Lead-Lag Live

Breaking the 60/40 Myth with Philip Toews

• Michael A. Gayed, CFA

Share episode

Phillip Toews, founder of Toews Asset Management, delivers a master class in portfolio construction that challenges everything you thought you knew about investing. Drawing from historical market catastrophes often ignored by conventional wisdom, Toews reveals how a traditional 60/40 portfolio would have been devastated during the Great Depression – losing up to 72% of its value and remaining down over 60% after thirteen years.

This eye-opening conversation explores the concept of "adaptive fixed income" as Toews walks us through the little-discussed bond bear market from 1945 to 1981 that eroded investor wealth by 21% in real terms. With high sovereign debt levels globally and unprecedented monetary policy responses, Toews suggests we may be vulnerable to currency debasement rather than traditional market dynamics.

The heart of Toews' philosophy lies in his revolutionary approach to behavioral finance. Rather than starting with conventional portfolios and coaching investors through volatility, he advocates designing "all-weather" portfolios from the ground up that address both economic and psychological needs. His hedged equity approach aims to capture most market upside while dramatically limiting participation in downturns, potentially allowing investors to maintain positions during crashes and capitalize on eventual recoveries.

Toews introduces the concept of "corona bias" – just as society was unprepared for a pandemic despite historical precedent, investors ignore financial catastrophes outside their professional lifetimes. This collective amnesia leaves portfolios vulnerable to recurrences of historical calamities.

Whether you're an investment professional seeking to differentiate your practice or an individual investor concerned about today's complex market environment, this conversation provides a roadmap for building portfolios designed to withstand various economic scenarios while managing the crucial behavioral aspects of investing. Discover why Toews' recently published book "The Behavioral Portfolio" is changing how advisors approach client relationships and portfolio construction.

With ChatDOC, instantly analyze professional documents using  AI — featuring word-level citations, chart/formula breakdowns, cross-file query, and full support for PDFs/epub/scanned files.
Free version handles 10 documents (up to 3000 pages) and cross-searches 30 files.
Click the link below to unlock +10 document slots : https://chatdoc.com?src=leadlaglive

 Sign up to The Lead-Lag Report on Substack and get 30% off the annual subscription today by visiting http://theleadlag.report/leadlaglive.


Foodies unite…with HowUdish!

It’s social media with a secret sauce: FOOD! The world’s first network for food enthusiasts. HowUdish connects foodies across the world!

Share kitchen tips and recipe hacks. Discover hidden gem food joints and street food. Find foodies like you, connect, chat and organize meet-ups!

HowUdish makes it simple to connect through food anywhere in the world.

So, how do YOU dish? Download HowUdish on the Apple App Store today: Support the show

Speaker 1:

If you lived through the Great Depression with a balanced portfolio, you lost as much as 72% and at the end of it all you were down still over 60% after 13 years and you think you're still going to have a client paying fees for that. So the thing that one needs to do with behavioral finance is start with a portfolio. You need to build a portfolio that's designed to address both economic and psychological needs of investors, which leads to your question about how do you manage behavior around that? The entire second half of the book talks about a proactive construct that we worked with through our Behavioral Investing Institute, which is a department of our asset management firm. We've done a lot of coaching and consulting over the years with advisors.

Speaker 2:

My name is Michael Guyatt, publisher of the Lead Lag Report. Joining me here is Felipe Taves, who some of you may be familiar with in terms of the content that he and his team put out at Taves. Felipe, introduce yourself to the audience more formally. Who are you? What's your background? Have you done throughout your career.

Speaker 1:

What are you doing currently? Yeah, so we've been running this shop basically, uh, since birth, uh, since 1995. Uh, we're a hedged equity asset manager and we manage adaptive fixed income strategies and we have mutual funds and etfs and, uh, one of the things that we're I'm trying to do is change how people drive, build portfolios and straight move away from the conventional construct, and I published a book recently called the Behavioral Portfolio. I have a thousand copies here in the office. It's been getting great reviews, michael. It's just like people say, it's changed the way they do business. So we're super excited about having maybe greater influence on how people run their asset management, run their portfolios.

Speaker 2:

Adaptive fixed income. I want you to talk about how you get to be adaptive in a pretty boring asset class.

Speaker 1:

Yeah, so one of the things that we've been doing for many years is looking at the history of bond bull and bear markets, and everyone's seen these stock, bull and bear charts, but not many people are looking at bond bull and bear charts. We have been since way before this recent downturn that started in. You know, you can argue when it started whether it was in 2020, if you're looking at the 30 year, or 2022, if you're looking at bonds but there was a monster bear market in bonds between 1945 and 1981. And it lasts. So that's 36 years for those who know math and during that period, bonds lost 21% real.

Speaker 1:

But if this is a conversation with the advisory community and it often is you had an advisory feed of that and you're down over 50% over basically, some investors' entire portfolios, and so, honestly, for me, this is one of the most interesting things to talk about right now, because we've got all these I don't know if existential may be a too strong of a word, but massive threats to bonds. You could argue that we are still in a bond bear market. That began a number of years ago, and so I'm going to actually answer your question, believe it or not. But ultimately but by adaptive it means able to leave just a core bond conventional construct and be able to be in different parts of the fixed income. Complex so high yield investment grade and T-bills. Complex so high yield investment grade and T-bills. And if you do a scenario analysis of different kinds of things, what that allows you to do is maybe not get a lot of above inflation gains in different periods but attempt to de-risk and not have principal losses during rising interest rates periods.

Speaker 2:

Is a bond bear market a function of the Fed just being wrong, delayed, late? I mean, can a bond bull market start with just the Fed getting it right?

Speaker 1:

So yeah, I mean bond bull markets can be amazing. After you know, starting last year we were looking at the possibility if the Fed could have gotten on just a regular track of lowering rates. Ag bonds can rally cumulatively or have rallied as much as 50% over a number of years. So that can be a great trade. But bond bear markets historically have largely been a function of mainly inflation and of course, as we all know, unfortunately inflation is tied to rising interest rates. So it's typically two things working against bonds at once. But if you look at that 45 to 1981 bear market in bonds, it was bookended by two episodes of inflation, one that happened in the 40s and then the one that most of us are aware of, that happened in the 70s and the 80s. And so it was that massive inflation and the fact that the real returns in bonds suffered during that kind of a period that had such a big impact.

Speaker 2:

There are, of course, a lot of different ways of defining a bear market. When it comes to bonds, there's bear market in duration, bear market in credits, spread movement, average default premiums. When you say bond bear market, are we just talking about a shift in the curve? Is it purely duration, or are we talking also about corporate?

Speaker 1:

Well, when I talk about it, really I'm trying to talk in just almost the simplest language to the advisory community, who you know. Yesterday, I was traveling out in Buffalo Chicken, new York, and you know all the advisors out there had large allocations to just conventional bonds and my message, which is echoed in a commentary that we sent out this week, said maybe one of the most important things you can do right now is to leave core bonds. So what I'm talking about is just the core bond space, people that are holding positions in their portfolios and the possibility that that turns into an asset that correlates with equities, if equities lose money and you could have losses in bonds at the same time that you have losses in stocks.

Speaker 2:

You hear the term stagflation thrown around a lot nowadays. I always had an issue with the idea that we're headed for stagflation, because I just don't think it works when your starting point is so much leverage and debt in the system, which then leads to a discussion around capping yields, yield curve control, things like that Take me to the logical extreme. If yields keep rising the way they've been rising, if inflation is not abated, if global bonds are at risk, where does this all lead?

Speaker 1:

to? That's the interesting question, michael, because much as Ray Dalio has been discussing, not just recently but for the past five years, he talks about many cycles within a mega cycle and that potentially we're at the end of this mega cycle. So we're all having this conversation and framing it in terms of how bonds and stocks have moved over the past four or five decades. But what's different this time is that now we've got record sovereign debt not record, but at peaks in sovereign debt, similar to where we've been in the US. But we also have debt to GDP of 100% or greater in virtually every other developed country. So, you know, as we watch over the last couple of weeks and you know, the 30-year breaks up to 515, the 10-year threatens 450 or potentially higher.

Speaker 1:

It may be a change that we haven't seen during our professional lifetimes, which is that I'll give you an example of Japan right, where for years, japan increased their fiscal debt and deficit with impunity, right and so up at 250% debt to GDP. And what's gone on in Japan over the last couple of years? We've seen this incredible. Well, a little bit of a change recently, but we've seen this incredible devaluation of the yen. So a change in the way to think of this, michael, may be from a typical bond market bear analysis, where you're losing principal due to rising interest rates. Thinking about it more in terms of a potential currency debasement, currency devaluation episode, where you're made poorer in your bond portfolios because your currency isn't worth as much.

Speaker 1:

Where it gets even more interesting, I think, is what if this happens on a global basis? What does that mean? I think is what if this happens on a global basis? What does that mean? Well, to a certain extent, what that means is inflation, but not capacity-driven inflation, right? This is a kind of inflation that's driven by currency issues, by sovereign debt issues. It's a completely different way of thinking about risks to bonds than people are used to.

Speaker 2:

Which, you can argue, is exactly why gold's done what it's done and why there's so much interest in Bitcoin and assets from that perspective. But there are risks there too, right throughout that sequencing. You mean in gold or yeah, as sort of the solution to it or the hedge to all this.

Speaker 1:

So I have some answers for you. I talk about it in my book and I talk about building a portfolio that's an all-season portfolio and attempts to address inflation, stagflation and deflation. Here's what's kind of interesting. Well, so first of all, let's talk about Bitcoin and gold. Gold obviously has performed amazingly recently and it has been a great trade, and there's certainly no problem with having an allocation there if we see this all play out. I'm just not a believer in Bitcoin and I know I don't make friends when I say that because it's just a speculative asset. I think maybe, if you're going to trade it and if you know how to do that and you're going to take a position and try to get out of it that's a thing, michael, we've wanted. Every three weeks, I asked the investment team can we launch a Bitcoin blow up ETF where it's positioned to be in Bitcoin but to profit it blows up? Unfortunately, the options are so insanely expensive in Bitcoin and there's not enough volume. It's just not doable. But I would love to do that. So the answer is where do you go? So if you're an advisor out there and you're thinking more from a conventional construct and you're not comfortable with speculative asset class and you don't want to go much beyond a 5% or 10% allocation of gold.

Speaker 1:

Here's what history shows. What history shows is that during periods of high inflation, stocks have done reasonably well over the entire period of inflation. So there are three episodes of inflation over the last 100 years. On average, cumulatively, inflation increased by about 100%, so doubling each time, way more than we've seen recently. Right, and bonds did miserably during those periods. But what's interesting is stocks did okay. So stocks kept up with inflation. And if you think about that 36-year bond bear market that I was talking about, stocks increased like 780% after inflation during that big bond bear market. Even during the Weimar Republic when you're seeing these massive inflation in Germany stocks did okay. So what's interesting is stocks act as a pass through ultimately for prices and so as a result, you know you've got sort of a natural thing there.

Speaker 1:

Here's the problem with that. The potential problem with that is that as you go from low inflation to high inflation, as we see the 10-year and 30-year break above the highs recently, we all know that's going to be horrible for stocks. So going into high inflation, you can have some significant losses in stocks. So our solution there, both for deflation and stagflation or inflation is in your equity portfolio, put about half in hedged equity ETFs are funds, something that can uncorrelate from negative economic activity. Here's what that allows you to do. You're adaptive in your fixed income, trying to get out of the way of rising interest rates. Your equities are allocated half to conventional, half to hedged equity. Now, if you do have a high inflation episode, that hedged equity piece allows you to stick to your equity allocation and potentially endure some kind of long-term inflation. That was a really long answer, but that's our thinking around it.

Speaker 2:

All right, but we got to define what hedged equity means. I hear hedged equity and I think to myself okay, well, you can do that through just lowering your net long exposure which I'm sure you can do but with lower beta positions. What does that mean?

Speaker 1:

hedged equity, yeah so we're very explicit we mean equity that is hedged, mean equity that is hedged. So we have an ETF that is an S&P 500 product that is just owning always the S&P, and it is a two-year full, 100% notional hedge in a leap that we roll every year in December and we adjust it. If the market moves up, we roll the leap up. If the market moves down a lot, we roll it down and monetize it and then we sell some calls and shorter dated put spreads, as long as they're not below our leap strike price, to help pay for the cost of that leap. So what that is designed to look like is exactly what we think an advisor should put in their portfolio. So you're looking for something, in our opinion, that has something like a 70% on average upcapture to the market. So if you've got half there and half in conventional equities, you're looking at an overall 85% upcapture.

Speaker 1:

During normal periods, during down markets, what that strategy, that ETF, is designed to do is attempt to have around 50% down capture during a more benign, declining market, like we saw in 2022.

Speaker 1:

But if things go off the rails and it's more financial crisis, start searching VIX extreme markets. What potentially happens is you make a lot of money on selling calls and the VIX causes that leap to really have lots of loss avoidance. So optimally you want to have as low correlation as possible during a crisis equity market. So we're looking for something like 20% or maybe 30% down market capture and here's what that allows you to do. If the markets go off the rails, then let's say, you do manage a sort of 20% to 30% down capture period and then you're rolling down your leaps and what you're doing is you're actually positioned to take advantage of the decline Because if you can capture a good chunk of the up, capture the falling rebound, but not participate in a lot of the down move, you've actually made money in the decline in that piece. But we're talking pure hedged equity, nothing terribly exotic.

Speaker 2:

I feel like this is a good tie into the behavioral portfolio, because we all know the markets tend to go up on more days than they go down. But when they go down they go down with magnitude, and it's hard to stick in a hedged equity portfolio when the frequency of up days is more than the frequency of down days, right? So how do you factor in sort of that behavioral response to time?

Speaker 1:

Yeah. So I think that the key is, as I was mentioning, making sure that you're not all in the hedge equity allocation and in the book that I was just talking about, which'll bring up again the first half. Here's what I think behavioral coaches and people in behavioral finance have gotten wrong from the beginning is that most people they start with coaching they say we're going to take this portfolio, which basically was a historical accident, something like the 60-40 construct and we're going to go out there and try to coach you around how do you manage behavior with this portfolio? What I reveal in the book is that if you live through the Great Depression with a balanced portfolio, you lost as much as 72% and at the end of it all, you were down still over 60% After 13 years and you think you're still going to have a client paying fees for that. So the thing that one needs to do with behavioral finance is start with a portfolio. You need to build a portfolio that's designed to address both economic and psychological needs of investors, which leads to your question about how do you manage behavior around that.

Speaker 1:

The entire second half of the book talks about a proactive construct that we've worked with through our Behavioral Investing Institute, which is a department of our asset management firm, we've done a lot of coaching and consulting over the years with advisors.

Speaker 1:

What that does is it builds an entire proactive communications construct around how to talk about the markets. You don't shy away from big down markets. You want to actually focus on how bad down markets can get. But then the very next thing is you talk about how the portfolio is designed to address it, and then you talk about what explicitly what actions you're going to take when you have these big down markets. And so you've got something called an investment owner's manual you give them, you walk through different investment challenges, how the portfolio is designed to address it, how you do that. And so it is important because if all you do, you're exactly right. If all you do is you execute this portfolio that we've been talking about and you don't attach the consulting around it, the messaging around it, after a couple of years investors are kind of like look, this thing's underperforming, can we please just leave it and go into MagSava or whatever else happens to be doing very well. So both parts are really important, both the portfolio part and the consulting part.

Speaker 2:

Yeah, no, I think that that makes sense, although, again, the thing is, I've used this line before it's like FOMO is more powerful than the Fed, right, yeah, fear of missing out, which basically is what happens when your up capture is less than 100% Exactly, tends to make people then over leverage, which then leaves them vulnerable to the tail vent whenever that does occur, which is always unpredictable. Even though the conditions might be there, you don't know the mile marker that might happen under. So talk me through, from what you've seen with what other advisors do. How do advisors, how do people like you, play the role of psychologists to get people to recenter around that point?

Speaker 1:

Well, the way our advisors that are using our behavioral guidance talk about it is they actually differentiate out the fact that you know oh, look at you know, if you would go through this market, here are what the consequences would be, you know. So, in a sense, advisors are able to brand themselves according to building portfolios that are all seasons, portfolios that address all these different kinds of markets. So in many cases it starts at the very beginning, in how you market yourself and how you talk about how you work with business. But then there's some other tools you can use too, like Income Labs is a great tool that allows you to look at different kinds of markets and how portfolios would behave in them. Hidden leverage is another portfolio tool that allows you to show true worst case scenarios. And so you start with, in the beginning, the vast majority of investors are just fully on board. But that's the easy part, right? It's really easy to get investors and get them on board to whatever you're talking about. What's harder is when you get down the road, and so you continue to talk about why you've got a hedged equity position in there. You continue to make sure that you've got a fully allocated position in there. Michael, we actually haven't.

Speaker 1:

For advisors that are executing on this plan, they haven't run into a lot of problems as long as their hedged equity allocation is performing according to that. Just generally 70% overall up capture statistic. Because, as I was saying before, if you're 70, 85% up, capture your conventional stuff. Look, your conventional stuff could be in whatever it could be in triple Qs. We're looking at launching a new product that's a hedge triple Qs. So even in our S&P product you've got plenty of Mag7 stuff, other kinds of things that are moving ahead as a market. It's a cap weighted product. We haven't seen a lot of problems there. So I think it's only when you're you know, if you're focused on the everyday, to recapture the market. If you've got someone looking every day in a trader mentality, that's probably going to be pretty hard to work with.

Speaker 2:

And then you might just lose a client to say like okay, we're just trying to chase returns every day. You've used that term a few times old weather portfolios, and I think about permanent portfolios, I think about risk parity. Talk to me about sort of old weather from a behavioral context.

Speaker 1:

Well, all weather means that when you're talking about clients, you're saying that we didn't design this case, this portfolio, just for the optimistic case. And this world is completely biased towards optimism Even now. I mean, even if you look at all of the threats between high sovereign debt levels, between God knows what's going to happen in terms of the tariff scenario and how that plays out in the economy, all of these different things. It's strange that we're just taught as advisors and investors sort of this mindset of it's fine and that comes from decades and decades of training for advisors. That just says, as long as you hold stocks for 20 years or longer, you would have never lost money. And so it creates and plus, gene Fama is a powerful influence in this whole idea that all you need to do is hold on to stocks and that's where you get the best return. But the kind of boring analogy that we use is that it's not about the best return. Obviously You're not driving a Formula One car down the highway. It's actually no, no, no. We need to build a portfolio that has different objectives. So I actually lay out in the book what are the objectives you want to. If you start from scratch, if you leave, just trying to match benchmarks. What does that portfolio look like? And what that portfolio looks like is trying to avoid losses above inflation gains, locking in gains when you have them, as much consistency of returns as possible. And so it's addressing all these different kinds of markets and starting from a totally different place.

Speaker 1:

It's fascinating. We look at like different iterations of all seasons. I mean, obviously Ray Dalio is brilliant, is brilliant and he's got 18 million times more money than I do or anyone I know does. But weirdly, when you look at his all seasons portfolio that he was talking about a number of years ago, it was like 50% bonds and a significant chunk of long-term bonds. And at the time I was thinking like, yeah, I don't know if that's designed for a high inflation, rising interest rate environment like we frankly had over the last four years. So I haven't kept up to date on how Ray is talking about an all seasons approach and if he's migrated away from that sort of heavily fixed income, intermediate, long-term duration play. But yeah, building a portfolio that addresses all those different kinds of markets. So then you say to an investor like we're not worried right, like we've built this to address whatever happens. It may not always have gains, but it's definitely designed to survive and maybe prosper when things are going badly.

Speaker 2:

You know it's funny that when you were talking about that point about optimism, um, it took me to the line that you often hear that hope is not a strategy. Yeah, all right, which is funny, because buying hold is, of course, hope. So, yeah, of course it's a strategy, right, and yes, it's going to work over very long time periods.

Speaker 1:

I mean, think about it like this, like if you were walking across a bridge it's's one of those wobbly wobbly bridges and it's on this course of fall a thousand feet and you say like, hey, well, about 10% of the time over, you know, if you're walking over the course of you know five years, it'll break and you'll fall to your death, probably not going to cross that bridge, right, I'm just not going to go there, I'll find it, I'll walk around, right. But in investing we say like, well, it's even more certain that we're going to have 50% declines, like significant adversity in the markets. But everyone just is like, oh, whatever, we're just going to go safely invested, because Gene Fama says that we just want to be passively invested and never do anything about the market.

Speaker 2:

It's crazy so I had a phase in my career where I was on the road every week presenting at cfa chapters. I've been to 47 states and these are, you know in the audience intelligent cfa charter holders, but always blown away by how they tend to not focus on certain problems that are in the industry that they are a part of. And I know you've talked about certain problems that you've identified that are not really acknowledged by the advisor community. What's wrong with the investment advisory community?

Speaker 1:

I believe that it has been too heavily influenced by Gene Fama and Jack Bogle Right. And you know what I find just the funnest ever, because I was raised in a small town in Kansas, michael, and everyone had a limited perspective. We were five towns from even something that looked like a city, or five hours from something that even looked like a city, or five, five, five hours from something even looked like a city. And so it was just such this limited perspective. And as I moved to first philadelphia and new york and brought and went to college and I was like, wow, a lot of that stuff that people thought or believed was just not really valid and and so isn't it, isn that you've got so many brilliant minds working in this industry community.

Speaker 1:

The investment management community thinks about portfolios and asset management. They're found, at least additionally, uh, bankrupt. You know to to exactly your point, right. So as when I, when I do a visualization and I walk through the great depression, uh, with a balanced portfolio, and I show year by year what's happening in the markets, what's happening in the news, what's happening in the economy and what's happening in the portfolio, you come through that and you're like that is a nuclear bomb on my investment practice and on my investors, yet we completely ignore that. So, michael, I created a word called the corona bias, and what that refers to is that there was a Spanish flu in 1915 through 1990. 25 to 50 million people died. A hundred years later, roughly along comes another virus. We're completely unprepared for it. We have no idea that something like this is coming.

Speaker 1:

And, similarly, what I say in the book is I say that you know, things happen in the markets that are so long ago that we lose immunity to them. We don't think about them when we build portfolios, and so we just build in our portfolios for things that have happened within our professional careers. But if you go outside of that circle, into the second circle, there are things that have happened historically that we don't prepare for. And I also I believe some people may be saying I grew up listening to this saying like, yeah, but that was a great depression, we had no FDIC, we had all these other things happening that wouldn't happen again.

Speaker 1:

I believe I successfully argue in the book that depressions could recur, even based on some of the things that happened over the last 20 years. So it's amazing, right? You've got all of these great minds that are thinking about portfolios are ignoring this history, and you know, along with that idea, that you know we could be wiped out by some of these mega cycles. It just so happens, right. It just so happens that when we're at this high debt to GDP ratio and high valuations in equity markets, we may be more vulnerable to some of these major major mega cycles than we have been in the past. And, in fact, some of these things that we're ignoring, they have more of an influence on returns over the next 5, 10, 20 years than anything else that we're thinking about or doing.

Speaker 2:

I tend to agree with that, although I do worry if it's more of a cycle where it's almost like a series of mini tail events, because there's no appetite for any policymakers to endure any pain for anything longer than a couple of weeks you were any pain for anything longer than a couple of weeks.

Speaker 1:

Interesting, I mean. Uh, you know, one of the one of the things that you can do in these scenarios that I love is that you can just ask the question if this would happen, and then what? So you can you say well, if you have the 30 year breakout and it goes all the way up to 6%, and then what? And then what? I definitely hear what you're saying, although I wonder if we haven't put ourselves into a situation, from a macro economic factor perspective, where we are powerless, both at the fiscal stimulus level and from a perspective of what the Fed can potentially do. So if you go to the last time in the US when we had 100% debt to GDP, which was in 1945, post-world War II, what was the play out economically? Well, we had 8% GDP growth for 20 years. Following that episode, we had top marginal tax rates of over 90% for over 20 years and we had massive inflation in the 40s. So do you think we're going to have 80% GDP growth coming out of this peak in depth of GDP? No, do you think any of these other factors that I was talking about are potentially going to play out.

Speaker 1:

So I almost wonder if it gets a little negative. It gets a little doom and gloomy when you talk about these kinds of things, but I almost wonder if. Because what are you going to do if you have more fiscal stimulus, when people are already bidding up interest rates because they don't believe there's sustainable debt? Is the Fed able to do anything if interest rates are moving higher and you've got rampant inflation? So I almost think that policymakers may be powerless. What do you? What do you think about that?

Speaker 2:

I I don't disagree um, although it's like. The one thing that we know is that policymakers are very creative at delaying creative destruction uh all right. So the numbers keep getting bigger and bigger, and maybe this is a conversation for another, different podcast. But I do think that the most consequential dynamic of what happened with the COVID crash was the Fed basically saying we'll buy up junk debt to save the system anybody's imagination at the time right and explains why credit spreads have been so tight.

Speaker 2:

Because there's this moral hazard now that the Fed is putting directly into corporate credit which creates all kinds of distortions. You can argue.

Speaker 1:

I'm just curious then, and I'm curious what your perspective is then on. So you start to have massive duress, you start to have risk assets falling. Does that happen again? Does the Treasury come in and buy this and then? What are the implications?

Speaker 2:

I don't know. A cynic would say it depends on if Powell's buddies with Trump or not.

Speaker 1:

You can argue, I don't know, haven't we seen that in Japan? Basically right, I mean, and I guess what have the consequences been? I mean, right now we do have yield surging right to crazy levels. I mean, can you imagine, like almost touching what?

Speaker 2:

4% yeah, and what's weird to me about this cycle, which I think is really underappreciated, is there's this belief that if you're, the government and the private sector are totally separate, so whatever's happening on the government financing side is irrelevant to what's going on in the corporate sector.

Speaker 2:

Right, and it doesn't make sense to me. It's like in 2011, when you had the first downgrade by S&P of credit quality of US credit quality, the reaction was actually the opposite of what you would have thought, meaning yields went down on that downgrade on treasuries and stocks collapsed and credit spreads blew out. Now you can argue that the reason that was actually a logical response to that downgrade of credit quality was because if US credit quality is garbage, then everything else's credit quality must be garbage, because the US government owns us through taxation. You don't have that anymore. It's like you don't see the private side of the investment landscape responding to anything going on as far as risks on the government side. But to your point, with what's going on with Japan, maybe it's just a long lag and we're going to see something very nasty hit. And if that's the case, can the policymakers really do much at that point, because the problem is coming from them.

Speaker 1:

And I guess I think I would argue no, and I guess you know, as you were talking, I was thinking, and so how crazy is it that, when you consider everything that's going on, everything that we're talking about here, we've just recently seen this massive bidding up of risk assets, right and sort of. There's a kind of impunity for equity investors in terms of like, this isn't going to have any ultimate effect, we're just going to keep rallying every chance we get into whatever happens, despite what, maybe just past June starts to hit really hard data and things like that. So it reminds me a little bit, michael, of do you remember that I actually placed this huge trade in my personal accounts when I saw what was going on over in China at the start of the pandemic and the empty streets and people coming over into New York and I'm like place this massive, massive short put trade on the S&P 500. And that was in February and then markets rallied like more than 5%. I got chased out of that trade. It went up even more and I was going to double down of that trade. It went up even more and I was going to double down on the trade and our options trader talked me out of it. Man, I would have really made north of like $5 to $10 million in the trade, but I didn't do it.

Speaker 1:

But it reminds me a little bit of kind of what we've been seeing recently, which is that you got all this potential negativity coming, I think, in the second half of the year, although maybe the tariffs get blown out of the water by the courts. I mean, it's very much in flux, obviously, as we know, but we've been rallying and this kind of reminds me of what was going on, coming into the pandemic. Of course, at the end of that, obviously, stocks went down 30%. Is that?

Speaker 2:

options trader still with you, is that?

Speaker 1:

options trader still with you. He's an amazing part of the firm. You know what he is. You know what the thing is about options traders. He's our derivative specialist. They mainly want to sell vol. They always want to make money selling vol. The idea of paying money for volume and doing the other side of the trade they just never like it. Yes, yeah, I think that's interesting.

Speaker 2:

Okay, let's kind of wrap up here back on the book, right? Okay, so it's a big endeavor to write a book. I mean, I've never done it. I remember as a kid my father doing it twice on an old WordPerfect machine or something like that, where it was a screen with a typing. I remember it was orange on a black screen. I don't know if you remember.

Speaker 1:

I'm hoping that it wasn't a typewriter.

Speaker 2:

No, no, it's not a typewriter. No, no, I actually remember having a typewriter when I was a kid. But talk me through that process of writing the book. How cook did you always have the idea? Were there things that you discovered as you're writing that were like aha moments?

Speaker 1:

because I think that's a whole fascinating journey in and of itself so what I would say is, if you're going to write a book, don't do what I did, which is take forever. First of all, for 10 years, I said I was writing a book and I wasn't really. And then I but one thing I did do that was right is I have a friend who's a in publishing and she's actually my writing coach. So I was sort of nowhere in the beginning and I started writing and every week she would look at it and do some edits and then I would write it again. And I actually got a deal with Harriman House in 2018. And this brilliant editor, craig, said just give me the final draft. And you know what I never did? And one of the reasons I didn't is I wasn't really happy with the book. So about two years ago, I said okay, I've got to get this done. My staff is like rolling their eyes when I say I'm writing a book. It's like it's a joke. I'll never get the book out. So I involved everyone at the company. I involved the marketing team to plan marketing stuff, the analytics team in the back office to review all the data compliance team. So I'd be so shamed, michael, if I didn't finish it that I would never be able to show my face even at the company.

Speaker 1:

But I did the rewrite and I completely changed the book. And what's really cool is, by the time I was done, I didn't need the writing coach. I could just sit down, hammer out a chapter, and that then, I think, has been influential, even in the stuff that I write now. That's shorter form. But here's what's so amazing, is that? So the first time I had a call with a multi-billion dollar RA, I hadn't realized he'd read the book and it had just come out. And I got on the call and said I just read the book. And he said I was terrified. After the first third of the book I felt better. After the next third. I finished the book and I realized I have to change the way I do business. Now, michael, I don't know how much you work with multi-billion dollar RIAs, but typically what you can tell them is nothing. You can market to them for two years and they might make a 3% allocation which they hold for six months. So that was transformational.

Speaker 1:

But here's what I'll say. I would say that if you have a, there's some significant messages in terms of how people should build portfolios and how you should manage investor behavior. That we know. That I wanted to share, and the only way that I feel like you can convey that super long form message is through the book. I don't think if I did 10 hour long Zooms, I don't think I could convey what's in the book nearly as well as someone reading the book. So for those on the line, my challenge is read the first third of the book. I think it'll change the way you think about investing, especially if you're a more conventional construct investment advisor. If it doesn't, you're mad at me. Just write me. I'll send you a refund or whatever it is. It's called the Behavioral Portfolio. It's on Amazon. Yeah, it's been fun doing. But find a coach, have them just edit it. Get through that first and have them help you organize it and get the first draft done. Don't wait five years to get the final draft done.

Speaker 2:

Appreciate those that watch this podcast. Felipe, for those who want to maybe learn more about your firm, where are you going?

Speaker 1:

to yeah, so just go to tavescorpcom website or tavesassetmanagementcom, thebehavioralportfoliocom website or taveassetmanagementcom. Or. If you want to learn more about the book, there's a thebehavioralportfoliocom link right to the book and you can read some more information on there.

Speaker 2:

The book is available on Amazon Kindle hard copy Audible Appreciate everybody watching this live stream. Hopefully I'll see you all on the next episode. Thank you, Felipe, Appreciate it.

Speaker 1:

Awesome. Thanks, Mike.

Speaker 2:

Cheers everybody.

People on this episode

Head Shot

Michael A. Gayed, CFA

Host