This One Weird Number Explains Everything: DataTrek's Colas

Data Trek Research. He is also a Bloomberg opinion columnist, and he's going to help everybody because he says, he has one weird number that explains everything. Nick, it's a pleasure to have you here. What is the number and what does his What does it explain? Yes, thank you. The one weird number isn't so weird, but it is

kind of sad. It is the twenty year compounded annual return on the S and P. This is the number that every investor ultimately cares the most about because how much money you can make in the market when you buy and hold, and sadly, that number is about five

percent over the last twenty years. In terms of a compounded annual growth rates, the average back to twenty eight is eleven percent, so more than double that number, and we've very rarely seen these kind of five five and a half percent to the actual precise number going back to the nineteen twenties. A matter of fact, it's just as bad as the period right after World War Two when the twenty years trailing numbers were about four percent.

But that includes the Great Depression. So we've had very very low returns in US stocks over the last twenty years. Does it matter if we then delve a little bit deeper and try to find out why? It matters intensely? And the simple reason why is we've had two thirty five percent corrections in the stock market, one from two thousand one to two thousand three, the second and two thousand eight obviously, and it's those major pullbacks that have

really crushed returns. So when you here that you've got to stay in the market because no one is good at market timing, and that if you miss those higher movements, those increases in price and start to worry about just as you describe these declines these sell offs, that's not really going to work to your advantage. What do you think the bottom line is? If you're going to be an investor, and an investor with a capital I you have to live through these cycles and they are wrenching.

It is painful to see your returns go down thirty plus percent over short periods of time. The good news is that the SMP at least has done better than say, emerging markets or the EFA stocks. If you look at the long term chart on e f A or e M the two E T F to track EFA and emerging markets, you'll see that they are below their two thousand eight highs today by twenty five plus percent. Those stocks haven't even had the bull run that the SMP

had from two thousand eight onwards. So is it is it possible to make the case that diversification is a great marketing tool but does not get you the kind of returns that you think you're going to receive. Well, you know it's the old past performance is no indication kind of phenomena. The best thing you can say are the most act thing you can say is for the last decade, they have not done you any favors. Diversifying

internationally has not worked. The SMP has been the place to be, and even this year with these parlos returns, it continued to be the place to be. Well. I was going to go down the path that if you are able to identify an investment, whatever kind it is, but let's just use the equity market as an example.

If you are able to identify and it may be more art than science specific companies or a specific company, and are able to ride it to a higher price while managing losses or downturns in other assets or other stocks, that that may be a way to actually produce returns. It absolutely is. This goes back to the whole active versus passive argument because what you're describing is a selective

active strategy. And look, something as simple as overweighting the text docs for the last five years has been that ticket. But it wasn't for the first five years after the financial crisis. It was financials and other more prosaic sectors that really worked. Tech was a classic mid to late

cycle play. So even in thinking through that paradigm, you've got to think about it in terms of where you are on the cycle in order to execute on It's something as simple as owning Tesla for the last ten years has actually been a reasonable way to app from the SMP because it's not even in the SMP. So does this beg the question all of the dynamics that exists in the marketplace and the various computer programs that slice and dice are really all for nought because that

is more of the selling machine rather than the investing machine. Yeah, I would put it as it's more than market making machine. It's how basically we arbitrage. Where stocks trade in the US. You know, the average stock trades at thirty different venues. Someone's got to arb those out a hundred shares at a time. And that's what the machine really is reasonably

good at in a fairly efficient automated fashion. But in terms of how society, how the US economy is creating value for shareholders, were coming were basically we're coming at the end of a really low period of returns. The good news it's better than the rest of the world. The bad news is it's less than half of what we've all been taught. Are the right long term returns of ten to eleven. You've been a watcher of markets for longer than I'm going to hold you accountable for.

Is there a psychological change in the investor community now versus when you first entered the business. There absolutely is, and I would summarize it around the numbers that we're talking about, because look at the twenty year trailing returns in nine were seventeen point seven percent trailing twenty year returns.

You were doubling your money every four or years. Now it's taking you much longer, and as a result, investors are both getting more passive because with low returns comes the need to have low fee structures, and that's a challenge for active managers. But it also says that people have to look much further afield for returns, whether it be the retail investor looking at cryptocurrency is trying to use returns, or the institutional investor buying into private equity

and venture capital to try to get their returns. Because remember most pension funds have a seven eight percent required rate of return or expected rate of return. They physically cannot get that inequities they haven't gotten inequities over the last twenty years. They have to go into PE, they have to go into VC, They have to find ways to either leverage or go into early stage companies to

get the returns they need. So it's a huge change. Nick, I want to ask you something about stock buy backs and the money that companies spend on stock buy backs. Given the five five and a half percent annualized return in the SMP five hundred which you have calculated, did does it make sense for companies to be buying their own stock if they're going to end up with the

same return that their investors do. Yeah. No, it's a great question, and the short answer is no, it does not make sense to the same magnitude that we've seen buy backs this year, which as we know, is close to a trillion dollars when it's all said and done. By far the biggest buyers in this market, better bigger than passive flows for example, or anything else we can measure.

And the reason it doesn't make sense is because if you think about buying back your stock as an exercise and investment, you're only going to earn that five and a half percent return. And most corporations likely think their cost of capital is ten percent because that's the number we've all been trained to think about. So it means that there's a whole raft of projects that are going to earn perspectively five to ten percent, but these companies aren't taking on. Now, look to give the CFOs of

these companies and boards these companies some credit. They probably look at all the volatility that we talked about in the prior segment, these thirty five percent draw downs twice in the past twenty years, and think, you know what, we have to mitigate the volatility of our stock and buy backs can help us do that. And so they might think of buybacks in the micro is a good thing because it minimizes or reduces volatility. But in the macro sense, it means that we are not as a

society allocating capital to its the best possible use. Because we're buying back stock at five and a half, we should be investing in seven and nine percent return projects, but companies aren't doing that. Does that also reflect the way in which companies account for their capital expenditures that if you spend money on research and development, that almost counts against you when you take a look at the

balance sheet. Yeah, it's a funny thing about R and D. I mean R and D in most cases is expensed in the current period because it has an uncertain outcome, and so it does hit the P and L. So if you're looking to make an EPs number, R and D is not exactly your friend, and you have to budget for it very carefully. And yet those are the projects that you want to be focused on because that's

what's going to produce those future returns exactly right. And you know, it's a funny thing about R and D and CAT and CAPEX and buy backs because buy backs don't really crowd out R and D necessarily, but corporations have to think about it in terms of what you just said, which is an investment in future growth, And if they're looking for more shut things, then you know, perspectively riskier things than they will be cutting back on R and D. Now does your one number the five

and a half percent return? Does that also lead you to the conclusion that fees when it comes to managing money will become even more compressed because people are gonna want to eke out whatever gain they can. Yeah, this is the most important point for active managers and for

the money management industry as a whole. And what's happened is look that the peak period of Wall Street for brokers, for asset managers, for active managers was the nineteen nineties, and that was the period where we had these fifteen to seventeen percent compounded annual returns, and of course ASCID owners are going to be feel fine about paying somebody one and a half for two percent active or two and twenty as a hedge fund in order to have

a shot at out performing when you're at five percent. Nobody has any patients for high fees. And as a matter of fact, we as we know, we see e t F basically almost zero fees and that's a direct function of these declining returns. And until returns begin to improve on a structural basis, asset management will find it very hard to charging her mental fees. So what do you see for the future when it comes to the specific industry dynamics. Fewer participants but bigger participants. Yeah, I mean,

basically you've seen it for the last ten years. Economies of scale at low fee structures is how the industry is shaping itself. Also making sure that the entire infrastructure of the industry, the trading that we see every day happens in an automated, very low cost fashion, and it creates some brittleness and markets as we've seen this month. Um, you don't want the same away from the recent market

volatility and these big points swings. Two things. The first is, you know, we had a very unusual year because things look rate until October, and then Tech rolled over and a lot of folks sold tech stocks that they've had

huge capital gains in. And then in only December, the entire market rolled over, and all of a sudden, a lot of managers began to realize, we cannot give our clients a big tax bill on top of showing them that they have negative returns on the year, and so you had wholesale selling of tax loss candidates all these stocks that have suffered the entire year in order to offset those gains managers took in October and November selling tech.

And that, to me is what just cranked this market down in December was profound tax laws selling over this issue of not wanting to show taxable gains on top of the paper loss for the year. Thankfully, we're almost all the way through it, and that's why you've seen market stabilize. Well. Thanks very much for sharing your thoughts with us, and really a wonderful piece. I encourage everyone to read it. Much appreciated. Nick cholis He is the

co founder of Data Trek Research. He is also a Bloomberg opinion columnist, and as he said, he's got one weird number that explains well mostly everything. Thanks very much for being with us, and just to bring you up to date on what's happening in markets right now. Stocks they're trading at their lows of the session, the Dow Jones Industrial Average down a hundred and thirty six points,

SMP five hundred, down fourteen, and the NASDAC down. The topic now is Brexit and many small businesses in the United Kingdom could face a big tax. This could be an attacks that would affect them after Britain leaves the European Union. Members of Parliament on the EU Scrutiny Committee have warned that VAT tax value add attacks will have to be paid by small businesses for the first time, and that comes at a time when even retail sales in the United Kingdom seemed to be suffering from the

Brexit effect. Here to tell us more about the effects of the pull out from the European Union is Dr Sam Nahapof. He is the president of Empire Global Ventures. He previously served as Senior Advisor to the Governor of the State of New York for International Commerce as well as Deputy Commissioner of the New York State Department of Economic Development for International Development, Dr Natapoff, thank you very

much for being with us. Maybe just lay out your scenario for what happens in Britain after they leave the European Union. What does it look like? Okay, okay, First, thank you for having me. Second, I think the probability now of a no deal brexit, no agreement between Britain and the European Union on how this exit is going to be handled, is a most likely scenario. So in a no deal Brexit, every major economic, social, and political

institution in Britain is under threat. The British government itself estimates that they'll lose ten of their GDP and seven fifty thou jobs, or about three percent of all jobs in Britain would be a hundred and fifty thousand in London alone. The Bank of England says that Britain would lose about fifty two trillion dollars in Euro denominated derivative contracts based in London which would be at risk in

a no deal Brexit. And to give you some sense of what that means, Britain's entire economy is only two point six trillion, So they're putting at risk twenty times the size of their own national economy. So the two things about Brexit that are important to remember is that it's almost completely irrational and it's almost completely unpredictable. Your your running talking about what's going to happen with V A T. Nobody knows, and that's what's making markets so scared.

Based on your experience and I know that you have contributed your expertise to the U S Department of Commerce, the European Central Bank, the German Bundesbank. Based on your experience and expertise, do you expect that kind of no deal Brexit to take place or will there be some kind of accommodation or maybe an extension of a transition period. I think that there won't. My personal opinion is there

won't be a no deal Brexit. They'll extend the transition period, and in my gut, I think there will be a second referendum in Britain. And do you believe that that second referendum will conclude that the British want to stay in the European Union. Yes, I think they do, because it has never been it was never expressed Brexit was never explained to the British people about what they were going to lose. It was always told to them about

what they're going to gain. They've since learned that everything they thought they were going to gain wasn't true, and everything they were going to lose was true. And the British people are pretty good business people in the end, so that I think they're going to change their minds. There's going to be a second referendum and they're going to try and put right this terrible mistake that they've been living under for about eighteen months. Do you believe

that the UK Prime Minister Theresa May will survive this effort? No, I don't um. Theresa May, in the next three weeks is going to bring her Brexit deal to the floor of the House of Commons for a vote on the agreement that she negotiated. She will lose that vote. Then there's only three possible outcomes. One they manage no deal Brexit, which will be an economic and political catastrophe, to a

second referendum on leaving the EU. Or three a general election, which will probably end up with a second referendum if she loses that vote. And I think it's quite clear that she will either her party will force her to resign for leading them down this path, or there'll be a general election and Jeremy Corbyn will become prime minister the leader of the Labor Party. Let's explore those scenarios. If Jeremy Corbyn becomes the prime minister, what kind of

Brexit or no Brexit will Britain experience. Jeremy Corbyn is an unregenerate seventies socialist from Britain's long and distant past. He doesn't want to stay in the EU because thirty years ago the Labor Party didn't believe in the European Union. His problem is his party wants to stay in and he will. He will reluctantly, I think, agree to a

second referendum. And we know this because his Shadow Chancellor, John McDonald said that a second referendum was inevitable about two weeks ago if Theresa May couldn't get her deal through the Commons. So if Labor wins the upcoming general election and Jeremy Corbyn becomes Prime minister, I think he will reluctantly hold a second referendum, and I think they'll

vote to remain this time. If it is not Jeremy Corbin but another Conservative or Tory Party candidate becomes Prime minister without calling a general election, who do you think it will be. I'm afraid it will be Boris Johnson. Bars Johnson is the former Lord Mayor of London. He's part of the reason that we're in this mess to this point. But you need to understand Brexit a little bit in the same way that in the United States we understand Obamacare. The Conservative Party in Britain is split

down the middle about Brexit. Half of them don't want it, but a small group of them, ideologically committed people, they do, and they can't agree in the same way that many in the Republican Party in the United States wants to move on from the Obamacare repeal issue on the Republican Party, but a small cadre of ideologically committed people still want to repeal it, and that is the problem. The Conservatives can't move on from Brexit in the same way that

the Republicans can't move on from Obamacare. Dr Natapoff, is it a lack of an ability to admit that there was a mistake made with some way to save face that has put the British Conservative Party in this corner. Yes, all right, well well done. Is there a way for them to do this? Though? I mean, because you know, people do make mistakes, Political parties make mistakes. Why is it so difficult to admit a mistake and move on? The governing philosophy of the British Conservative Party over Brexit

now seems to be a hundred thousand lemmings. Can't be wrong. They would rather leap off a cliff than rethink their position, and that's a really bad way for a governing party to rule a country. Indeed, yes, all right, well anything more? I mean, you've certainly put paid to this to this topic. I mean, I just just quickly give you twenty seconds. Do you think the European Union is just standing by

watching with dismay at what the British are doing. It's fair to say that the Europeans have never understood the British, and today that even more true. Today they're looking and think what are you doing? The only two economics um economic economic benefits the British shall for the world their membership in the European Union and their ownership of Europe's financial capital, and Brexit is Britain intentionally giving up both of them. No one can understand why they're doing it,

not even the Conservative Party. Thank you very much. Dr Sam Natapoff. He is the president of Empire Global Ventures. You can follow him on Twitter at Sam Natapoff. You're listening to Bloomberg Markets. I'm pim Fox. This is Bloomberg Radio. Well, the partial government shutdown that began last week appears as if it will continue into the new year. Here to help us understand what is open, what is closed, and

what the likely resolution will be is Eric Wasson. He is a congressional reporter for Bloomberg and he joins us now from Washington. Eric, thank you very much for being with us. What can you tell us about any negotiations that are taking place? Who resolved the shutdown or is this now just a public slanging match between the president and Democrats in Congress. Yeah, so there were really no

negotiations going on whatsoever. Democrats have basically decided that their hand is strengthened on next Thursday, on January three, when Nancy Pelosi will become Speaker of the House and then Democrats will take over the lower chamber. At that point they're going to just start passing bills to reopen the government and to pressure Trump and the Republicans Senate to also pass those bills and reopened government. And they feel like, you know, once they have the gavel, they can start

that process. So, you know, there was some show of potential talks this week, but it really became clear that, you know, after there was a offer from Vice President Pence to Chuck Schumer, the Senate Democratic leader, last Saturday, there really was no more back and forth negotiations. So we were told that Pence went in there and said, instead of five billion for the wall, uh, the President would accept two point five billion for some kind of barriers.

You could call it offence, we could call a wall. Let's just be done with it. But the thing is Trump never publicly embraced that, and the Democrats feel that they've been burned before, and they say, you know, Trump, when he was a private sector businessman, he often would try to get the best deal by ripping up negotiations and until Trump comes out and says all except half of what I thought about, we're not going to talk

to you. So that's where things stalled. The capital is completely empty this week except for maintenance screws and people moving boxes around as lawmakers get into their new offices. So uh yeah, right now it's just a public show of of mud slinging and no talks. Now, this affects more than just let's say, certain areas of the government

National Park Service and saw on. I mean, it could be something as specific as the federal investigation into Facebook because the agency, the Federal Trade Commission, is going to run out of funding today. Are there any repercussions that have not been highlighted that are going to prove very detrimental to the public. Well, I think you know, you see that there's a diffuse group of agencies and tasks that are being affected. Everything from the I R S

which is furlowed. Most of it's some ployees that was attempting to roll out the tax filing season of this new tax code that was passed by Congress and semi President Trump. And you know they say that they were going to be into training or to open up the tax season uh next month, and that may be delayed the filing season. We're looking at economic reports from the Commerce Department that will also be delayed. We're looking at sec fraud, securities fraud investigations that are on hold. As

you mentioned, the Justice Department is also affected. This is really a wide range of government activities. You know, most of the e p A Is on furlough. Uh. You know, it might be hard for the average citizen to feel a direct effect unless they're one of the eight hundred thousand federal workers who aren't getting paid, but you know that the effects are going to start to mount. And there's also just the general inefficiencies. You know, the two

government shutdown costs the economy twenty four billion dollars. This is a smaller shutdown, but nonetheless, you know, you've got a lot of workers who are sitting at home idle and intradition is that those people do get paid eventually, but they're being paid for doing nothing. Yes, and also to know that about what ent of Coastguard employees could be forced to work without pay for the duration of

the shutdown. Yes, that's right. The Coast Guard is now under the Homeland Security Department, which is one of the departments that has been affected. We're also looking at border patrol, customs and Border protection agents. We're looking at ICE agents. And you know, the President did come out and say

that most the people affected their Democrats. There's really no evidence for that, and especially if you look at some of these agencies that tend to skew more towards Republican membership, you know, you're seeing a wide range of people who are affected by this directly. Just go back to what you said earlier about the political battle between Democrats and President Donald Trump. What do the Democrats and if Nancy Pelosi is indeed voted to be the Speaker of the House,

what do they expect to accomplish. Well, you know, just like the Republicans, Democrats are a bit diverse, but certainly the left wing of the party really wants to see Pelosi go after Trump. They have their voters are very frustrated with the president, think he's completely out of control. They want to emphasize investigations, oversight, possible impeachment, and they view the shutdown battle as you know, one of these, uh, you know, things that they must win that there will

be no compromise. So that's that's a factorness as well. On the on the side of the Republicans, you've got people who don't like federal government. We have had guests here in Bloomberg Radio talking about how, well, maybe these federal workers shouldn't be getting paid for these activities that are not essential. So that's part of the debate as well.

But there is there is probably a consensus in the middle, a group of rank and file Senate Republicans who don't like a months long shutdown, a group of moderate swing district Republicans who maybe even be willing to override a presidential video in the House. And you know, if this drags on into February, you can start to see those dynamics come into play where the President would lose leverage.

I think, what is the role of the Senate in this, because of course they are also part of the deliberations. But according to Senate Majority Leader Mitch McConnell, uh, he has said that in order to preserve maximum flexibility, they'll only vote for this procedure if there is a funding agreement on the wall. That's right. I think Ms McConnell was really put out on a limb by President Trump. The Vice President came up and said that Trump was

willing to sign a stopgap measure till February eight. They put on the floor, It passed the Senate, and then suddenly Trump changed his mind, and and that makes Mitch McConnell very vulnerable to right wing pundits and and radio. Uh he's someone who is up for re election in Kentucky, a very Trump heavy state. Uh So he's got to really look out for that as well. Uh So, his current position is we're not putting anything on the floor. The President won't sign. We'll see though, if the if

the shutdown drags on for months. Uh you know, at some point that position may change and he may be willing to put something on the floor to try to provoke an agreement. All right, Thanks very much for the detailed analysis. Eric Wasson is our congressional porter for Bloomberg, joining us from Washington. D E see where we have entered day seven of the partial government shutdown. You're listening to Bloomberg Markets. I'm pim Fox, my co host and

colleague Lisa Bromwitz on holiday. You're listening to Bloomberg Radio. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa abramowits one before the podcast. You can always catch us worldwide on Bloomberg Radio