Daniel Rasmussen (03:05):

And I think that the next thing that had a big influence me was the general framework through which Bridgewater seemed to approach investing, which was to say investment strategies should be logical, they should follow a logic and they should back test well. You should be able to prove that they work empirically. So there’s a burden of proof, if someone says, hey, gee, stocks do well when interest rates go down, you don’t just say, okay, great interest rates are going down, so stocks should go up, right? You say, well, gee, let’s pull all the data, take a look at that. Is that true over all of time or just recently, or what about in other markets?

Daniel Rasmussen (03:39):

And that really turned me on to this idea, which led me down the path eventually to quantitative or quantimental investing, of taking a look at the data and seeing what the data says as opposed to relying on stories or memes or theories. And I think if you compare and contrast that approach with Buffet’s approach, Buffet is not necessarily back testing his strategies or using a lot of quantitative tools. He has a simple formula, however, that has worked for him for a long time. And I think there are a lot of quants that have tried to diagnose what that formula is and replicate it. But I think at its heart, it’s started out doing deep value and then transition into doing large, high quality value. And I think that’s the story of Buffet.

Daniel Rasmussen (04:24):

And I think the final question that you asked was about the relationship of macro to the buy and hold equity approach, and I’d say that they’re not contradictory. A large empirical understanding of the world would lead you to say that most investors should have the majority of their money in low cost, passive equity index funds or the equivalent, if you said I want to choose 10 stocks or whatever. But broadly that’s the conclusion, active management doesn’t seem to work by and large, diversification out of equities tends to reduce your long term returns. And so for most people, the right answer is to have the vast majority of your money in essentially low cost passive index funds that charge next to nothing and provide you with broad equity exposure.

Daniel Rasmussen (05:09):

But I think then there’s the temptation or desire to do something around that, to change your return patterns and I think there are a few things that people often are interested in achieving. I think the first thing they’re often interested achieving is saying, hey, can I achieve higher returns? What’s going to beat an all equity portfolio? That’s hard but possible maybe. The next thing is reducing risk. And I think, I think about risk as drawdown reduction. So the peak to trough drawdown in an all equity portfolio could be 50 or 60%.

Daniel Rasmussen (05:41):

So if you say, gee, I spent my entire life and I’m 65 and I’ve got 10 million, and then in the year that you turn 66, there’s a 50% drawdown, now you’ve got 5 million, you ain’t going to be too happy. So drawdown mitigation is another worthwhile goal. And I think some people pursue that through diversification or through asset allocation, and I think that’s another reasonable goal.

Daniel Rasmussen (06:06):

So I think I’m very interested in these questions, these problems of gee, within equities, what is over the long term, beaten a broad market index, and are there times that it’s easier or harder to beat an equity index? And then the second question is thinking about asset allocation and diversification, what else do I need to complement my equity portfolio, to diversify it, to reduce risk and enhance the returns of my total portfolio, assuming that I still have a large portion of my wealth in low cost passive index funds? And those are the intellectual questions I’ve been grappling with one way or the other since I started my career, whether that’s at Bridgewater or Bain Capital or now at Verdad.

Clay Finck (06:49):

A big reason I wanted to have you on the show was to just give our audience members a fresh perspective, as we seem to be entering this changing and very uncertain economic times with the higher inflation we’ve seen and rising interest rates, and we’re going to talk about all of that.

Clay Finck (07:05):

To transition our conversation, in your work, you outline that Dalio has four macroeconomic conditions that investors might find themselves in. That includes the four iterations of whether GDP is rising or falling and whether inflation is rising or falling. Could you talk about what the overall economic conditions have looked like over the past decade and where it looks like we seem to be heading?

Daniel Rasmussen (07:32):

So I think if you think about traditional answers to asset allocation or diversification, they basically take mean-variance models and they take long term correlations between asset classes, assign weights to them, mix them up, et cetera. I think another approach is to say, well, asset class correlations are unstable because they’re based on macroeconomic drivers.

Daniel Rasmussen (07:55):

Take for example, growth and inflation, which I think are the two primary drivers of asset class returns. When inflation is low, when you have no, low inflation or minimal inflation, stocks and bonds will be perfectly inversely correlated or almost perfectly inversely correlated based on growth. When growth is going up, you’ll have rising rates and low bond returns, but high stock returns. Conversely, when rates come down, when growth goes down, rates go down, bonds go up and stocks go down. You introduce inflation to that mix, however, as we have recently, and you can find that stocks and bonds can go down at the same time because the inflationary pressures that are hitting both and the negative growth pressures are driving bond yields up and stocks down at the same time.

Daniel Rasmussen (08:43):

Conversely, you can think of other asset classes like gold or oil and how they perform. Oil and gold both theoretically do well when inflation is rising because they’re commodities, but it turns out that oil is very sensitive to growth as well, typically. Now this last few months have been somewhat of an exception, but typically when you have high inflation and low growth, the stagflation, oil can crash as demand destruction occurs. And on the other hand, gold can hold up very, very well. Or if you’re coming out of a recession and you’ve got low inflation, but high economic growth, you can see big rises in oil prices. So oil ends up being quite growth dependent even though most people think of it as an inflation hedge.

Daniel Rasmussen (09:23):

So I think trying to then think through those macroeconomic relationships leads you to different conclusions about asset class returns. Traditional mean-variance models, for example, don’t find huge use for gold. I think there’s a lot of skepticism about why you’d want to own gold, for example, in a portfolio. But people that approach the world from a growth and inflation perspective get really excited about gold. You can go read all Ray Dalio’s old notes where he’s super excited about gold. Well, why? Why are people excited who look at the mac world from a macro lens, why are they excited about gold?

Daniel Rasmussen (09:56):

Well, if you start from a stagflationary period, high inflation and falling growth, gold is going to do well in those periods because it’s an inflation hedge. But what naturally or typically happens during stagflationary periods is that stagflation increases the risk of recessions and sharp drawdowns in equity markets. And what happens with sharp drawdowns in equity markets or market panics is that people push into gold as a flight to safety asset, the world’s falling apart, I wish I owned gold. So you have this whole back half of the cycle from stagflation into recession where gold is doing really well.

Daniel Rasmussen (10:32):

Now the minute the economy starts recovering, gold tanks. But if you think about what other asset class is going to perform well on both of those quadrants, equities, no, bonds, no. So it’s playing this really unique role in your asset allocation mix. And so you come to these interesting, I think novel conclusions looking at the world through the lens of growth and inflation about how to adapt a portfolio, to make it robust to economic scenarios we might or might not have in the future.

Daniel Rasmussen (11:00):

We haven’t had meaningful high inflation since the ’70s, right? A lot of mean-variance models that are based on the last 20 or 30 years, I think aren’t going to work very well if they’re not adapting or incorporating the data from the ’70s and other periods like that when you head meaningfully real high inflation.

Clay Finck (11:19):

We were talking a little bit pre-show and you mentioned that we’re currently in an environment with falling growth and rising inflation and you expect inflation to eventually roll over. So I’m really curious to hear why you believe that to be the case. Is it just the recessionary pressures, the stagflation that you were just mentioning?

Daniel Rasmussen (11:39):

The way I think about the world and the research framework that we’ve developed is to view markets as primarily driven by credit and liquidity, the availability of credit and liquidity. And we measure that through the high yield spread, which is the cost of borrowing for the marginal company that’s a double B or single B issuer. These are mostly small-cap companies relative to treasuries. And so when that borrowing cost is going up, so it’s getting harder for small companies to borrow money, we view that as contractionary, that growth is going to be slowing.

Daniel Rasmussen (12:12):

You think if there’s two things going on, banks are repricing risk. So say banks are saying, hey, gee, this seems like a riskier time than it was three months ago, we should probably lend at higher rates to account for that risk, and that’s a bad sign. And then the second thing is those companies themselves that, oh my gosh, I was going to borrow at 4% and now I have to borrow 5%, well, maybe I should invest a little bit less or maybe I shouldn’t hire that marginal worker or build that marginal part of the plant that I was going to build, because the debt’s not as cheap.

Daniel Rasmussen (12:40):

And conversely, when borrowing costs come down, just like when you’re thinking about the housing market, if mortgage rates come down, the housing market goes a lot better. And the same is true as the business world. If companies can borrow more, they’re going to invest more, they’re going to buy more things and hire more workers, et cetera, so it’s stimulative. And then the second dimension is, well, are borrowing costs on an absolute basis high or low? When they’re low and money is cheap, it tends to be inflationary and conversely when they’re high and debt is expensive, it’s deflationary.

Daniel Rasmussen (13:09):

So you can overlay that credit driven view of the world onto your four quadrant growth inflation matrix and say, where are we? Where are the credit markets telling us we are, because it’s hard to know? Is growth rising or falling, is inflation rising or falling? We’ll know in a few months what the retrospective data says. We don’t really know right now, we’re fishing in the dark a bit. And using credit markets is the way we think to provide direction and a radar as to what economic environment we’re in.

Daniel Rasmussen (13:35):

If you look at where we are today, if you think about since COVID, COVID was the peak in high yield spreads. It was the highest spreads had gone on since 2008. So you were in a major recession, a very brief one, but a very major one. And then spreads came down rapidly. So you went through the normal stages of credit spreads being wide and falling, which is basically low inflation, high growth, and then tight and falling, which we’d say is a reflationary moment where growth is rising and inflation’s coming back. Nobody probably expected how much inflation would come back. And then spreads started rising again in November of last year and they’ve been volatile, but rising since. And that typically is a stagflationary environment, where you’ve got rising inflation, which you certainly have seen and growth starting to fall.

Daniel Rasmussen (14:23):

I think the growth starting to fall point is probably a little bit more controversial than the rising inflation. But I think that if you look at both rising rates and rising spreads, meaning higher borrowing costs for everybody, higher mortgage costs, a separate issue, but all these things should play out in hitting the real economy as consumer demand and business demand reacts to tighter monetary conditions.

Daniel Rasmussen (14:46):

And in that environment, what you’ll often see and what you typically see in environments where inflation is elevated is a higher risk of a crash and more severe crashes. And when you have recessions, you don’t have inflation. Recessions destroy inflation and are deflationary actually. We don’t know when that will happen and I think the nature of, especially this time in markets where spreads are tight is a lot of uncertainty and it’s a period where more things could happen than will. And so I think there’s an element of saying, gee, do I think there’s an elevated risk that we go into a falling growth, falling inflation environment? I certainly do, and I think investors should be prepared for downside protection in their portfolios. But at the same time, who knows?

Daniel Rasmussen (15:31):

I mean, I think who would’ve thought that Russia was going to invade Ukraine and then who sitting there in the middle of this month, would’ve thought we’re going to see a massive rally in the equity markets in the middle of this war? We just have no idea, which is why, again, buy and hold should be the largest percentage of your portfolio, because this stuff is so hard to predict. But I think looking out on a nine month to a year horizon and trying to say, hey gee, roughly what economic environment are we in and how can I best prepare my portfolio, I think is a pretty logical approach as well.

Clay Finck (16:02):

You mentioned that you look at the high yield spread to try and figure out what’s happening with GDP going forward or whether it’s rising or falling. For those not familiar, could you define what the high yield spread is?

Daniel Rasmussen (16:16):

High yield market is sub investment grade companies. So an investment grade company is Apple, Google, Microsoft. A sub investment grade company might be, I’m thinking Crocs, the company that makes those little sandal things. It’s not a huge company, but these are … a lot of them are still brand name companies, or the companies that make cardboard boxes or some of the auto companies are high yield issuers. So you’re just thinking, not the safest companies, but still companies you probably would know, those are high yield companies.

Daniel Rasmussen (16:47):

And so you look at the cost of those companies face to borrow. What are their bonds yield essentially, and then what is a treasuries or equivalent duration yield, and you take that difference. So you’re basically looking at the premium that risky companies have to borrow. That’s the high yield spread and you can find it on FRED, the economic database site. And it’s a wonderful metric and in my view, the most important macroeconomic indicator to understanding the US economy.

Clay Finck (17:10):

When I was looking into your research, you had proposed portfolios for each economic environment. And thinking about how Ray Dalio has influenced you, he has his All Weather Portfolio, which has an equal weighting between commodities and gold. And I’m curious why you didn’t include commodities in your proposed portfolio, but you did include gold?

Daniel Rasmussen (17:35):

Yes. So we did actually include oil and copper. And a lot of people say is gold a commodity or not, and whatever. I think gold is a currency, but you can also think of it as a commodity, whatever. Let’s not get into that. Gold and silver, the precious metals behave very differently from what I call the growth sensitive commodities, namely oil and copper. And so when you really want to own oil, the first half of the cycle. So from when you’re in a recession, think of buying oil futures in March, April of 2020, and then owning those for the next year. That was a really good time to own oil and keep holding it probably through the back half of last year.

Daniel Rasmussen (18:13):

Now what’s been unusual is typically what you’d see and what you started to see in November is as growth starts to roll over, oil starts to sell off, but instead we got the supply shock from Russia and so oil has gone up a lot, but gold has started to do well as well. So really gold behaved quite normally. Gold did badly until about November and then it started to do well since which makes total sense in a stagflationary context. Oil’s been an outlier in this cycle.

Daniel Rasmussen (18:42):

But I think broadly, if you think about a more tactical approach, what do you want to own, what are the big muscle movements, the big things that you should be aware of is that in the middle of a recession, so when everybody is panicked … We spent a year or two working on a research paper called Crisis Investing. You always know when you’re in a crisis, which makes crises unique … the optimal thing to buy is small-cap value stocks. So the cheapest, most illiquid scary things that everyone’s panicked about are the things that you should be going to buy in the middle of a recession, because they are on sale.

Daniel Rasmussen (19:16):

There’s always a buyer for Microsoft, there’s always a buyer for Amazon, but there’s not always a buyer for some small-cap industrial company in the Midwest who, they might wake up on March 24th and it’s all sell orders and no buys and the bottom just falls out. So if you can take the other end of that trade, you tend to do really well. That’s the single biggest return driver available in markets in terms of absolute return opportunities.

Daniel Rasmussen (19:42):

And then I think the other tools and lessons are really about diversification and risk reduction. As spreads are wide and rising and you’re entering that recessionary period, dramatic, as much exposure to fixed income as you can possibly have the better. That’s really what bails you out in recessions is fixed income. And then when you’re thinking about inflationary periods, owning oil and gold, depending on your view of growth is really meaningful as a diversifier, as we’ve seen over the last few months, having that commodity exposure, really valuable.

Daniel Rasmussen (20:14):

Now all weather and risk parity approaches to markets, just say, hey, it’s impossible to predict where we are in markets. Why not just own a risk weighted basket of commodities, gold, stocks, bonds, and risk weight them? And that’s a great strategy. I mean, there’s a real elegance to that. But I think where I would differ from that is that I think certain market conditions demand really different approaches. I think if you start from just the basis of a middle of a recession, should you be behaving differently in the middle of a recession then when you’re not in a recession? I think of course you should be rebalancing into equities, you should be taking up your equity risk. If you’re in fixed income, you should be adding high yield. These things are really robust in the data, you can really see them very strongly.

Daniel Rasmussen (21:00):

And then I think if you go from there and say, okay, well if I know I’m going to be doing things differently in the middle of a recession are the things that I’d do if I was worried that a bull market was coming to an end. Maybe put in trend following or risk reduction rules or maybe take up my fixed income or gold exposure. I think largely what I’ve been spending time thinking about for the last year or so is how to adapt a portfolio to different macroeconomic conditions.

Clay Finck (21:24):

I like how you take this very contrarian approach. And you hear over and over how growth has outperformed value over the past decade, and we’ve also been hearing talks of a potentially lost decade for the overall stock market, with interest rates at historical lows and inflation on the rise. Do you think that small-cap value might be something that someone that has that buy and hold approach, small-cap value could be a diversifier for them to try and enhance their returns?

Daniel Rasmussen (21:58):

Yeah. I think if you look at really any large empirical study of what works in the equity markets, you’re going to come to value. And where small comes into play is that if you think there are 500 large-caps and 2000 small-caps, just to round the numbers out, if you then say, well, how many stocks trade at less than five times EBITDA or trade at less than five times P/E or have a greater than 5% dividend yield, pick some extreme value metric, you’ll find that 9 out of 10 are small-caps.

Daniel Rasmussen (22:32):

Small-cap value is just pure value essentially, right? Whereas if you constrain it to large, you’re not getting the real value hit because all the really cheap stuff is in small-cap. Now the thing to note about small-caps is that they’re riskier and bankruptcy risk is higher than in large-caps. So you get much bigger swings, especially during recessionary periods where small-cap is going to sell off a lot worse than large-cap. Conversely, it’s going to come back a lot more when the recession ends and the recovery begins, but you have to, if you’re thinking about moving from large-cap to small-cap, that increase in volatility and drawdowns is meaningful.

Daniel Rasmussen (23:07):

On the other hand, again, almost any large scale long term empirical study across markets is going to find that value works and the more extreme value exposure you can take, the better it works. And so I think that absolutely small-cap value deserves an outsized place in people’s portfolio. If you think small-caps are 10% of the market and small-cap value, therefore is roughly 5%, I think people shove at least 10% of their money in small-cap value, at least a 2X overweight, given the robustness of the empirical findings about its outperformance potential. Now more than that, you’ve got to have some real fortitude to take on the ups and the downs. But I think as much as you can handle within reason is probably good.

Daniel Rasmussen (23:48):

Now I think we’ve lived through a period where this style, small-cap value, has just had atrocious performance, especially 2018 through 2020, right? If you’re saying, well, the reason I want to own small-cap value is because it outperforms and someone says, oh, it outperforms? Not in the last five years, not in the last 10 years. Were you asleep during 2018 to 2020? Small-cap value sucks, it’s the worst performing part of the market. What are you talking about?

Daniel Rasmussen (24:13):

And that’s true too, right? We have to grapple with that. There are long periods where it doesn’t work. And I think sticking with it requires a lot of conviction and I think a lot of grounding in the data, because again, the data is very, very strongly supportive of this and the logic of it is very strong. Small-cap value has not crowned itself in glory in the years leading up to COVID. Now, since COVID, it’s done quite well and I think people are starting to see the reasons that you have it.

Daniel Rasmussen (24:35):

And I’d say one of the things that I would note about small-cap value is that periods of volatility, especially the more economic recoveries you have, the better small-cap value does. Whereas when you have protracted bull markets, those tend to favor the types of risk taking that often reward people going further and further out in the valuation spectrum. And so you tend to see growth bubbles occur at the end of long bull markets. I don’t think those are the conditions that we have today and I think growth is selling off for that reason. So I think it’s a very good time for people to think about small-cap value, adding it to the portfolio, adding exposure, especially given how well small-cap value did during the last lost decades during the ’70s and during the 2000s.

Clay Finck (25:18):

Yeah, that’s why I mentioned that you take this contrarian approach. A lot of people want to put more money in the NASDAQ while the small-cap value underperformed up through 2020, and when you buy something that’s cheap, that’s when you can get that outperformance. And another way to potentially diversify a portfolio full of equities is to expand into international stocks or emerging markets. I’m curious what your thoughts are on this approach.

Daniel Rasmussen (25:46):

International markets are another area, which has not been crowned with roses over the past few years. So it’s understandable that I think people are skeptical about international diversification and why do I own international stocks? They seem pretty correlated with US stocks, they just perform worse. And then they say, well, all the best companies are in the US, so why do I need to go to the international markets?

Daniel Rasmussen (26:06):

I think that all seems right when the US is winning, but the US has been winning for a long time. I don’t know that there’s a reason why great Japanese companies or great European companies or great companies in the United Kingdom shouldn’t do just as well, if not better, starting from much lower valuations today than US companies. We just don’t know. And so I think you start from saying, hey, from behind the veil of ignorance of not knowing economic conditions, why take such a disproportionate bet on the US? I mean, it just seems crazy, especially given how much cheaper international markets are and the potential for diversification.

Daniel Rasmussen (26:42):

I think international investing is deeply attractive, but also, it’s correlated with value. I mean, I think that the growth names that have been winning are disproportionately in the US, international markets are disproportionately value markets. So a lot of this stuff, it’s the same trade or the same logic that when one of them works, the other one doesn’t work as well.

Daniel Rasmussen (27:02):

Emerging markets, Clay, I have a contrarian view on. I am a permabear on emerging markets. I think emerging markets stay emerging. And I think if you look at people that make money in emerging markets, watch what they do. They make their money in Brazil. What do they do? They buy a condo in Miami, they get their money the hell out of Brazil as fast as possible because what they know about their own countries, they know how corrupt these countries are. They know how risky the political system, fragile the political systems are.

Daniel Rasmussen (27:32):

These countries, most of them are one socialist away from complete economic devastation. They’re one stupid invasion away from being locked out of the economic system. They’re one firing of a central bank governor away from complete monetary collapse. The line between stability and complete devastation is so quick in these emerging economies. In our research, what we found is that the defining attribute of emerging markets is the frequency and severity of economic crises that happen three to five times as often as in developed markets and are more severe and you’re less likely to recover.

Daniel Rasmussen (28:09):

I think that emerging markets are sort of the original ESG. So in the 2000s, we all wanted to help close the income gap between poor countries and rich countries by spreading democracy and capitalism. And the way to do that was to invest your dollars in building bridges in Vietnam or factories in Thailand, or helping make China less communist by building up their tech entrepreneur scene. And it all sounded good and it was a disaster for investors who put their money there. It might have been good for the emerging markets, but it certainly wasn’t good for the investors.

Daniel Rasmussen (28:44):

And I think there was a conflation of a political goal with an economic outcome. And I think frankly, neither the political goal nor the economic outcome were achieved. I’d say probably ESG investing, which is so invoked today is probably doomed for a similar dual failure on both political and economic outcomes. But I think that investors are suited to broadly avoid emerging markets. I think there are rare, interesting times in the EM, so generally after major crises, that can be of interest, because things just get so bombed out and disastrous. But you’ve got to, again, have a lot of fortitude to take advantage of those.

Clay Finck (29:19):

So I’d assume China and Chinese stocks fall into that emerging market bucket for you where it’s just something you won’t even touch?

Daniel Rasmussen (29:27):

Yeah. I mean, what is an equity in a communist country? I mean, who owns it? What rights do you have? I don’t know. I mean, I don’t understand. It boggles my mind of how much money has fallen into China. And then you think of what’s even more crazy is the fad among college endowments for Chinese VC. And you’re just like, not only are you investing in a communist country, where who knows if you’re ever going to get your money back, and who knows who controls it, and who knows who owns the thing? Now you want to do that in an illiquid way, so there’s not even a market you can buy and sell it? You just want to give it to somebody? I mean, it just seems totally, totally nuts to me. And I know some people have made a lot of money there, but it just seems not worth the risk to me.

Clay Finck (30:07):

Back pedaling to when we were looking at the big picture. Since you foresee a falling growth and falling inflation environment, does that put you in a position where you’re very defensive, where you’re holding a lot of bonds and you’re not necessarily predicting a recession or anything, you’re just looking at the data and it says, this is the time to be much more defensive?

Daniel Rasmussen (30:30):

I’d still say we’re in a moderate risk period, where I think you want to be diversified, you want to have meaningful equity exposure, meaningful commodity exposure, meaningful fixed income exposure. It’s not a high conviction time right now. So do I anticipate it’s possible that we go into falling growth, falling inflation, we enter a recession? Of course I do. Is the risk probably elevated today? Yes. But am I ready to go into a highly defensive portfolio today? No.

Daniel Rasmussen (30:56):

The question is what do we need to see to do that? And I’d say I’d want to see high yield spreads go above 450 or so. So they went to about 420 at the height of the Ukraine crisis and I thought, okay, maybe we’re headed there. A few more bad days and we’re basically there. And the markets recovered. And so having a reasonably high threshold for your true defensive portfolio in my view is a savvy thing to do. So no, I don’t think that this is the moment to go into recession mode in your poor portfolio. This is not where spreads are.

Daniel Rasmussen (31:25):

Again, we’re in this moment where more things can happen that will happen. We could very well see a whole variety of economic outcomes come out next. But I think again, both the high CPI print, and remember periods of high inflation tend to be punctuated by sharp and severe recessions, and then second, a lot of the volatility and spreads we’ve seen isn’t a positive signal for the economy, nor is fed tightening generally a positive sign for the economy. I think there is a lot to be worried about, but I’m not ready to say, hey, gee, it’s time to go fully defensive yet.

Clay Finck (31:56):

That makes sense. Now there’s been a lot of talk lately about inflation, especially in relation to interest rates. First, CPI inflation is far higher than treasury rates creating a negative spread between the two. The 10 year treasury today is around 2.5%, maybe slightly lower while the most recent CPI inflation print was roughly 8%. Second, we are starting to approach an inverted yield curve as the short term rates are currently rising much faster than the longer term rates because of the higher inflation we’ve seen as of late. I’m curious what your general thoughts are on what you’re seeing regarding these interest rates.

Daniel Rasmussen (32:35):

I think first of all, look, the fed model, the Taylor rule, these basic models of where interest rates should be, they’re too low. The fed has kept them too low, too long. Any reasonable application of the Taylor rule or other sort of monetary policy formulas should mean rates are at four and half, five. I mean, they should be just meaningfully higher than where they are today.

Daniel Rasmussen (32:58):

You add to that we’re seeing a lot of inflation and you’re going to say, well, gee, I think probably the fed’s pretty worried about inflation and all their indicators telling them that they need to raise rates. And then if you say, well, gee, is there any evidence of a speculative bubble caused by rates being too low? And you don’t have to look far for evidence of speculative bubbles in the US economy. I think all that combined is going to push the fed to be fairly aggressive and move even in the face of sell offs in the stock market, et cetera. And so I think investors need to be prepared for that because I think it’s logical what they’re doing, but the risk is that it ends up in a big correction of the equity market are reasonably high.

Clay Finck (33:37):

The pushback to that I always hear, I know you’re much more knowledgeable on this than I am, but I always hear that the federal government can’t really afford interest rates to rise because of the high levels of indebtedness they’re in.

Daniel Rasmussen (33:50):

Of course there’s some truth to that, but the fed’s goal is price stability, it’s not making government debt affordable for the US. It’s price stability and employment, that’s the dual mandate. And I think if you look at those, they’re clearly failing to control inflation, and so they’ve got to act, that’s their mandate. Yes, other parts of the government might be concerned about borrowing costs, but that’s not necessarily the fed’s mission.

Clay Finck (34:12):

Got it. We also talk quite a bit about Bitcoin on this show. So I’m curious what your thoughts are around Bitcoin in particular. I know you aren’t able to look back at a lot of data for Bitcoin as it’s only been around for a decade. But yeah, I’m curious what your general thoughts are on that.

Daniel Rasmussen (34:30):

Recently reviewed a few books for the Wall Street Journal about cryptocurrency. I’m not the world’s most knowledgeable person about crypto obviously, but yeah, I’ve read a few books and I’ve tried to think about it in a logical rational framework. And I think if I had a takeaway I’d say, first of all, I don’t think that cryptocurrency is useful. I don’t think DeFi or the blockchain are useful. There’s not many uses for them today and I don’t see them being many uses for them tomorrow.

Daniel Rasmussen (34:57):

I think people would rather use a credit card company or a bank or another strong financial institution with very high safety, privacy regulations, that’s regulated by the government, that’s regulated by industry trade groups, et cetera. You’d much rather trust your money with those types of companies. Plus you want chargebacks. What if you have a fraudulent transaction that you want them to be able to fix it? Having to rely on the blockchain and code as law and some random hackers out there to manage your investment portfolio, that’s a niche case, right? So you have to be an ideologue to want to use that DeFi system as opposed to using the standard financial system, which frankly works pretty well for most people for most uses.

Daniel Rasmussen (35:38):

I think on the other hand, Bitcoins in particular does have this scarcity value. There’s only a limited number of them and the extent that it has a potential to become something like digital gold, I think there’s a strong logic for Bitcoin as a collectible or as a store of value or an alternative return stream that’s diversifying. And I can see people owning it and holding it for that reason.

Daniel Rasmussen (36:04):

And the more people that have faith in it and believe in its value, obviously the more its value goes up in the same sense that gold does. And I think I’m more sympathetic to that use case. And I think that also makes me again, more sympathetic to Bitcoin than a lot of the quote-unquote, “alt coins,” because I think so many of those are again, designed to be useful and I don’t think usefulness is ever going to be Bitcoin or crypto’s selling point. But I think the scarcity value and the potential to act as digital gold is.

Clay Finck (36:33):

So you mentioned earlier that small-cap value is a good portfolio diversifier. And many of our listeners are like you and I, where we’re younger and we have many years before retirement. Are there any other asset classes you think that a millennial or someone that’s younger should consider to add to their portfolio, assuming they’re invested mainly in something like the S&P 500?

Daniel Rasmussen (36:58):

Yeah. So I think very broadly, remember the S&P is 60, 65% of global market cap. So adding international exposure is step one, right? I mean, you’ve got to have some developed international exposure and probably meaningful, somewhere between 35, which is market weight and 50%, which is closer to GDP weight is probably the answer in book. That’s step one. There’s no reason not to take that simple equity diversification, add more stocks and a broader regional few.

Daniel Rasmussen (37:27):

I think the second is within stocks, the factors and small-cap value is the biggest dose of the value factor that you can get. There are other folks that advocate for other factors, momentum, et cetera. I think value makes more sense to me. I think there’s a lot of evidence that momentum works, but I think adding small value is a very logical simple step.

Daniel Rasmussen (37:45):

I think from there you say, okay, what about fixed income? What about gold and oil? I’d say broadly, inflation hedges tend to be bad long term buy and hold investments. So owning gold and oil as a buy and hold investment, I don’t think it makes a lot of sense. I mean, I think using it as a tactical play within your portfolio, if you have a view about inflation, yes, that makes a ton of sense, that’s what it’s useful for. But long term buy and hold, the record isn’t good that you’re going to do all that great. You’re going to add some diversification in your portfolio, but you’re going to reduce the long term return.

Daniel Rasmussen (38:18):

I think fixed income on the other hand, obviously as a yield, you’re going to get a decent yield, and I think you’re also going to get a benefit and risk reduction from the flight to safety that you get during recession. I think that having a fixed income allocation is important. Now, as millennials, it doesn’t need to be big right now, but over time, it should get bigger and bigger. And I think if you think about the big drivers of returns than fixed income, it’s treasuries, which I know the yields are low, they’re always low, but gee, the yields are going to go down in the middle of a recession and the value of those treasuries are going to go up and then you can rebalance out of them into equities, and that’s very useful and it diversifies your portfolio.

Daniel Rasmussen (38:54):

And then the other is corporate fixed income, which earns a little bit more, has a little bit less juice in recessions, but can provide you with a return that’s somewhere between treasuries and stocks. So I think that those are the big things that I’d consider. I know a lot of that’s dull and boring, but most of our portfolios should be dull and boring if we’re doing it right.

Clay Finck (39:12):

Yeah. I think it seems a lot more dull and boring because they’ve maybe underperformed over the last decade, but that’s how you should position yourself as an investor, if you’re looking to find ways to outperform the S&P 500 in a thoughtful way.

Clay Finck (39:25):

Dan, before I let you go, and we close out the episode, where can the audience go to connect with you and learn more about your work?

Daniel Rasmussen (39:34):

Absolutely. I’m on Twitter at @verdadcap. I also have a weekly research email list. It’s free. You can sign up through my Twitter bio. About 20,000 subscribers and I think people really enjoy reading the research that we do. So if you enjoyed this conversation, I think you’d enjoy the weekly research.

Clay Finck (39:52):

Awesome. Thank you so much, Dan.

Daniel Rasmussen (39:54):

Thank you, Clay. This was great.

Clay Finck (39:56):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app, so you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it if you left us a rating or review on the podcast app you’re on. This will really help us in the search algorithm so others can discover the show as well. And if you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There you’ll find all of our episodes, some educational resources, as well as our TIP Finance tool that Robert and I use to manage our own stock portfolios. And with that, we’ll see you again next time.

Outro (40:32):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.