John is the most well-connected man I know, extremely intelligent and hard-working, and a true Southern gentleman to boot. He is on a first-name basis with high-ranking senior-level politicians, prominent hedge fund managers, economists, and celebrities, and has deep insight into the world economy.
It was a privilege to talk with John, and we talked for a good half-hour discussing all things investing and economics, including:
With thanks again to the awesome Casey Research team, here is John Mauldin!
Hello! I’m Susan Fujii with Kung Fu Finance. I am honored to be speaking with John Mauldin, Chairman of Mauldin Economics, President of Millenium Wave Investments, New York Times best selling author, and smart money investor.
Let’s not go too far now. (laughs)
It’s true — you are one of the few people I know who is truly a smart investor and it’s an honor to talk with you.
Thank you, you’re very kind.
I wanted to talk with you a little bit about your new book. You have this great book that I think should be required reading for all investors, called The Little Book of Bull’s Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets.
I really like this book because you debunk a lot of Wall Street myths that are perpetuated that I believe many people fall prey to.
So, I was hoping you could talk to me a little bit about some of those — why buy and hold doesn’t always work and may not be the best strategy right now.
The market is moving sideways.
We call them secular cycles from the latin saeculum, which means an age.
And so, we have something that those of us who analyze these things call secular bull and secular bear markets, and that’s different than pricing and what I argue is that we should look at these long term cycles in terms of valuations and not in terms of prices.
Because, you see, prices do this (up and down motion), big up and down wiggles. If you look at valuations — price to earnings, price to book, price to sales, however you want to value stocks, they move in nice big ebb and flow markets over long cycles, over an average of about 17 years.
Markets go from high valuations to low valuations and back to high. And so far, in our Anglo-Saxon experience, they don’t go half-way down and then back up.
We get to valuations that are much too high, and then we get to valuations that are much too low and stupid, and if you actually look at your returns that you get in terms of price over 10 years, you find out that the correlation between the time you first invested, the valuation there, and the return price you get is really correlated.
So if you’re investing in the bottom 40% of valuations, there is actually quite a broad range — you could compound at 10% a year for the next 10 years, 15 years. I mean you get really large compounds and you get to be a genius.
However, if you invest when it’s in the top 10 or 20 or 30%, the top 10%, you’re not going to get anything—you could actually get negative returns, the top 20%, maybe…
Where we are today, we’re in the 40% or 50% range, you’re probably looking at 4 to 5% compounded, including dividends, over the next 10 years—nothing to write home about.
So, you have to recognize the cycle you’re in. When I was writing about secular bear markets in 1999 and 2000 saying we were getting ready to start a secular bear market, it’s not going to be good, you’d get people saying things like “Oh John, you’re so bearish”. “You clearly don’t get that we’re in a new paradigm, in a new world”.
And I said, “well, I don’t think so,” and the market got truly bizarrely overpriced and it started to come down.
But, it doesn’t come down in just one bear market. It takes time. Typically it takes about three recessions until you’ve really just gotten everybody completely exhausted and valuations get low. Well, we’ve had two good recessions now. The next one will probably be the one where everybody will just go “Oh God, don’t talk to me about stocks again,” and prices go down, valuations go down, earnings get hit in the cycle, and you get low valuations again.
And, just when nobody wants to buy stocks, I’ll turn around and go “Wait, look! They are cheap again on a long term basis, not just on a momentary basis, but on a longer term basis!”
And that changes your style of investing. When you’re in a secular bearmarket, you want to invest with an absolute return focus. That means that your benchmark, what you’re measuring yourself against, is zero.
I want to do better than zero!
In a secular bull market, I want to do better than the market. It’s a relative value because in a secular bull market, you’re a genius if you just stay invested and you let them rise. Okay, so from ‘82 to ’99, even if you had to shut your eyes during ’87 and ’98, it just kept going, and so people were compensated for taking the risk and people learned to just buy, and all of our grandparents’ experience of going through the depression and all — no, they’d forgotten that.
So the boomer market, which came along in ’82 and they finally started getting some money invested, the ’66 to ’82 secular bear cycle, where from ’66 to ’82, you made zero in the market and in fact, in terms of inflation, you didn’t get back to even until 1992.
Twenty-six years it took you to get back to the same buying power that you started with, with $1.00 in 1966.
Now, from ’82 to ’99 we were up like 13 or 14 times—it was a huge historic bull market. Well, 60% of your returns were simply due to valuation increases.
We just simply—I’m willing to pay you more for $1.00 of earnings by a great deal more in ’99 or 2000 than I was in ’82.
The other 20% of it was inflation.
The remaining 20% of it was actual growth of the companies in terms of their earnings.
So, what happens is that during a secular bear, those valuations collapse. Earnings continue to grow. That’s what we do in the United States, that’s what businesses do — the are either growing or they die, and you still have some inflation, but inflation is lower because you’re in a deleveraging world. It’s not like it was before.
So, you’re working in the headwinds. We’re in a deflationary, deleveraging world. We’re getting ready to see a softening in the economies where the US government is going to start being forced to cut back.
So, those are all things that are going to reduce potential earnings, reduce growth, and like I said, you get a recession and people just throw the towel in. Well, about the time you’ve gone through that deleveraging and deflationary world, you’ve got valuations low again. We’ve dealt with the deficit crisis, we’ve gone through all of that depressionary, recessionary stuff, it will be time to buy…and you are young enough, young lady, that you’ll get a bull market and it’ll be a glorious thing.
There is nothing like a bull market in full run, because you just get to watch your money grow every year and you think you’re a genius because you were there at the beginning of a bull market. It’s just a function of age. If you hang around long enough, you’re going to have a bull market. If you live long enough, you’re going to have a secular bull market.
So, what you want to do is you want to be born and start investing at the beginning of a secular bull, get out of the secular bear, and then have one more secular bull at the end of your life.
Now, if you’re unfortunate enough to have started investing in 1966 and then you have to go all the way to 2015, you’ve had one bull market, you’ve had two secular bears…that’s not as much fun.
So, it’s much much better to have been born where you can get two bull markets in your life. So, having been born say in 1960 and to have started saving and investing in ’82, you’re a lot better off because now, you’re only 52 and in another five or six years, you’ll be you know, the secular bull is over, three years, I don’t know what it is, and you get another bull market at the end of your life. You’re rich! Yay!
Right! So, what are some strategies that work when we’re in secular bear markets?
Well, absolute return strategies, alternative funds, hedge funds, managed futures, dividend and income plays. There are still stocks that you can pick, you just can’t buy the broad market, you don’t buy index funds, you don’t go get big cap mutual funds. You can find times that those particular funds will work well, but then you find times they don’t. So, then you have to use market timing and trend following.
Do you do much technical analysis?
Yes. I don’t do a lot of it in the sense of buy this, sell that on a daily or weekly basis. I mean, I watch other people do it and I have money with people that do that type of thing, but I’m more looking for larger, bigger trends within those secular bear and secular bull cycles that you can follow. I don’t try to tick-tock the top of the market, I don’t look for the bottom…I just want to pull the stuff out of the middle, whether it is down or up.
Makes sense. You said something else in your book that really resonated with me because I know I have fallen prey to this in the past, and this is the concept of looking at past returns and going to the Morningstar site and saying, “Oh! Morningstar says it’s a 5-star fund and therefore it’s going to be great for the next 10 years!”
Why is that not a good idea?
Well, you know, as they say, past performance is not indicative of future results. Well, it’s actually worse than that.
Past performance is pretty much guaranteed not to look like future performance and past performance when actually looked at and invested in, is pretty much a description for disastrous results.
I mean, past performance is interesting to analyze and you should look at it and pay attention, because what you want to do is see what did an investment manager or strategy or whatever it is do during a particular set of economic circumstances. And then you go, do those circumstances look like today’s circumstances? Is there a correlation?
That’s where you want to pay attention — if you’re looking for returns going back to our secular bear/bull thing, if you’re looking at the past performance of something from ’82 to ’99, that bears no relationship to the markets and the fundamentals from 2000 to 2012 today, different valuation fundamentals, different markets.
We’re at the end of the debt super-cycle. That’s a fundamentally different macroeconomic world than we’ve lived in for the previous 75 years. And so, we’ve been taught that economies come back, you get a little stimulus spending, borrow a little bit more and things work out.
Well, not at the end of the debt cycle. We’ve borrowed too much money. We’ve come to the end. Now, we’ve got to cut back. We’ve got to restructure our investments. We’ve got to restructure our debt portfolios as a nation, as individuals.
That’s a different environment than the past performance of how funds did or managers did in the past with their past performance. So you have to look it and go how likely are these guys, how robust is their model that would allow them to repeat their performance in this new economic environment.
What my friend Mohamed El-Erian calls the new normal.
The normal that we had for 70-75 years is gone. That normal is gone. That normal is gone and it’s going to be gone for a long time. That long time being 5, 7, 8, 10 years. We’ve just got to work through our excess debt and you can work through it quickly sometimes in some countries, because they just repudiate it and go away and hit the reset button. Of course, it collapses all of your other assets. But it is a start.
And if you’ve got your money on the outside so that you can come in and buy the collapsed asset values, it’s not a bad thing.
I had friends, I wish I had been smart enough to do it, when Argentina collapsed here 19 years ago, they flew into Argentina with big bags of money, and they were buying stuff, real estate, whatever, for 10 cents on the dollar. I mean it was just—if you had cash and you were willing to buy when blood was knee deep in the streets, when there was absolute panic everywhere, they got remarkable values and made a great deal of money.
So, if you had looked at the past performance of managers in that world, you’d think, “No! I’m not putting money there. Can’t do it. No way.”
Now, if you went and looked at the returns of the guys that bought at the bottom, you can’t expect them to have their past performance because you have to have a collapse.
So, it’s the economic circumstances you’re in. What’s the environment.
Now, those guys if there’s an economic collapse in some other country that’s relatively sophisticated that’s got good infrastructure where you want to go and if there’s a collapse there, then those guys might be the guys to give money to so they’ll go in and buy stuff when some other country collapses.
I’m advising some funds and groups, and one of the things I’ve been telling them is I put people on the ground in Greece, Italy, and Spain, because I think there’s a real chance that those countries could, in fact collapse, go to another currency, and if they do, you want to be there with your cash because it’ll be the buying opportunity of decades.
But, you want to be buying when there’s blood in the streets, when nobody’s there, when nobody wants it, when “Oh my God, Greece is going to die!”
No, it’s not. It’s going to exist. The Parthenon has been there for 2000+ years. I mean, I think Paris, France, is going to collapse. France is going to be one of the biggest collapses of this decade.
Would I want to go buy assets in France at that collapse? Yes. I love Paris. Paris has lived through the guillotine, Napoleon, Napoleon the III, the Germans beating them, and all sorts of World Wars and Paris is still there, and it’s still beautiful and it’s a great city. So, the next time something collapses and if I’ve got some spare money around, I might want to go to Paris and see what I can pick up. But, right now, it’s pretty expensive.
That makes perfect sense. So, if Greece collapses, and France, and Spain, should these worst case scenarios come to pass, how does that affect us here in the United States? Are our banks exposed to these derivatives?
Not as much anymore.
They were. Banks around the world are going, “Oops, maybe we should cut our exposure down some.”
Would it hurt? Absolutely, because there are connections internationally, but not enough, I think, to create a 2008-type crisis.
So, it could certainly be uncomfortable. We’re not growing all that fast in the U.S. A true crisis in Europe would push us over into a recession.
Europe, I think, is going to have a depression. It’s very sad.
They’ve just built up too much debt, they’ve got a system that is structurally unsound. They don’t want to restructure their labor markets which is what they have to do. If you’re one of the southern tier countries, you’re not as competitive and as productive as Germany and the Netherlands and so forth, and you’ve got to rationalize your labor cost. It used to be that you did it with currencies. Now, you’ve just got to reduce the wages, and nobody in Greece is going to say, “Well, you know the Germans are more productive, so I’m going to volunteer to take a 30% pay cut,” because the Greeks look at themselves and they look at the Germans and they go “Well hell, I work harder than the Germans,” and do you know something?
They do. By all the data and all the standards, Greeks work longer and harder than Germans.
It’s just that Germans have capital and they’re more productive during the time they work. So, their cost of producing stuff is a lot less than the cost of the Greeks producing stuff. The government is going to be forced to balance its budget. For it to deleverage, it means it also must fix its trade deficit. To fix its trade deficit means it has got to stop buying more stuff from outside and start producing it more internally, or create a currency that it can adjust.
Not having a currency where you can adjust it is very, very difficult, and that means a very slow, slow recovery. It’s a depression-type thing. Greece is in a depression. It’s 25% unemployment…I’m sorry, that’s a depression.
Yes. Do you think the euro will break up?
I don’t know. I mean it’s a political decision. It’s not an economic decision. If you’re asking me economically…yes, it should break up.
It was a stupid thing to do to begin with. You should stop doing stupid things.
But, it’s a political decision. It’s an emotional decision. So, if you ask me politically and emotionally, “What are the Europeans going to do?” I don’t know. They don’t either.
They know what they most want to do. Would they be politically able to do it?
Will the voters keep voting in the same politicians who are producing the depression?
Maybe, because the politicians say “if you vote for those guys, they’re going to take us out of the euro, and we all want the euro because we want to be good Europeans, right?”
Right now, they are all nodding and saying “yes, we want to be good Europeans”.
So, it is truly difficult to say what they’re going to do. I mean I know people and there are a lot of analysts that say, “well, they’re going to break it up” or “they’re going to keep it together” or “they’re going to become a union”. Well, if you really read what’s going on in there and you talk with people, and I do, they’re making it up as they go along.
There is no playbook here, there’s no “here is how we go”.
They wanted to be a European union and somebody back in the early dawn of humanity said, “Well, to be a united country, we’ve got to have the same currencies.”
That’s actually a fairly stupid idea. All they need is a free trade agreement and let the computers figure out how the currencies work. OK? I mean if you want to have the same currency, fine, but there are problems that come with that and now they don’t want those problems.
The Greeks and the Italians and the Spanish and it will soon be the French have to restructure their labor markets. They just do, and if they’re not willing to restructure their labor markets…because right now their labor unions say “No, you can’t do that”…well, they’re not competitive.
So, you’re either forcing yourself to have serious, serious economic and political difficulties or you’re going to have to restructure. If you can tell me what politicians are going to do, what voters are going to do, then you have a better crystal ball than I’ve got.
I can tell you what the polls say today. That doesn’t tell us what the polls are going to say 6 months or a year from now.
My guess, for instance, is that Greece is going to leave the euro because it’s going to continue to be bad over there and at some point the Greeks are just going to get fed up and they’re going to vote somebody in who will take them out. And that will be disastrous. It would be just as disastrous to stay.
So, they are just choosing how they want their pain. Getting out of the euro is a short, but very deep, ugly recession as opposed to the long and more shallow depression that they’re in. It’s just choose your pain. You’re going to have the same amount of pain. Do you want it over a short time or a long time. I think eventually they’ll get to the place where the voters say, “We’re out of here, we can’t take any more of this slow pain, let’s just pull the bandage off!”
What about here in the United States? We’ve been talking a lot at this particular conference about the politicized economy and Lacy Hunt was talking about how interest rates might stay low for 20 years…now that’s prolonged pain. What do you see happening? You were actually somewhat optimistic.
Well, I’m optimistic in the sense that I think we fix our problem, because the problem is the deficit. I’m optimistic because the consequence of not doing so is really, truly disastrous.
It’s ugly, and I think most politicians at the senior levels really get that. They just don’t want to talk about it prior to the election because it’s not a vote-getting, vote-winning proposition. “Hi! Vote for me and I’m going to cut benefits and raise taxes!”
What a platform to run on. No.
But after the election, they’re all going to have to hold hands and walk off the table together or walk off the cliff, rather.
And if they don’t do that?
Well, then we become Spain or Greece.
I mean we eventually hit our own wall and we’ll end up having to raise taxes and cut spending far more than anything that we could do next year that we could do in a controlled manner. And we’ll have to do so in a way that would guarantee a recession. If we put it off long enough, it will guarantee a depression.
So, it could be ugly.
When people are kidding me about being optimistic, I’m optimistic because I think politicians can actually do something, when it’s in everybody’s best interest to do so. If they don’t, then I become very defensive and we’ll have to look at the situation as it develops, at how dysfunctional we would be. We don’t know how this election is going to turn out.
I know the way I want it to turn out. I could probably shock people if they found out that I was a Republican.
Really? He’s a Republican and he’s going to vote? Do I think Republicans have some kind of magic elixir?
No, we’ve certainly shown ourselves to be incredibly incompetent at controlling budgets. I just think the group that’s in there now get that.
We’ll see. By my way of thinking, Romney should win. It’s his to lose. No President with 8% unemployment and the economic circumstances that we have today should be able to win a reelection. That being said, it will be close…and Republicans in my experience of having been involved in party politics for 30 plus years, we’re perfectly capable of shooting ourselves in the foot, reloading and shooting again and continuing to do so. We show an amazing ability to be incompetent.
We all do. (laughs)
Yes, but we keep making the same mistakes over and over again. We’ll see how it goes. Hopefully, from my perspective, this election really is about the nature of the compromise. Are we going to compromise through larger government, compromise through smaller government, because both the Romney budgets and the Obama budgets don’t get us there. They’re just not workable, they’re not realistic. It’s about the direction of the compromise. We’re going to have to compromise. I don’t see a scenario where the Republicans get 61 Senators and total control of everything. I just don’t see that happening. We’ll have to compromise. So, we’ll see how that goes.
So, in this environment where the Fed has pumped so much money in and they have done everything they can to keep interest rates so low, how are you able to find yield? You have a product called Yield Shark and all my readers and all our viewers are out there asking me the same question every day and it’s “How do I find yield?” and you’re actually doing it, to my knowledge. How are you doing that?
Well, you look around the world and there are spots here and there that you can find; a company that has a good dividend that’s covered, they’ve got a good business and they’re just not on the big multi-million dollar fund screens. They’re too small.
So, small investors in this particular case, actually have an advantage over the Blackrocks of the world. If you’re trying to put a trillion dollars of bond income to work of fixed income, you can’t invest $20,000,000 at a chunk.
Some of the places where we’re talking about buying yield and looking for it, $20,000,000 would buy everything they had. You’d own the operation. You’d own that debt issue.
So, we’re talking smaller companies, more focused plays, but the smaller guy has an opportunity to allocate capital into solid, reasonable places. You spread your money out. You don’t put all of it in five different plays. You put it in 20, 30, 40.
Whereas if something does happen bad to one of them and, something bad will happen if you’re investing in 40 different smaller fixed income plays, one of them is going to go ugly on you and you’re going to lose 20 or 30% on it, well you’re trying to make that up by having a few go up and balance those. The total return you’re looking for on a yield of this type is 5 or 6% is what your optimistic target should be.
I think many investors today would be thrilled with 5 or 6%. Absolutely. Thank you!
And if people want to find out more about Yield Shark or to buy your book?
Just go to http://www.johnmauldin.com/ or Google my name. They can get my newsletter. It’s free and it comes out every week.
I love reading it.
Thank you. I sit down and write, and I write about what I feel like that week!
Great! Thank you so much. I really appreciate your time.
Thank you. By the way, I love the name of your website. I think that’s just cool.
I hope you enjoyed that! Please let me know what you think in the comments, and thank you for reading and being an awesome Kung Fu Finance subscriber!
I am at the Stansberry Alliance conference today in stunningly beautiful Sea Island, GA (near Jekyll Island…spooky!) and will have much to report on from here soon!
To your financial success,
— Kung Fu Girl