Free Lunch – The Government Has Removed Left Tail Risk

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During their latest episode of the VALUE: After Hours Podcast, Hoffstein, Taylor, and Carlisle discussed Free Lunch – The Government Has Removed Left Tail Risk. Here’s an excerpt from the episode:

Tobias: When you look at the way that strategies work in other countries, It’s been one of the– Japan, for example, has always defied on momentum. I know that Cliff hasn’t written a paper about it. Like, why does momentum not work in Japan? I don’t know how long ago that came out now. 10 years or 15 years, probably. You familiar with that paper?

Corey: Yeah, it’s been a while since I’ve read it.

Tobias: I think you just said it was the statistical anomaly.

Corey: Yeah. Look, at a certain point, the way you can find a positive statistical anomaly, you can find a negative statistical anomaly.

Tobias: Yeah.

Corey: You test enough things, it’s bound to not work somewhere. For the same reason, if you test enough things, you’re bound to find something that works. Statistics work both ways. All right, so this might be wrong, but I’m looking at earnings per share of the S&P 500. The trough was July– Hold on. Yeah, trough, July 2023, and has since been marching back up through August.

Tobias: That must be expected. What is that that they’re measuring there?

Corey: I have to look at the description of this exact measure. This is the best EPS on Bloomberg. But I think this is as reported. Anyway. [crosstalk] Everyone is going to skew– Let me go back. Let me rewind. Let me replay some of the things I’ve said, because I said coming out of COVID, and this might just be my 2008 over influence over indexing. We have to experience a real recession. If you’re telling me that we can have the threat of a massive economic contraction, and we can have stimulus via monetary and fiscal policy, and we don’t suffer a massive real contraction, now that doesn’t mean nominal growth can’t be positive. Like, real economic growth has to be negative. If we don’t have that, either shallow over a long period of time or acute over a short period of time, you’ve basically eliminated economic risk.

Tobias: Yeah, it’s a free lunch.

Corey: You’ve basically said that the government can get rid of the left tail. In which case, if we actually believe that– I would argue stock prices should be substantially higher because they have substantially less risk, and therefore they should have much less of a risk premium.

Tobias: You should run with more leverage too as a result.

Corey: Absolutely.

Tobias: And then that increases your risk.

Corey: So, aggregate valuation ratios should go way up. I sit there and I go again, and maybe like 2008, there was an argument that we exported a lot of the recession pain elsewhere, maybe we’ve managed to export some of our economic contraction and inflation elsewhere. Well, who knows. History isn’t fully written yet, but I am ultimately confounded. So, when I say maybe we’re not going to have a recession, I was all on board that like, if we don’t have a recession, my fundamental understanding of asset pricing is totally broken. So, I’m incredibly confused. Now, that hasn’t influenced the way I manage money particularly. But from a philosophical perspective, none of this makes any sense to me.

Jake: Well, layer on top of that too, everything was just cranking for US business. You had profit margins as high as ever, corporate tax rates about as low as they’ve ever been, employees share, like wages of the pie has been very small, a lot of bargaining power for corporations versus their employees. Interest rates super low, so debt is super cheap. Every single thing that you had going for you to really push the price of a company up happened and was there. Can you do that all over again for the next 10 years? I’m a little skeptical of that.

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