: Yeah, that was not me. As you can tell, people on the radio can’t see me, but I am as bald as could be.
RITHOLTZ: And this is kind of being your look for a long time, right?
BERNSTEIN: It has been. It has been my look for a long time.
RITHOLTZ: That’s why you look timeless. Like, the first time I met you. I don’t think you look very different than you do today.
BERNSTEIN: Well, thank you for saying that. I think I probably do look a little different —
RITHOLTZ: Right.
BERNSTEIN: — because I’m 20 years older or whatever. But, yeah, you know, I mean, my attitude has been just go with the flow.
RITHOLTZ: That’s a good attitude.
BERNSTEIN: Yeah.
RITHOLTZ: When markets do what they do, that means you’re not finding the tape. You’re not finding the Fed. You’re letting price tell you, hey, here’s what’s happening.
BERNSTEIN: Yeah. Exactly.
RITHOLTZ: So I got some of those questions from 10 lessons learned over 20 years. That was Savita’s farewell speech at your exit. A few weeks ago, we had Neil Dutta on, who worked under David Rosenberg. You and Rosie were like, you know, the fearsome twosome.
BERNSTEIN: We were.
RITHOLTZ: What was it like the two you working, with the reputation you guys had constantly on the all-star team, constantly described as bears, but you were fairly constructive and useful to your clients. It wasn’t like you would just sell everything. What was it like working with Rosie back then?
BERNSTEIN: Well, I think we had a blast. I mean, we were traveling all over the world together. It was fantastic. But I think, you know, our bearish views, especially when markets get very heady is a testament to Merrill that they allowed us to say what we really thought we were going to say and not trying to muzzle us to do better, to do more business. I think that was really a testament to them, and I can tell you how much both Rosie and I appreciated that.
RITHOLTZ: Really interesting. All right, so let’s jump to our favorite questions that we ask all our guests starting with, tell us what kept you entertained during lockdown. What were you streaming?
BERNSTEIN: What was I streaming?
RITHOLTZ: Well, what are you streaming now?
BERNSTEIN: What am I streaming now? Right now, I’m streaming Fauda —
RITHOLTZ: God.
BERNSTEIN: — the Netflix —
RITHOLTZ: Oh, my God.
BERNSTEIN: — series about the Palestinians and Israelis.
RITHOLTZ: I have to say we have a rule in my house, we will not start that after 9 o’clock because it’s so gripping, you just won’t go to sleep.
BERNSTEIN: You won’t go to sleep.
RITHOLTZ: Heart-pounding.
BERNSTEIN: It is fantastic. I mean, my wife and I are just about to finish Season 2, but fantastic. The acting, everything is just wonderful and heart-wrenching.
RITHOLTZ: Right.
BERNSTEIN: And you’ll never figure out.
RITHOLTZ: Thrilling, frightening, just like, oh, my God —
BERNSTEIN: Yeah.
RITHOLTZ: — you can’t look away.
BERNSTEIN: No.
RITHOLTZ: It’s amazing. Let’s talk about mentors who helped guide your career over the years.
BERNSTEIN: Ah, that’s an interesting question. Well, first and foremost, I would have to point to Chuck Clough. Chuck was the chief investment strategist at Merrill who hired me at Merrill. And he gave me two good lines of advice, which I won’t say to Chuck, if you remember, he said this and he did not. But line one was I went to him like my first day at Merrill, and I said, what do you think I should do? And he said, I don’t really care, just don’t make a fool of yourself. That was number one.
And number two, the best line anybody has ever said to me is make sure you’re a star and not a Roman candle. Fantastic line, fantastic line. And I have lived my entire career, thinking there’s a big difference between being a star and being a Roman candle.
RITHOLTZ: Really interesting. Let’s talk about books. What are some of your favorites and what are you reading right now?
BERNSTEIN: What am I reading? I don’t even know the title of the book I’m reading right now. I hate to say that. But I always love Cold War, spy, espionage. And I’m reading one right now which is a true story about one of the heads of the KGB that they turned and became an informant for MI6.
RITHOLTZ: That’s really interesting. So last two questions, what sort of advice would you give to a recent college grad who was interested in a career in finance or asset manager?
BERNSTEIN: Oh, I actually speak to a lot of college grads and the one thing I always tell them is keep a very open mind about what you want to do. When you’re graduate in college, you really don’t understand what the financial sector is all about. You don’t understand what Wall Street is all about as much as you might think you do. And don’t put on blinders and say, this is what I’m going to do. Wall Street changes so dramatically. You don’t want to be caught saying this is what I’m going to do, and then whatever you wanted to do becomes obsolete. Be very flexible. As I said before, go with the flow. There’s many different things in finance that people never consider.
RITHOLTZ: And our final question, what do you know about the world of investing today you wish you knew 40 or so years ago when you were first starting out?
BERNSTEIN: Oh, just the experience of living through cycles. I mean, you know, you can’t go back in time. There’s no way to replace this. But living through cycles, remembering, keeping notes, living history, I think, is very, very important. If you’re going to be a true investor, if you’re going to be a market observer or anything like that is living history, realize your living history and don’t forget it.
RITHOLTZ: Really interesting. Thanks, Rich, for being so generous with your time. We have been speaking with Rich Bernstein, CEO and CIO of Richard Bernstein Associates.
If you enjoy this conversation, well, be sure to check out the previous 467 we’ve done over the past eight or nine years. You can find those at iTunes, Spotify, YouTube, wherever you find your favorite podcasts. Check out my daily reading list at ritholtz.com. Follow me on Twitter @ritholtz. Follow all of the Bloomberg podcasts @podcast.
I would be remiss if I did not thank the crack team that helps put these conversations together each week. My audio engineers were Justin Milner and Robert Bragg. Atika Valbrun is our project manager. Sean Russo is my head of Research. Paris Wald is my producer.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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