In Episode 6 of The Acquirer’s Podcast, Tobias interviews Michael Batnick, the Director of Research at Ritholz Wealth Management and author of Big Mistakes: The Best Investors and Their Worst Investments. During the interview Michael discusses:
- How He First Met Josh Brown (Author of The Reformed Broker Blog)
- Some of The Biggest Mistakes Made By Great Investors
- Why Investors Need A Set Of Written Rules To Follow – Dumb Rules Are Better Than No Rules
- In Investing Knowing What Not To Do And Not Doing It Are Two Separate Things
- Diversify, Not Just Across Assets, But Across Strategies
- How Bull Markets Make A Mockery Of Risk Management
- You Don’t Need To Be A Perfect Investor, You Just Need To Be Good Enough
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Tobias Carlisle: You ready?
Michael Batnick: I’m ready.
Tobias Carlisle: All right, let’s go. Hi, I’m Tobias Carlisle. This is the Acquirers Podcast. My special guest today is Michael Batnick, the artist formerly known as the Irrelevant Investor. I didn’t realize you’re no longer at that Twitter handle. Michael’s written a fantastic book. He’s the director of research at Ritholz Wealth Management. We’re going to talk to him right now.
Speaker 3: Tobias Carlisle is the founder and principal of Acquirers Funds. For regulatory reasons, he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcast participants are solely their own, and do not reflect the opinions of Acquirers Funds, or affiliates. For more information, visit AcquirersFunds.com.
Tobias Carlisle: Hey Michael, how are you doing?
Michael Batnick: Good, Toby, thank you for having me. I am an acquired taste, so I hope that your listeners enjoy this conversation.
Tobias Carlisle: I’m very sure that they will. You’ve got one of the better hero stories out there for how you got started in this business. I know that it involved Josh, running into Josh. Can you just tell us what happened?
Michael Batnick: Sure, so there’s the longer version and the shorter version. I’ll go a little bit longer than I normally do. I’ve told this story a bunch of times, but it is a good one. In 2009-ish, 2010, I became aware of Josh Brown writing of The Reformed Broker. I took to it instantly because a lot of the stuff that he was writing about at the brokerage industry, I saw a lot of the same incentive structure where I was working at, an insurance company. It wasn’t quite as nefarious, but certainly people are motivated by how much they’re paid and by the products that they’re paid to sell. I was reading Josh on a daily basis, and I guess I was at the insurance company for just under two years, and I left, and I didn’t know what I was going to do.
Michael Batnick: I was hoping to break into the industry somehow, but I had no natural network. I didn’t have the chutzpah to do like what Jamie Catherwood is doing, which is just introducing himself to everybody and anybody. I wish I had that in me, but I lack self confidence. I had nothing to offer. My resume sucked. My college experience and my educational experience was lacking, so I thought I had very little to offer. I had been trading on my own probably for about a year and a half, two years. I had very bleak job prospects, and was basically ready to throw my hands up in the air and just say, “All right, I guess I’m just going to be like a barista at Starbucks, or get a job at a retail.” I just, I didn’t know. It was not a great time for me. I’m sitting down for game three of the 2011 … No, I’m sorry, 2012. The Knicks were playing the Heat.
Michael Batnick: Lebron and Wade and Bosh were in town, and it’s game three, and obviously the Knicks were down, 0-2, but I was super excited about the game. Then as I’m sitting down, I get an email. I remember, it was literally as I was sitting down. I had an email from my last job opportunity, like the last one, and the guy said, “Sorry, I can’t help you.” I’m sitting down and I’m just like, “Ugh.” The Knicks were getting buried. It was the third quarter, and I remember this very clearly. Mario Chalmers hit a three to put the Heat up by like 18 points, going into the fourth. I said, “Eff this, I’m out of there.” Ordinarily, I would never have left, but I was in such a pissy mood from that email that I just decided, “You know what? I’m out of here.” My friend’s like, “Where are you going? It’s playoffs,” and I just said, “I’m out.”
Michael Batnick: On the way home, I was on the train. This was a Friday night, probably 10:30, and I’m scrolling through Twitter on my Blackberry, and I see Josh Brown tweeting about how old he feels because Eminem’s daughter, or Kurt Cobain’s daughter, or whatever, is 17 years old, something like that. We pull up to my train station. My phone died. The reason why I say that is because if it didn’t die, I probably would have been walking with my head buried in the phone. My phone dies as we’re pulling up to the train station, and I walked right past Josh. I knew we grew up in the same town. I didn’t realize that he was on the same train as me at that time, obviously, and so I felt like, “Holy Shit, this is my moment.” I basically tackled him. Josh was nice enough to give me some time, and that’s how I met Josh.
Tobias Carlisle: Had you started the blog at that time?
Michael Batnick: No. No. I was basically day trading. I thought that I was like doing Ben Graham style investing, but one day, I walked into TD Ameritrade’s branch, and they were like, “Oh, Mr. Batnick, so good to see you.” I was like, “What?” They told me that I spent $12,000 on commissions in 2011. I was like, “No, no, no. Maybe you have the wrong statement. This isn’t me.” They showed me and I was like, “Whoa.” That was really eye-opening. I think I had been keeping a journal, but I didn’t realize to the extent that I was turning over my portfolio.
Tobias Carlisle: What was the impetus for launching the blog? That’s just something if you join Ritholz, you’re just expected to start a blog.
Michael Batnick: When I started writing, it was 2012. The first thing that I wrote was totally inappropriate. It was basically me trashing my former employer at the insurance company. The person who ran the company was like, “Yeah, I get it, but you can’t do this.” I was fortunate to be given a long runway where nobody was reading what I was writing, and I was totally fine with that. It’s not like I was like, “Oh, how come I’m not getting any traffic?” I had no delusions of grandeur. I knew that my writing sucked, but I felt like I wanted to continue it because I didn’t want to go down the path of becoming a CFP. I had already started down the road of being a CFA or a charter holder. I just thought, “Like, why not? Barry and Josh are doing it.” I guess, I don’t really remember why I was like, “Oh, I got to do this,” but I just. I tried it and it just happened to work out.
Tobias Carlisle: Do you find it useful to kind of document what you’re thinking at the time? Do you ever go back and look at it years later and think, I’ve changed my mind, or-
Michael Batnick: Oh yeah. Well, oh, in terms of the blogging stuff?
Tobias Carlisle: Yeah.
Michael Batnick: Yeah. There’s some things. I guess this sounds ridiculous, but there are things that I have very strong opinions about, and things that I really don’t feel that strongly about. Believe it or not, I don’t care how you construct a portfolio. I think there’s a million ways to skin the cat. I think that the most important thing is just finding what you’re comfortable with. I certainly don’t think that active management is dumb, or you’re an idiot for paying fees to try and beat the market, if that’s what you want to do. Let’s say, obviously it could work out and you can beat the market, or let’s just say that you don’t beat the market.
Michael Batnick: You trail, you’re invested, and you lag by 80 basis points here. Who cares? I think the real problem is dropping in and out and trying to time the market. I think that’s much more destructive to wealth creation. To answer your question, I have gone back periodically and read my journal, my trading journal, and it’s an amazing abomination of ridiculous thoughts and ideas. That actually got me away from banging my head against the wall, because I was doing it real time, and I remember going back and reading what I wrote and just thinking, “This is ridiculous. These thoughts are ridiculous. This is not how the market works,” and I’m very indebted to StockTwits in particular, because I saw people posting every single day. I was unemployed. I was trading, so this was all that I was doing.
Michael Batnick: I saw people and I’m like, “Wait a minute, I know you’re lying because I read what you write, and I saw what you said yesterday and the day before, and I know that you’re full of shit.” It wasn’t just one person, it was like, a lot of people. It didn’t take long for me to smell the roses. Not that I think I’m a genius or anything, but I’m not a complete idiot. I just, I’m very grateful that I woke up very quickly to the realization that the market is A, really, really, really hard to beat. I think that people understand that and they accept it, but they pay lip service to it because they still trade way too frequently. And then later on, I came to the realization that in order to grow your nest egg and to have your money work for you, you don’t need to beat the market.
Tobias Carlisle: Yeah, 100%. When you said you were a Graham style investor, what were you doing? Were you looking for net-nets, or were you just looking for undervaluation, or what were you [crosstalk 00:08:53]-
Michael Batnick: Oh, I was totally kidding. By the way, that’s sort of why I call myself the Irrelevant Investor, because I did read all the Ben Graham stuff, but I wasn’t doing any of that. I was looking at PE ratios and thinking that that meant something.
Tobias Carlisle: I think it’s one of the funny things. I remember that period vividly because that’s when I started my own blog. I started in 2009. Those Graham net-nets just don’t come out very often. They’re like cicadas, they come out every seven years or so. When they come out, I was buying a lot of them. There’s a lot of volatility both ways, so I traded quite a lot, getting in and out of positions, also because they’re very small. I just thought, “It’s possible. You could be doing a lot of trading.” Although I was using, like, Firstrade. I don’t know if that still exists, like, [crosstalk 00:09:33] and round-trip.
Michael Batnick: I was day trading based on tangible book value. But to your point, Ben Graham wrote two pieces I think, in Fortune, in 1931, about how basically two-thirds of American companies were worth more dead than alive. Obviously, those opportunities have long since vanished.
Tobias Carlisle: Yeah, they come, that was also close to a market bottom. That was an extreme time. I think there was 600 issues. 200 of them were, or some portion of them were, net current asset values. 50 of them were sub-cash. They have them in the bank, which is just crazy times, but that happens occasionally. I find Benjamin Graham is an interesting … It makes sense because you read The Intelligent Investor, and naturally that’s where the Irrelevant Investor comes from, which I hadn’t kind of appreciated until I read your book. He’s the first guy who you discuss in your book. Can you tell us a little bit about him? What’s his bad trade?
Michael Batnick: I remember reading The Intelligent Investor in probably 2009. I had no investing background. I did not grow up reading Barron’s or anything like that. My dad is a dentist and my mom stayed at home most of my life. I remember reading that, and particularly the part about Mr. Market. I remember being so excited, I read it to my mom. I was like, “Oh my God,” and she was like, “What is this?” But I just had to share it with them because it really was like a light bulb moment. But I didn’t really take that to the next step. I didn’t really, because I didn’t know anything. I couldn’t look at a balance sheet and make heads of tails of anything. Anyhow, to answer your question about what Ben Graham’s bad trade was, he ran a partnership, and going into the Crash, he was actually positioned very conservatively.
Tobias Carlisle: This is ’29.
Michael Batnick: Yeah, he had maybe 70% of his assets in cash and money markets. I’m sorry, not money markets, in preferred stocks. He avoided a lot of the carnage, but he went in too early, and I think he had like a 75% draw down.
Tobias Carlisle: Which is probably about market right? Maybe he beat the market.
Michael Batnick: Yeah, no, he did, but I guess the point of that chapter was like, this is literally the guy that wrote the book on value. He missed the Crash, he saw value, but the point was, that only tells you so much. You don’t know when the tide is going to turn. Timing things, certainly based on valuation, is supremely difficult, probably not worth people’s time.
Tobias Carlisle: What’s one of the crazy things I find about reverse compounding, so, particularly when you’re trying to time the market, and particularly for value investors, if a stock’s down 80% and you jump in down 80%, and then it proceeds down 90%, you’re down 50%, and that’s a big draw down. Sure, it’s not 90%, but it’s still half of whatever you’ve put into that position. Yeah, timing the market, timing the stock market is impossible, but timing individual stocks is also impossible. I’m 100% in agreement there.
Michael Batnick: One of the things that I did repeatedly was I thought that stocks that got cut in half were like, a good value. If you know nothing else, you know buy low, sell high, and so I was bottom fishing for a living. Obviously, I’m not making a living doing it, but I think what I was doing was I was trading, but I had sort of a … I don’t even want to call it a valuation mentality, because that’s like an insult to value investors, but my time line didn’t match up at all. I was trying to catch a bottom, and it’s just ridiculous, like, wait a minute. You think a company or stock is cheaper … I wasn’t even thinking about the fact that these are actual businesses, but let’s just say that I was. Okay, so this business is cheap and I want to flip it in 10 trading days.
Tobias Carlisle: Yeah, might be too short. I know that a lot of value investors like to hunt on the 52-week lows list, like that’s the place where you’ll find stuff that it’s as cheap as it’s been for the last year, so it makes some sense, but then Wes Gray pointed out to me years ago that that’s all the companies with the worst momentum, so you’re buying these low momentum stocks, which, if you’re constructing a long-short momentum portfolio, that’s your short portfolio. That’s the short portion, so that’s not a good place to hunt. Like, the fact that it’s down a lot is kind of meaningless. You want to look at it relative to its intrinsic value.
Michael Batnick: Yeah, so once in a while, I will tell myself that I could probably trade okay, and then, you know, I smack myself. I’m like, “You’re an idiot. No, you can’t,” but I’ve had young people who do want to start trading, and I think that I encourage young people to trade because no 18 or 21-year-old is going to … I forget what the age is. Nobody’s going to open up an account and buy the Vanguard Total Stock Market. It’s just not realistic. Nobody does that, nor should you, because maybe you find out that you really love to invest or trade, which there’s nothing wrong with that. More likely, you find out, “Huh, okay. I get it. This is hard. I don’t want to waste my time doing this,” but one piece of advice that I always give is, and I think Jon Boorman said this, he said, “If you want to buy a stock that you want to go up, buy one that’s already going up,” and I think that is easy to understand, but in practice, it’s hard to buy a stock on a 52-week high list. Right? That’s where I don’t want to say the value is, but that’s what works.
Tobias Carlisle: Yeah, I mean. That’s momentum trading right there, and that’s momentum investing, and that certainly does work. I mean, you can be a value investor too. You don’t have to buy it going up, but you just got to know what you’re doing when you’re doing it. If you’re buying momentum, then you got to expect that it’ll fall apart faster than a value trade. Like, value can work for five years. You stick value on, you get the bulk of your return the first years, but you still get some as you go down the pike.
Michael Batnick: I’m also a big believer in having written rules, and I had no such rules when I was doing it, but I just think that if you’re making decisions in the heat of the moment, you’re setting yourself up for disastrous failure, and I think that that’s true, and I don’t even care necessarily what the rules are. They could be, you know, dumb rules are better than no rules, because I think you’re going to shoot yourself in the foot. At least I did. What I would do, this is sort of my M.O. One of the things that I did consistently was I would buy a stock on a breakout, and it would run two or three days, and then I would sell it on the retest, because I didn’t have the discipline to sell on the way higher, and then I got scared that my profits were being ripped away from me.
Tobias Carlisle: I read at the same time Benjamin Graham’s writing his Intelligent Investor, across the Atlantic, John Maynard Keynes is also going through similar sort of pain, because he was running various different portfolios, and he was bailed out by his dad a couple of times, and he was also pretty wealthy from the books that he had written. He eventually got to this point where he was like this very Buffet-like buy for the very long term, buy good businesses, just concentrated on the ones he liked to hold, but what was his big mistake?
Michael Batnick: Well, similar to Graham, he also got annihilated in the Depression, like basically everybody else. I think that one of the most impressive things about the Keynes story is that by all accounts, he was sort of an asshole, or at least I shouldn’t say that. He had a large ego, which is understandable given the contributions he made to the monetary world. He had the mental flexibility. The guy is basically the father of macroeconomics, and he realized, “Huh. I can have all of the important inputs. I can know what interest rates are in Great Britain, and I can know what currencies are doing in Brazil, and I can know what stocks are here and bonds are there in Kumai, whatever, whatever.”
Michael Batnick: Doesn’t matter, because what he realized very, very early on was how important behavior is, and the whole newspaper thing that he did where if you’re judging a beauty contest, it’s not who you think is the prettiest girl, it’s who you think the average opinion is going to be. He realized that that’s just a loser’s game that nobody can know what the average opinion, expects the average opinion to be. I think that he was doing the second level thinking, like, literally 70 years before Howard Marks started talking about it. To your point, he realized that the way to be a successful investor for him was to value businesses, good, solid businesses, and just hold on the for the ride, and let compounding do its magic.
Tobias Carlisle: Very Buffet-like. Well, before Buffet existed, and he was doing it at the same time as Graham was. It’s interesting to read some of the stuff that he writes at that time, because he does sound very Buffet-like, and Buffet refers to him a few times in his letters.
Michael Batnick: Yeah, I forget what chapter it is. It’s chapter 12 or chapter 11 in his book is definitely, like, one of the best things ever written on investor psychology, and I encourage everyone to read it if they haven’t already.
Tobias Carlisle: Yeah, I agree. It’s excellent. Another one that I really enjoyed, I don’t know if he falls into the category of super investor, but Mark Twain.
Michael Batnick: Yeah, I think this was one of the most fun people to research, because I had no idea what a lousy investor he was. I guess I just knew him from like, Huck Finn and whatever, but he was almost like a cartoon of how bad he was. It was like, you couldn’t believe it. He was obsessed with entrepreneurs, and was basically I guess the worst venture capitalist of all time. Not only did he do that, but he also dabbled in the stock market, and he just threw good money after bad and doubled down repeatedly, and got involved in, like, the gold rush in California. I’ve said this before, but if he were on Twitter today, he would absolutely be the king of social media. I don’t think that there’s ever been a more clever, wittier writer than him.
Tobias Carlisle: The best one-liners.
Michael Batnick: Yeah, by far, and a lot of them were about investing, actually.
Tobias Carlisle: Yeah, I agree. He’s hilarious. There are two big names that you have on this list, Buffet and Munger. Why include their worst investments, and what do you sort of learn from their worst investments?
Michael Batnick: The Munger one somebody pointed out to me that he didn’t really make a mistake, and I was like, “Huh. Yeah, good point. I guess he really didn’t.” The Munger one was in his partnership, I think in the ’74 to ’75 bear market, he lost 50% and one of his investors in particular basically came in at the top and sold Munger at the low, which is kind of funny, but the really bad investment that he made, and again, not necessarily a mistake, it’s just, you know, it’s what he does, is this company Blue Chip Stamps, which I think became the conduit to the Buffalo Evening News and maybe even provided the cash flow to buy See’s Candy, I can’t exactly recall, but that turned out to be an okay thing. The Munger thing, maybe I would like a Mulligan on. The Buffet one, Buffet’s made a ton of mistakes.
Michael Batnick: There was a bunch to choose from, whether it was the airlines or Wells Fargo, not today, but in the early ’90s. I chose the one that he just has highlighted, the Dexter Shoe Company, which he bought, I think, for like 430 or $450 million, which is in stock, in Berkshire stock, which is now the equivalent to like, 6.5, $7 billion, and not only did he use Berkshire stock, but some of the quotes did not age well. He was very overconfident in his assessment of Dexter, because he had recent success with other shoe companies. The point of writing this book was like, I just wanted to humanize these people, to show people that everyone makes big mistakes, and it’s sort of part of the game. If you want to play it, you got to accept the losses. I just think that we learn a lot more from failure than from success. There’s been a million things written about how Buffet is the greatest, and you know, on down the line.
Tobias Carlisle: I think it’s one of the interesting things about studying the records of great investors like this is that you see how often they do make mistakes, but they still somehow figure out how to thrive and make a lot of money despite the fact that they’re making mistakes. It’s something about the way that they construct their portfolios. They’re never sort of super concentrated. They’re not using leverage that’s going to kill them. You draw any other lessons from the guys who’ve been successful despite those big mistakes?
Michael Batnick: Yeah, I think that they’re pretty much all behavioral driven. Certainly in the case of like, Stanley Druckenmiller, there’s a perfect example. He went all in at the top, and somebody said, “What did you learn?” And he said, “Nothing. I knew what not to do. I just couldn’t help it.” Jesse Livermore, who is the single most quoted trader of all time, every single time he made and lost a fortune, he came away with like, these almost, like, soliloquies, just beautiful language on what an idiot he is, and he couldn’t even follow his own rules. I think people have a pretty good idea how to lose weight. Doesn’t mean that you’re going to have a six pack. We know what to do. We know what not to do, but knowing what not to do and not doing it are two separate things.
Tobias Carlisle: Yeah, the problem’s not intellect. The problem’s not not knowing what you should do. It’s being able to actually do what you should do, which is a totally different thing.
Michael Batnick: Right, which is why I firmly believe that there is not a … I don’t think that you could be a super investor without having a high IQ, but you could be a very average sort of intelligence person and do just fine in the market. I think that it’s really more of your temperament and your personality, and some are better suited to it than others. Myself, I was just way too emotional. Not that I would like, stew over my losses, but just, again, I didn’t have any rules, and I was making decisions based on how much I was up or how much I was down, rather than following any sort of process.
Tobias Carlisle: One of the really interesting people in there, Benjamin Graham, just to go back to Graham, because you know I’m a Deep Value guy, so I’m a big fan of Graham’s, the interesting thing for me about Graham is he had those losses and that sort of led to him codifying value and writing security analysis, and he wrote those articles for Forbes, or for Fortune-
Michael Batnick: I said Fortune, but it might be Forbes.
Tobias Carlisle: Well, I don’t know. I can’t remember either. Doesn’t matter, but they’re fantastic articles, but what I take from it is, and I’ve never actually done this study separately, but I’ve read that Graham’s record would have underperformed the market but for his investment in GEICO.
Michael Batnick: I’m so glad you said that. I was just about to say that, and I almost wrote this blog post, but I didn’t want to get eviscerated. Now, you can’t take it away from him, because-
Tobias Carlisle: He did it.
Michael Batnick: … he did it, but truly, and I think even with that, and I don’t want to say he only beat the market by 2% a year, because very few people have done that, but you’re right. GEICO, it was a mixed bag. He said shortly before his death in 1976, I believe, that he didn’t really believe in security analysis anymore because too many people were doing it, and obviously, that’s been repeated by a million people, but he was a very fascinating, fascinating person. He had, as anybody who’s read knows, that he had very wide ranging interests outside of finance.
Tobias Carlisle: Outside of his marriage, too.
Michael Batnick: Yes. Well, I guess that rubbed off on his students as well.
Tobias Carlisle: True. Yeah, so I really enjoyed the book, and I love the focus on mistakes rather than successes, because everybody knows the successes, but I honestly do think that you learn a great deal more from the mistakes. Does any of that sort of flow into your investing now? Has it made you diversity more? Do you not use leverage? What do you do?
Michael Batnick: Absolutely it has. For our clients and for myself, I’m a big believer in diversifying and not just across assets, but across strategies. We’ve included a fairly simple trend following model into our process because I do think that the idea that somebody can sit through a 50% equity draw down, even if it’s not all of their portfolio, I just think that’s a really hard ask of people. I don’t think that we’re equipped to deal with that, so that has certainly shaped how we view our portfolios.
Tobias Carlisle: What do you use, 200 day, or just year on year or something?
Michael Batnick: I’m honestly not even that … We sort of data-mined the hell out of this, and where I came out is I don’t really have a firm opinion that one is better than the other, that the 200 day is better than the 190 day, that the 10 month is better than the nine month. For that reason, we have sort of diversified across signals within that portfolio.
Tobias Carlisle: That makes sense. That’s like Corey Hoffstein, Butler-Philbrick type approach.
Michael Batnick: Yeah, but with a much lower IQ.
Tobias Carlisle: But you can always lean on their research.
Michael Batnick: We have.
Tobias Carlisle: That’s what we like to do. Yeah, there’s something interesting about the way that the stock market moves that makes those 200 day … I think a lot of value guys find it very hard to accept that those moving averages do anything for portfolios, but they definitely do truncate the big losses, but then they lead to these long periods like now where you slightly underperform because you get whipsawed on a regular basis.
Michael Batnick: I mean, I’m fine with that. To me, that’s the premium that you pay. You don’t want your house to blow up.
Tobias Carlisle: Right.
Michael Batnick: You’re not hoping to collect, like, “Oh, man, if the market was only down 40%, this would have looked a lot better,” but who wants that? Because the bulk of our money is invested in strategic asset allocation, buy and hold type of investing. I just think that again, I don’t really care what line you draw, because I think the simplest explanation for how markets work, and this is probably it sounds like you could just reduce everything into something so simple, which is why people that actually analyze businesses probably get so frustrated, understandably so, is that rising prices attract buyers, and falling prices attract sellers.
Michael Batnick: Obviously, there’s a little bit more to it than that, but that’s pretty much how markets work, and it doesn’t matter if it’s the market for sushi, for giant tuna, or the market for sneakers, or the market of stocks or bonds. I think that’s pretty much how it works, and by using some sort of moving average, it just smooths out the noise and usually, it tries to get you on the right side of the trade, particular when markets are falling apart. One of the things that I really like about this type of investing is that a lot of the alternative strategies, the black swan type things, and not even the ones that are so tail-heavy, but just the alternative strategies that are pitched to be non-correlated, I think those are very difficult for investors to stick with, particularly because a lot of them can’t survive a bull market, as we’ve seen over the last decade.
Tobias Carlisle: Right.
Michael Batnick: I think that this strategy allows you to have … Obviously, you’re not going to beat the market, an up market, and you might not even beat the market when it goes down. That’s possible too, but I think you understand the mechanics, and we know all of the warts and everything, so it gives us hopefully the wherewithal to really encourage our clients to stick with us when it is having a rough time.
Tobias Carlisle: The only time that I’m aware of that the 200 day really didn’t work as a hedge was in ’87, just because it was so fast, the draw down was so fast.
Michael Batnick: It actually did work in ’87, but the 10 month and the 40 week did not.
Tobias Carlisle: You’re right. Okay, so that’s the most popular version of it, which is that’s the 200 day, is the 10 month. Is that the 40 week as well? Is that the same?
Michael Batnick: Yeah, but the thing is, like, who the hell was using this in ’87? You know what I mean?
Tobias Carlisle: Well, Paul Tudor Jones said that he was.
Michael Batnick: Well, yes, but I think he was doing Elliot wave, and he literally lined up the Crash of ’29 onto ’87, which is so funny because now we mock that, but he actually did it, and you know, good for him. It worked. I think that just you have to have realistic expectations.
Tobias Carlisle: You just have to understand your strategy, I think. You have to understand what it’s going to do. Sometimes you’re going to get whipsawed, and in a long bull market, whatever you use, whether you’re hedging with volatility, or you’re hedging with whatever you’re using, hedging with a 200 day, you’re going to underperform a little bit, and that’s the cost of insurance. That’s what it costs you to not wear the entire draw down.
Michael Batnick: Well, whatever you’re doing, however you’re managing risk, a bull market makes a mockery of risk management. That’s what it does, particularly with these V bottoms. It’s just killer. Obviously, CTs have had an extraordinarily tough time. Is the strategy broken? I don’t know enough to say, but it literally says that it’s not correlated, and guess what? In bull markets, people want positive correlation and they want negative correlation in bear markets, but if a strategy like that existed, it would raise $7 trillion, and then it would no longer work.
Tobias Carlisle: Yeah, good point. That’s a very good point. I have read your blog posts for a long time. I often get the feeling that you’re maybe a little bit more bearish than some of the other guys at Ritholz. Is that fair, or am I mislabeling you?
Michael Batnick: I’ll take it. Thank you.
Tobias Carlisle: That’s not true?
Michael Batnick: I mean, I’m generally an optimist, but if by bearish you mean in the camp of expecting low returns, yeah, definitely. I’m definitely in that camp. I mean, I don’t know really anybody who isn’t, but the thing is that A, I’ve been probably in that camp for, I don’t know, three or four years now, but not to the point of idiocy where I say, “Okay, we have lower expected returns based on just basic sort of math, therefore you should time the market, or go to cash,” or anything like that, because let’s just say that the expected returns are actually lower realized returns, and so stocks, instead of doing 15% like they’ve done over the last five years, let’s say that they do five or six.
Michael Batnick: Well, if you’re jumping in and out when expected returns are lower, and they actually are lower, then the margin for error is much lower. Like, a bull market is kind of more forgiving in certain respects, maybe not on the risk management side, but I guess I don’t want to be misinterpreted that I expect lower returns and therefore I think you should do an overhaul of your strategy. I’ve never said anything like that, because one of the best lessons in this bull market, I think, is that valuation is just not a good timer. It’s how you set expectations, so if you’re doing any sort of financial planning, which is what we do, we incorporate lower expected returns, and if our clients can survive that, then our plan should be bulletproof, but it doesn’t mean that you make wholesale changes to your portfolio. You just set the bar lower, and if you jump over it, fantastic.
Tobias Carlisle: What are the implications for lower expected returns? You need to save more.
Michael Batnick: Save more, spend less, work longer. I mean, those are the hard conversations. Quite frankly, those are the real conversations that matter. That’s where we add value. It’s not because we have the best asset allocation or the most sophisticated trend following model.
Tobias Carlisle: What do you use as your … Are your DFAs … Is that …
Michael Batnick: I mean, yes, we do use them, but it’s-
Tobias Carlisle: Not exclusively.
Michael Batnick: Oh, no, no, no, no. No, no, we use Vanguard, iShares. We’re pretty provider agnostic.
Tobias Carlisle: One of the names that really jumped out from your book was Chris Sacca, because I think that he’s quite distinctly different from the other names there, because he’s VC, and he’s much more modern. Just a little bit about Chris Sacca.
Michael Batnick: One of the hardest parts about investing is that I think, like, regret is the most poisonous sort of … I don’t know what the word is, but it’s terrible for the investor psychology, because there’s always going to be something that you regret. Either you bought something and it’s not doing well, and then even probably more true is that there’s always something going up that you’re like, “Shit. I knew it.” Obviously, you didn’t know it, but you fool yourself into thinking that you knew it, whether it’s Amazon or Bitcoin, or whatever it is. There’s always something that can make you feel like a real idiot, and you know, basically all that I write about is how hard investing is, because I just think that somehow it’s still underappreciated, how difficult investing is.
Michael Batnick: Again, even just buying SPY and holding it forever, really, really hard to do. Even though you’ll do better than most people over the next 40 years, you can’t do it. Chris Sacca is, I think, from all accounts, the most successful, ran the most successful VC fund ever, had returns, I don’t know, 20,000%? Something like totally obscene, but he, like everybody else, is not perfect, and he not only missed three of the most successful IPOs, or private companies that did IPO, but he actually said no to them, and I think the companies were Dropbox, Airbnb, and Snapchat. He was on two podcasts.
Michael Batnick: He was on with Bill Simmons, and he was on with Tim Ferriss, I think, talking about how, again, he was pitched, and he had a reason for why he didn’t want to invest in al of these, and that’s one of the permanent frustrations of investing is that there’s always going to be something that either it’s an error of omission, like Munger and Buffet regret not investing in Costco, and there’s been other stocks that they just missed, but that’s a permanent source of frustration, and I think that you just have to get over that. The idea that the name of the game is not to be perfect, because you’re not going to be. It’s just, for the average person, it’s pretty easy to be good enough, and that’s what you should strive for.
Tobias Carlisle: One of the things that Chris Sacca in particular illustrates, and I think VC portfolios do, is that there’s that tail of returns where it’s really only one or two. In a 10 stock portfolio, it’s one or two that sort of deliver the very vast bulk of your returns. We saw that with Graham, and VC’s sort of really, really reliant on that, so it really must gall them to miss those two or three home runs in a portfolio that’s sort of game changing.
Michael Batnick: Yeah, they don’t come along too often.
Tobias Carlisle: It makes me wonder whether that YCombinator approach, where they have like a $10 million portfolio, for example, I’m sure it’s more than $10 million, and then they put $100,000 into, like, 100 companies, so your tail is a little bit more granular, so instead of getting three, maybe you get 10 times, maybe you get 30 that kind of work out.
Michael Batnick: Yeah, and I’m sure that there’s probably a lot of funds that were 0 for 100.
Tobias Carlisle: Yeah, that’s probably true too. I mean, that’s the quant approach to investing, when they’re looking at, you know, so, a regular portfolio for a value investor might be 10 or 30 positions, and then a quant portfolio might be like 1,000 positions, or 500 positions, or something like that. Do you think that by investing in ETFs, are you kind of capturing that diversification, to grab both the upside and the diversification?
Michael Batnick: What types of ETFs?
Tobias Carlisle: Just rather than investing directly, so you’re investing in funds rather than individual names?
Michael Batnick: Like give me an example.
Tobias Carlisle: Well, if you’re investing through an ETF, so you have like a Vanguard Total Market, or you have some view on, you know, you want exposure to value, you want exposure to momentum.
Michael Batnick: Okay, I understand. Yeah, I mean, I think that that’s why investing in index funds work, because I think Research Affiliates put out a thing that by investing in index funds, you’re systematically buying high and selling low. I don’t really think that’s necessarily the case. I mean, for example, GE was a top five holding in the SNP 500, and now it’s whatever, the 70th biggest? I have no idea, but that didn’t drag down the index. Facebook got added to the SNP 500 at, again, I’m making this up, a $200 billion valuation, or $100 billion, 150? Now it’s 500. I think that indexing does allow you to ride the wave, and I think Ehren Stanhope wrote a post that like, it’s not really a momentum fund. Fine, we could argue with the nomenclature, but yes, I think that it does allow you to have exposure to all the biggest winners, and the biggest winners, by and large, more than offset the biggest losers, and if you’re not in the biggest winners and you’re just throwing darts, you’re going to have trouble, because Henry [Bestenbender 00:39:06], I think, was his name, wrote a post that all of the returns came from like, 4% of the listed stocks. It’s Microsoft, it’s Apple, it’s Exxon. You know the names.
Tobias Carlisle: And the other 96% were ultimately losers?
Michael Batnick: Yeah, now you could take the flip side and say, “Well, you could do great by just screening out the losers,” and I’m fully on board with that. I think there’s probably a lot of great quant processes that just try and get rid of the shit, and I’m sure that’s a perfectly reasonable approach, but most of the time, I’m trying to help the average person, because I know how difficult this can be. That’s who I consider to be my audience.
Tobias Carlisle: One of the crazy things is that it is crazy that the index is so hard to beat. You wouldn’t look at the index and construct a portfolio the way the portfolio’s constructed.
Michael Batnick: That’s a good point.
Tobias Carlisle: Greenblatt has this book that almost nobody read called The Big Secret for the Little Investor where he compares. It came out like after the Little Book.
Michael Batnick: Okay.
Tobias Carlisle: It was a green book.
Michael Batnick: Yeah, I never even heard of that one.
Tobias Carlisle: He talks about smarter indexing in that book, and so one of the things he says is that the market capitalization weight index, loses about 2% a year to an equal weight version just because it’s overweight, all of this stuff that’s expensive, and then it’s underweight the stuff that’s cheaper, which, you know, if you believe in value, then you’d prefer to do it that way. He advocates for what he calls … Well, he talks about Research Affiliates Fundamental Index in there, and he says that then performs like another 2% better than the equal weight version, because it’s getting close to-
Michael Batnick: I’m sure that it did in the back test.
Tobias Carlisle: Well, that’s the thing, it’s been one of those periods of time where that’s not been true, so the equal weight has underperformed the market capitalization weight. It’s just one of those things that the market, as soon as you find something logical and it kind of makes sense, it’s just moments away from underperforming for an extended period of time.
Michael Batnick: I don’t think anybody would look at the ideas behind fundamental indexing, “Oh, okay. So you want to weight a company based on its actual economic footprint versus just what the market ascribes a price to.” Who would say that’s a bad idea? But the market is just relentlessly humbling, and again, I think you have to be an absolute moron to keep doing the same things and expecting a different result, and so I did that for like, two years, I guess. Again, not that I am the smartest person at all, far from it, but I think that I’m very, very thankful to have an early appreciation for how difficult it is to beat the market.
Tobias Carlisle: Yeah, that’s an awesome thing to get at any stage for it. Like, I’ve been a value investor, really, since running Greenbackd came in 2008, basically 2008, 2009, outperformed pretty materially. Like, since 2010, it’s just been increasingly depressing, how hard it is to do.
Michael Batnick: As RAM Capital would say, “Thanks for playing.”
Tobias Carlisle: It’s rough, man. It’s tough for value guys out there, and that’s why I think value guys complain about, “Well, look at the index. I wouldn’t construct an index that way.”
Michael Batnick: Of course, I get it.
Tobias Carlisle: But here it is, beating everybody, relentlessly.
Michael Batnick: I mean, the thing that I think often gets lost in just general market conversations is like, it doesn’t have to be black or white. You know what I mean? You can have a portfolio that’s just, say, 80% beta and 20% hardcore deep value.
Tobias Carlisle: Underperformed.
Michael Batnick: What’s that?
Tobias Carlisle: It underperformed.
Michael Batnick: Yeah, but that’s a much better conversation to have than, “Now I’m going to do trend following, and now I’m going to do momentum, and now I’m going to try value, and now I’m going to try growth at a reasonable price.” That’s just a way to drive yourself absolutely mental.
Tobias Carlisle: The other thing it’s important to remember is that the SNP 500 is basically the best performed asset class in the world. If you had international exposure or you had exposure to other asset classes, you’ve basically underperformed that which you can get for basis points, so everything looks stupid compared to just being long the market at this point, which has historically been the time when it’s probably important to do other things beside just being long that index.
Michael Batnick: I mean, I’m fully with you. I am big advocate for not going all in on U.S. stocks. That’s probably one of the hills that I don’t think I could change my mind on, that like, global diversification makes sense. Obviously, I get the reasons why the U.S. has outperformed, but I don’t necessarily know that I think that’s a reason that it’s going to continue to do so in perpetuity.
Tobias Carlisle: It’s hard to know whether what you’re looking at is secular or cyclical, which I guess is always the question at the peak of every bull market is, “Is this time really different, or is this not?” The answer has historically been, “No, it’s not different. But maybe this time.”
Michael Batnick: Yeah, but maybe it is. I don’t dismiss that as a possibility, that truly, maybe there are structural changes that make this time different, which is why investing is so freaking hard, because in real time, it can make us look like idiots. We could look back in 10 or 20 years and be like, “Of course it wasn’t different that time. We’re idiots. The CAPE was 32 in the United States. It was 13 in Europe. Of course it wasn’t different, you know?” But I’ll tell you today that I just don’t know, but I don’t think it’s different enough that I want to go all in on U.S. stocks, particularly today.
Tobias Carlisle: Equally, you could look back and say, “Well, it really was a winner take all type economy. The internet had changed everything.” If you got big, there’s no way that anybody could catch up to Facebook. It was so well entrenched. Netflix was so far ahead. Uber’s so far ahead, it’s just impossible to compete with them, and that’s the way it’s going to be.
Michael Batnick: People would say, “Oh, well, General Motors was 15% of the market and look what happened.” All right, but Patrick O’Shaughnessy was on a podcast recently with somebody saying that people are always looking for the next Amazon, and maybe that’s just a dumb thing to be searching for. Maybe the next Amazon is Amazon. Not that it’s going to continue its performance, but like, maybe this is it, and maybe the rules of the past, like that these companies get replaced, I mean, that’s probably going to happen, but maybe it doesn’t, and maybe we should stop looking around the corner, thinking about what’s going to disrupt Amazon. Again, these are all things that could look ridiculous in hindsight. I guess where I’m at is I just don’t have too strong of an opinion, so I would be inclined to listen to the global portfolio.
Tobias Carlisle: I think as hard as it’s been for investors this last decade, I think it’s been great to be a consumer, because catching a cab sucked, and Uber’s such a better experience than catching a cab. I remember having to rent movies and get the VCR, hope that the cassette was actually in the box and it wasn’t just like, one of those empty boxes. You know, when you were a kid … Maybe you’re too young for VCRs.
Michael Batnick: No, no, no, you would walk around Blockbuster for 40 minutes. You’re like, “I don’t want anything.” I mean, now you scroll for 40 minutes on Netflix, but at least you’re home while you’re doing it.
Tobias Carlisle: Right, but there’s not a limit to the number of times that someone can borrow the cassette, either, so you can watch it at the same time the other person’s got it out.
Michael Batnick: These companies are great. Can you imagine what life would be like without Google?
Tobias Carlisle: No, it’s impossible. It’s so good. Facebook, too, you know, for stalking old friends and for things like that. Although I think I saw this statistic that people are using it less and less, which is kind of interesting. I don’t know what the outcome of that is. They’re migrating over to Instagram, which it owns anyway.
Michael Batnick: You know what’s weird about that? I hate Facebook. Not necessarily just the platform, which I think is pretty toxic, but I don’t like the people that post on Facebook. It’s the same people over and over, and I don’t know what it is, but when you see a Facebook post with a caption, you’re like, “Ah, I hate that person,” but when you see that person on Instagram, it somehow feels less offensive, and I don’t know why.
Tobias Carlisle: Maybe because it’s less political. It’s just pictures. Mine’s just pictures of my kids.
Michael Batnick: It’s just a much different experience. I don’t have Facebook on my phone, but when I open the Instagram app, I never find myself getting angry.
Tobias Carlisle: Yeah, I just don’t open the Facebook app. That’s the secret. Just delete it off the phone, but use Instagram. It’s great.
Michael Batnick: Yeah.
Tobias Carlisle: It is interesting. It’s interesting that there’s this phenomenon where companies go public later. They sort of seem to collect increasing levels of VC money, so where previously, they would have come out as small-caps, and then grown to become successful, large-caps, now they list and they’re like Facebook, massive when it lists. Like Uber will be, when it lists, massive when it lists. Do you think that that has sort of impacted the returns to small-cap stocks?
Michael Batnick: I don’t know that I buy that, because I think that certainly the mega-IPOs is a structural change, but there are still a lot of small companies IPOing, and if anything, we just had a late bubble in the ’90s where companies were getting listed that had no business going public, and so I think that it’s probably not a bad thing for the investor that there’s less of these junky companies to pick from, and so I don’t think that, although Wilshire 5000 is now 3000 stock, I don’t think that’s a big thing that I’m worried about. Have you released any episodes yet?
Tobias Carlisle: Yeah, Chris Cole’s came out yesterday.
Michael Batnick: That guy is out there.
Tobias Carlisle: Yeah, so Chris is a really old friend of mine. We lived in the same building in Santa Monica.
Michael Batnick: No shit. Oh, we might have spoken about this.
Tobias Carlisle: That’s how I met him.
Michael Batnick: I listened to him on Patrick’s podcast, and I was super intrigued, and then he said something that I was like, “Wait, what?”
Tobias Carlisle: Chris is a genius.
Michael Batnick: He’s got some outside views.
Tobias Carlisle: He was in Santa Monica in this building, and basically, we used to drink a bottle of wine every night, and he’d talk about volatility, which is how I sort of … Not that I understand it, but I had zero understanding and talking to him gave me some understanding, so it vastly improved, just because he’s so smart, but he’s moved to Texas, to avoid the taxes in Santa Monica. He made some money, he was working at Merrill as some kind of structuring guy, because he was really good at building these models and things like that.
Michael Batnick: Yeah, he’s obviously got, like, a brilliant quant mind.
Tobias Carlisle: And he’s trading VIX, like, VIX had just been invented, and he says on my podcast, he was like 20% of the VIX volume some days, like, just his PA. That’s how small VIX was, not how big he was. That’s the point he was making, but he’s got a $350 million portfolio now-
Michael Batnick: Oh wow. Could you-
Tobias Carlisle: … and he’s nowhere near that size.
Michael Batnick: Did the podcast go live?
Tobias Carlisle: Yeah, it’s yesterday, so I posted it yesterday.
Michael Batnick: Okay, I’ll listen to it. He said with Meb, I think, that Warren Buffet is the greatest shortfall trader of all time.
Tobias Carlisle: Well, yeah, so he thinks that basically there’s two asset classes, longfall and shortfall.
Michael Batnick: Right. I think that’s a bit out there, but he’s definitely entertaining.
Tobias Carlisle: But there’s a good argument that value is a shortfall strategy, and he says that value is the safest shortfall strategy. If these things blow up, volatility spikes, so you go in and you buy the equity. Worst case scenario, equity goes to zero, so you can’t lose more than equity at zero.
Michael Batnick: What does his fund do?
Tobias Carlisle: It’s crisis offer, so he uses volatility. He’s in VIX futures and options, and basically, what he’s trying to do is deliver, when the market crashes, it’s like a Taleb Spitznagel type portfolio, but for the rest of the time, he’s looking at the VIX term structure, and you know, it gets out of shape, and it moves up and down in all these weird ways, and he’s trying to arbitrage that term structure so it’s not losing money.
Michael Batnick: Oh, so it’s not designed to lose money every year?
Tobias Carlisle: No, well, I think he’s basically either broken even or he’s slightly ahead after fee, since he launched in 2012, with no big volatility event.
Michael Batnick: I would pay for a strategy that could lose 2% a year, but when the market’s down 35, this is up 50. I think everybody would pay for that, right?
Tobias Carlisle: That’s what he’s trying to do. I think he’s trying to hedge the market. Crisis offering distinguishes from a tail event, so he says, basically, when the market’s down 10%, he’s not going to do much.
Michael Batnick: Yeah, that’s nothing.
Tobias Carlisle: Because that’s how he’s structuring, but if the market goes down 20, then he should have returned 20, and sort of beyond that, he’s trying to match basically what the market does down by going up.
Michael Batnick: Is there any risk that he can’t deliver what he’s trying to do?
Tobias Carlisle: That’s the conversation that I’ve had with him many times.
Michael Batnick: Because imagine, like, he just fucking swings and misses. That would be a problem.
Tobias Carlisle: He’s aware of that, though. Like, his business risk is that basically, it just has to be long front month volatility for that to pay off, and that’s what he does. He’s always long that front. He’s some way of being long that front month, but then, to the extent that he can do it, he’s hedging the back, so it’s not an alpha strategy. He is going to lose money in that front month, but he’s trying to lose less and less by being smartly positioned through the term structure.
Michael Batnick: If you have that, whatever, five, 10% of your portfolio, like, I could get behind that, totally.
Tobias Carlisle: I don’t know if you’d want to put as much of that in, but yeah, it’s something like that. I don’t think you need as much as that in there.
Michael Batnick: Oh yeah? Okay.
Tobias Carlisle: There are lots of different ways that he structures, so you can have a managed account with him and basically, he can use what’s in your managed account, and then, because it’s a futures strategy, he can hedge what you’ve got in the account, so you could be long whatever you’re doing in the ordinary course. You long $100 million of the market, somehow, and he needs, like, one or $10 million in premium to cover the 100 million in notional.
Michael Batnick: Oh, so it could be that small. All right, so for institutions, that probably makes a buttload of sense.
Tobias Carlisle: That $350 million is mostly institutions who had come in for like, 75 or 100.
Michael Batnick: That’s crazy. Wow, good for him.
Tobias Carlisle: He’s so smart. He’s got this very out-there mind, which I kind of like. Like, I like talking to someone out on the fringes.
Michael Batnick: Oh, the thing that got me, when he said that Dennis Rodman was the best basketball player ever.
Tobias Carlisle: Right.
Michael Batnick: I was like, “Okay, I’ve never heard that one before.”
Tobias Carlisle: But it’s smart, because he says, on that team, you’ve got all these superstar offensive players, and he’s just recycling the ball and getting it back to them, and he’s recycling it like twice the rate at anybody else, feeding it back to superstar shooters. That’s going to improve the results of any team, just because he’s rebounding so strong.
Michael Batnick: Thank you for having me. This was great.
Tobias Carlisle: Just before we go, if somebody wants to get in contact with you, what’s the best way to do that?
Michael Batnick: I guess @MichaelBatnick on Twitter.
Tobias Carlisle: And you’re director of research at Ritholz Wealth Management?
Michael Batnick: Yep, we’re a Berkshire Hathaway subsidiary.
Tobias Carlisle: Michael Batnick, thanks very much.
Michael Batnick: All right, Toby. Thanks for having me on.
Tobias Carlisle: Pleasure.
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