Editors’ note: This is a transcript version of the episode of Alpha Trader that we published earlier this week. We hope you enjoy.
Aaron Task: Welcome to Alpha Trader. Our guest this week, Morgan Housel, is a partner at the Collaborative Fund, a venture capital and private equity firm. He is also the author of The Psychology of Money: Timeless lessons on wealth, greed and happiness. Morgan, welcome to Alpha Trader.
Morgan Housel: Thanks so much for having me, Aaron.
AT: Thanks for being here. We are talking to you on Friday, September 11, obviously, a Solemn Day. In terms of the markets, the Dow, unless there’s a miracle in the last hour of trading here, it’s going to be have its worst week since June. The S&P 500, it’s worst since late June as well and its second straight weekly loss for the first time since May. The NASDAQ is having its worst week since March.
Also, a couple of days this week, where there has been a lot of intraday volatility. Clearly, the idea of two-sided risk is back in these markets after an incredible run, after the steep sell-off we saw in March and April. So, Morgan, what, in your book, you think is most relevant to what is happening for people who are very focused on the markets day-to-day right now?
MH: Well, it’s interesting. I finished writing the book in January, so before COVID. And look, when I was writing it, obviously, I had no idea of what was going to happen, none of us did. But I also wanted to go out of my way to make sure that this was a timeless book that’s right there in the subtitle things that have always affected investors for the last 100 years, will keep affecting them for the next 100 years is one of the timeless things that we deal with – dealing with money and dealing with as investors.
One of the things I bring up and this is – might seem obvious But it’s so easy to overlook, and it’s so frequently overlooked is that, there is a cost of admission in the stock market. You can get a lot of great gains out of it. You can do very well. You can become wealthy doing it. But they’re like anything else in life, it’s not free, there’s a cost you have to put into it.
To me, the most obvious cost of investing the cost of admission is putting up with uncertainty and volatility. That’s it. That’s the cost of admission. That’s what you have to be willing to give the market, enable for the market to give you the odds of success over time, as we have to give.
So I just think it is in the nature of markets to go through periods, where they don’t make a lot of sense. We have that this summer where we’re dealing with what is still, maybe we avoided the worst-case scenarios, but still probably the worst economic crisis since the Great Depression.
And now, we are dealing with, in the last couple of weeks, a lot of volatility that doesn’t seem that connected to the news that’s going on. And I think it’s hard to put up with that. But again, that’s kind of the point. The idea that it doesn’t make sense that what’s going on is not necessarily tied to the news.
We can’t make sense of it. It is common and I think to associate that with maybe the markets broken. Like, why is it going down this much what’s going on? And I just think that’s actually the full nature of markets and like accepting that, that this is the cost of admission for what we – of what we are paid to do over time. I think just makes it a little more palatable to deal with these ups and downs.
So I think if it’s part of your just baseline scenario that this is kind of the norm. And I think historically, that’s the case. I’ve been following markets for a long time. You have as well, Aaron. I think it is par for the course for there to be these kinds of weeks. And these kinds of things that are often unexplainable, they’re usually unpredictable.
And I think dealing with that with a little bit more equanimity, keeping our heads on straight, keeping them level is so key for investing, whether you’re a trader or a long-term investor or anything in between, I think, it’s key for everyone.
One of my favorite quotes is from Napoleon. I use this at the beginning of the book. Napoleon was once asked the definition of a military genius. And he said, “The military genius is the man who can do the average thing when everyone else around him is losing his mind.” I think that’s true in investing as well. No matter how you are investing, that’s so critical to do.
AT: Well, I appreciate that. And yes, I’ve been following markets for a long time. And over the course of the last 25 years, it’s been incredible bouts of volatility and drama. One could argue that this year, like, as you put it, the cost of admission has been a little higher than normal, right? I mean, we have the fastest bear market in history than the steepest, fastest rally in history in terms of the best 50 days and the best 100 days ever. Is this really anomalous? Or do you think that we’re going to be living with these kinds of increased amounts of volatility in the months and maybe years to come?
MH: I think there’s an argument to make. And when I say this, I need to preface it by saying, I don’t have 100% confidence in this theory. But it seems logical to me is that, the Federal Reserve, and to a somewhat lesser extent, Congress has learned after the 2008 financial crisis what to do when the economy slows down. Things that are done today on a fairly regular basis, particularly at the Federal Reserve, but also Congress with multi-trillion-dollar stimulus packages would have been unthinkable even a decade ago.
But after 2008, when Ben Bernanke just started flooding the economy with cash, and a lot of people, including myself, I would say, really worried about the ramifications of that. But to date, 10 to 12 years later, the ramifications of it were not that, that severely – were not the worst-case scenarios that people thought.
And also in 2009, we had the $800 billion stimulus package that, again, felt like it was the biggest thing in the world at the time. And it actually didn’t do that much in terms of consequences. It helped the economy and it didn’t have a lot of consequences. I think Congress on both sides, this is not a partisan thing, on both sides looked at that what happened in 2008.
And Jerome Powell looks at what Bernanke did in 2008. And everyone is just saying, “Okay, if the economy slows down even a little bit, we’re going to come in guns blazing, pull out the howitzers, we’re going to come in blasting things to pieces, multi-trillion-dollar stimulus packages, $5 trillion from the Fed, here we come.
There’s an argument to make that because of that, and that’s probably going to be somewhat of the new norm. They’ve kind of like raised the bar on what policymakers are expected to do when the economy declines. But because of that, that a lot of the historical precedent that we have for recessions might not apply as well anymore. It’s not to say ever that we’re going to get rid of booms and busts, that’s never going to be the case.
But are they going to be steeper and faster now than they were in the past? But during the Great Depression that took three years from peak-to-trough. Whereas in 2020, of course, it’s a very different kind of recession. It’s not directly comparable. But our steep decline, both in the market, but also in the economy was measured in weeks, not years.
MH: And even in 2008, I think, things started getting really nasty in September of 2008. And by March of 2009, for the stock market, at least, it was over, and jobs started coming back in late 2009.
So even that was like fairly short relative to what’s happened in the past. And I do think there is probably some logic to that, that it’s different. The Federal Reserve and Congress have learned to do things that were previously unthinkable, and therefore, it’s a slightly different game than it was in the past.
And one of the consequences from that different game might be that things just happened faster. That was true in March, where I’m sure you and everyone else remembers, there were days when the market was going up or down 10%, day-after-day, it was the wildest thing. It was – I mean – and that, too, didn’t have much precedent outside of the Great Depression.
And maybe that was just, we were taking this adjustment in the economy that normally would have taken place over six or 12 months, and we did it in six or 12 days. Then same with the rebound this summer, like maybe that rebound would have taken place over the next year or two now that we’re coming out of COVID. And maybe all of it just took place in August of this year. I think there’s some logic to that.
Now – and that’s not any projection of what might – we might be heading into for the next year or the next two, like that’s not my game. But I think that’s something to think about. And it’s always this level of humility with investors, where, look, if you’re a smart investor, you use history and you say, “What’s happened in the past?” And maybe that’s your map for the future, but things change.
Like the past is not always this perfect map of what we’re heading into, especially when there’s a fundamental shift. And the biggest fundamental shift in the last decade is what Congress and the Fed have learned to do when the economy declines.
AT: You just use that Powell has got a howitzer. It’s like Hank Paulson had a bazooka…
AT: …and now Powell has got a howitzer. Hey, and maybe the next Fed Chairman is going to use nuclear weapons. And to your earlier point, there were so many people and myself included in that, you as well and your comps at the Wall Street Journal and The Motley Fool and other places, you thought what Bernanke is doing. We’re going to have run away inflation. The dollar is going to become toilet paper. We’re going to be the Weimar Republic all over, again. And at least to this point, that has not been at all the problems that we’ve had to deal with the last decade plus?
AT: So the people of today are saying the same thing, right, that the Fed is going to – the Fed is destroying capitalism?
MH: Right. I think anyone in that situation and, again, I was in that camp in 2008, 2009, that hyperinflation was right around the corner. I was there. I changed my mind fairly quickly. But anyone who had that view, and it’s not updating their views, given what has happened over the last 12 years, I think, this has kind of stuck in a – this kind of dogmatic approach to the economy.
So I think that’s really true. Yes, it’s just a different world that we’re living in compared to the past. And I mean, think of something really simple. Ben Bernanke was really criticized heavily by smart people for cutting interest rates in 2007, 2008. Whereas Jerome Powell is literally out there buying corporate bond ETFs. And everyone’s like, “Yes, that makes sense. That’s what the Fed can do.” It’s a different world than it was 12 years ago.
Stephen Alpher: And then that leads one to one better, as we’ve kind of see the progression from Greenspan through Bernanke through Powell. Greenspan kind of said, “Well, we’ll stand by to provide liquidity to Bernanke with cutting rates to zero quantitative easing to Powell going into the corporate bond market to buy the bonds of Apple and Berkshire Hathaway, among others…
SA: …companies that clearly don’t need it, what’s their next act. When we – when the next panic comes and there will be one.
MH: I mean, yes.
SA: …at what point do they just go full bore into the stock market?
MH: Who knows? I mean, there are global central banks that do buy equities. Japan does that. I have no idea if that’s going to come next. But what’s interesting to me is just our acceptance of it. If you go back – if you use like the Wall Street Journal Op-Ed pages as a proxy, 2008, 2009, everyone was criticizing Ben Bernanke, this is reckless, you’re going to destroy the dollar, yada, yada, yada. Today, it’s just, like we said, they’re buying corporate bond ETFs or buying Apple debt, and there’s kind of a shoulder shrug, there’s not that much to it.
So not only is the Fed learn, but I think everyone else, even a lot of the critics 10 years ago, have learned and come to accept it. Now maybe there is a level of complacency in that, that our acceptance of this and our inability to say, “Hey, raise my hand here? Is this what we should be doing?” Maybe that’s what’s going to lead to the risk.
I don’t know if it’s going to, but it’s just – I keep coming back to this point of just, because we started this conversation with like, is what’s going on in 2020? What are the historical parallels? I just don’t think there are many, because the Fed is so fundamental to what is going on in the economy right now. And it’s operating in a way that we don’t have a lot of historic precedent for.
SA: Yes. That was going to be my next question. I agree with you. Now, there seems to be this acceptance of well, of course, the Fed has got to cut rates to zero, of course. They’ve got to go into the corporate debt market and no – but nobody is too bothered by it. At the point where everyone is accepting of it might be the point where something bad is about that and because of that?
MH: Yes. I mean, I’ve used this analogy before that. In 1946, Harry Truman was asked giving an interview about why he dropped the atomic bomb in – on Japan at the end of the war? And he said, look – I’m paraphrasing here. He said, “if the American people found out that I had a bomb that was capable of ending the war and I did not use it, I would have been impeached, which is probably true.” And I think there’s a similar thing for the Fed and Congress.
Look now that people know that if there’s a wide bout of unemployment that Congress can send you $600 a week. Now that people know that, that is possible, then any future Congress when the economy is really shedding jobs at a brutal pace, it does not do that, is going to look reckless.
Once you raise that bar, it’s hard to do anything else below it. If people know that a solution exists and you don’t do it, then suddenly you’re the bad guy. I think people will give policymakers a pass, if people think that there’s nothing policymakers can do. But now that we have seen what Congress and the Fed can do, then they’re – then their decision not to do those things in the future, that starts to look reckless.
AT: Right. So that’s very interesting, because the most rational case that we’ve heard on this podcast for why the markets done, what it’s done this year, and particularly the rally in the face of Great Depression, like economic data, is that the Fed and the Congress have been incredibly accommodative. And the cost of money is so [indiscernible]. And so if what you’re describing is true, that would suggest that this rally probably has a lot further to go, is that your baseline scenario if assuming you have one?
MH: No. I think your valid point is good. I’m not necessarily in the forecasting game and certainly not as it pertains to the investment decisions that I make. But if I’m just someone who is curious looking at the economy, the biggest thing is this. If the economy slows down, again, because there’s more lockdowns, whatever it is, then there’s going to be more stimulus packages and more Federal Reserve financing. And the – if the economy speeds up, the Federal Reserve is not going to tighten up.
So there’s this like a, it’s really asymmetrical right now in terms of where the momentum is. If things decline, there’s more Fed stimulus. If things improve, there’s the same amount of Fed stimulus. So there’s a lot of fuel going on there.
I think if you’re trying to make sense of the market in the last five months, so to me, probably the biggest point is that, the big five tech tech companies: Facebook, Amazon, Google, Apple, Microsoft, they make up a quarter of the S&P 500 now…
MH: …and 40 some odd percent of the NASDAQ. So that’s the biggest explanation of the disconnect between Main Street and Wall Street, as people say. It’s like, yes, just because of the fundamental weightings what we’re looking at, even in the S&P 500, it’s not as diversified as a lot of people might think.
You’re looking at tech companies that can operate their businesses from home, or their employees from home without any disruption. And most of those businesses are actually seeing a huge tailwind right now because of COVID. So it makes a little bit more sense on those grounds.
SA: I’ve been reading some of your blog posts in Collaborative Fund. And correct me if I’m wrong, I think, I detect a little bit of the Nassim Taleb, in some of your writing. Hey, he is the author of The Black Swan and other things, that kind of outlier events occur a lot more than we expect. You tell the story of Bill Gates – a young Bill Gates at Microsoft to despite the roaring success of his company insisted on keeping a year’s worth of operating expenses in the bank in case revenues went to zero. Am I correct in kind of reading that?
MH: Yes. I think that’s really true. To me, like I’ve always been a long-term optimists on people’s ability to solve problems and become more productive and for corporations to use those that problem solving to increase profits, profits back to shareholders. I’m always an optimist in people’s ability to solve problems. But I’ve always been kind of a worst-case scenario, borderline paranoid guy, that’s kind of my personality.
And like, how do you reconcile those two? To me, it’s always just been like, “Look, in order to achieve the long-term, in order to stick around for the long-term, you have to survive the short run. And I’m also just a fan of economic history. And the whole story of economic history is things constantly breaking and falling apart in recessions and bear markets within constantly, like things going really well.
Like we have some of these years once in a while, like, let’s say, like 2017, where it seems like everything goes well in the economy and the stock market. There’s no big news. That’s the rarity, like 90% of years, there’s a big news story of something fundamentally falling apart in the world in global economy. That’s the norm. Even though over the last 50 or 100 years, there has been a ridiculous amount of growth and progress, and 90% of years, it looks terrible.
And so I think just reconciling that of “Look, I’m still very optimistic on the long run. I always have been, I think, I always will be.” But I’m always and maybe even increasingly right now pessimistic on the short run, not because I’m forecasting anything in particular, just because I know the world is fundamentally fragile, especially right now. And I need to situate my personal finances to make sure that I can survive the short run, both financially and mentally, so that I have a fighting chance of doing well in the long run.
It’s Charlie Munger, his quote that I love so much. He says the first rule of compounding is to never interrupt it unnecessarily. And the only way that you could do that is to survive the short run, this constant chain of breakages and surprises and uncertainty, pandemics and whatnot, so that I have a fighting chance to do well over the long run.
So a lot of the pessimism that I have in the short run, or my asset allocation, the amount of saving, the cash savings that I have makes me look like I’m paranoid. But I actually feel like it is actually – like that paranoia is the fuel of my optimism. That is the cushion that makes sure that I’m going to get to the other side to achieve that optimism.
AT: It’s interesting. The book has broken up into about 19 different chapters, and one of them is about your own personal investing in your wife’s portfolio. And you basically described that your entire net worth is your house, a checking account and Vanguard funds and a few shares of Berkshire Hathaway.
AT: You mentioned earlier, though, that the five stocks now make up a quarter of the S&P 500. Does that make you concern that you’re not as diversified as you would like to be or maybe I think you are in – as an index fund investor?
MH: Not necessarily, because it has always been the case that a few companies make up the majority of the index. It is more so today. We’re at more like a more skewed level, where it’s roughly the same as it was in 1999.
But if you go back to the 1980s before IBM, just one company was making up a larger share than any companies do these days. So it’s always been the case that a few companies will do that. But also, I think you have to look at it within the holistic context of your network.
So as a percentage of my stock portfolio, those companies make up a lot. But that also doesn’t necessarily bother me, because Apple and Amazon are incredibly strong companies with good moats and profitability, et cetera, et cetera. So it doesn’t bother me that they make up a disproportionate share of it.
And also, just as part of my investing mindset, I totally expect there to be huge volatility in the future. And it’s not that I enjoyed going through it in March of this year, it sucked for me as much as anyone else, it’s not fun to go through that. But if you accept it as a baseline, then it just becomes a little bit more palatable to deal with.
So if I look at like the lack of diversification in an index these days relative to where it was five or 10 years ago, that doesn’t make me feel great. But it’s not even in the top 100 of my worries about that would lead me to take action in my portfolio to mitigate that.
AT: Right. And I just want to be clear about this, because obviously you’re a partner to a venture capital firm, so there’s some risk inherent in that. But do you have some other trading account that’s your funding money account, where you take flyers on stuff, or is this really it?
MH: No. That’s it. I used to. But look, I value so much simplicity, that structure that I have of just owning three or four assets means the world to me. And it’s also this thing, where, look, the one variable that I want to control for the most, because I think it’s going to be the most important variable is, can I actually dollar cost average into funds and hold them for another 30, 40 or 50 years? Because if I can do that, if I can actually hold these funds for 50 years, I’m going to achieve every financial goal that I have and then some.
So by doing this and focusing all of my effort and attention on the psychology side of investing to make sure that I can do that, I think, I’ve given myself the highest odds of achieving those goals. And anything else – any other knobs that I have to fiddle with just increases the odds that something is going to break in there and it lowers the odds of achieving those goals that I think I have a really high chance of making doing this simple strategy.
So I also have to say whenever I mentioned this that, that I’m not recommending other people do that. This works for my wife and I, way works with our goals. But I know there are people who I really respect and admire who could not look them – who could not look themselves in the mirror if they did that with their money. They have to be out looking for the better opportunities and whatnot, which is the thing that intellectually I enjoy as well.
I love talking about the economy, talking about different sectors. I just value simplicity so much in my personal finances. And if I’m focusing on this one goal of being able to stay invested for 50 years, could I stay invested for 50 years if I was a concentrated value investor? Maybe, but at much lower odds.
Could I stay invested for 50 years if I was a day trader? Probably not. It’s just hard to keep that going. And so if you really believe in the power of compounding, then the single variable that I want to focus on is just my endurance, and I’m going to increase the odds of having endurance if I can keep things as simple as possible.
AT: All right. We’ll be right back with more with our guest, Morgan Housel. You’re listening to Alpha Trader.
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AT: All right. Welcome back to Alpha Trader. We’re continuing our conversation with Morgan Housel. He is a partner at the Collaborative Fund, the venture capital and private equity firm, whose chief investments include Beyond Meat Lyft, Kickstarter, Impossible Foods, WHOOP and many others.
Morgan is a former columnist at The Motley Fool and the Wall Street Journal, award-winning one of that, I should say. And he is the author of most recently, the Psychology of Money: Timeless lessons on wealth, greed, and happiness. And Morgan, we’re talking a little bit about your own personal investing style, which for most people in the world today looks very conservative, but it works for you and that’s great and God bless.
You are writing the biggest realization I’ve had about investing is that it’s not the study of finance, it’s the study of how people behave with money. So what would you say to Warren Buffett or anybody else who is a devotee of Graham & Dodd that they’re doing it all wrong, at least, if I don’t think correctly?
MH: No. I definitely wouldn’t say that. And there’s one thing, too, I would say about my personal portfolio in terms of looking conservative. I think this is important getting into the Psychology of Money. And we know that from the statistics, that if someone can dollar cost averaging the index funds and do that over the course of decades, they will likely end up in the top 10% of professional money managers over time.
MH: So to me, like, though, one of the reasons I do it, it’s not that I’m conservative, it’s I’m trying to increase the odds of doing really well over time. So that’s – but that’s, again, that’s just like a shift in expectations and how you’re looking at things.
AT: So let me ask you a question, “Why don’t most people do that? Why is it so hard? Because you’re right, 90% of active managers underperform their indices, their benchmarks?
AT: So why do we still have this fascination with the people who do outperform for a year or two or sometimes 10 or 12? And also think that we can do it ourselves, like we’ve got to be able to beat the market.
MH: It’s two things, I think. One is in almost every other field in life, every other endeavor in life, there is a strong correlation between efforts and results. If you are a professional athlete or you want to be a doctor, you need to go practice, practice, practice. Practice your butt off hard work, the harder you work, the better you’re going to do.
And I just think there’s not a lot of evidence in investing and that’s the case. It’s not black and white. There, of course, are people who devote their lives to it and do very, very well. Of course, that’s the case. But on average, for most people, it’s not. And I’ll add it for a lot of people, it is actually the opposite.
And the other thing in terms of why people do it, it’s still rational that if there’s opportunity on the table an inactive trading and active investing there is, if that opportunity exists, it is totally rational for people to try to grab for it.
It’s not rational for there to be opportunity in the market and everyone say, “Well I’m passive, so I’m just going to leave that $100 bill sitting on the sidewalk and walk past it.” It is always going to be the case that if something is possible, if it is statistically possible, people are going to go for it.
So I don’t – I’ve always viewed the thing of 90% of active managers underperform as, look, that’s the way it should be. You wouldn’t expect there the world to work any other way. And when people look at the college players in college sports, and if someone said, “Look, only 10% of college players make it to the pros.” I don’t know if that’s the right number, but let’s let’s say it is.
AT: I think it’s small, but yes.
MH: …I’ll say, yes, that’s if they make all, maybe it’s in the single digits, whatever it is. People would say, yes, of course, that’s the case. It’s really hard to make up to the pros. You would not expect every college athlete to make it to the pros, that word should not exist. But for some reason, inactive investing, people say 90% of fund managers underperform and that’s a critical statistic that we should be in shock of and see, say, the industry has broken.
I’ve always just viewed it as that’s how it should work. And therefore, if I can do something with my investments in a passive manner and really focus all my efforts on endurance, and therefore, almost practically guarantee that I’m going to end up in the top 10% of all money managers with near 100% certainty versus the lower odds that I’m going to end up lower – or that I’m going to do better than the top 10%. It seems like the weighted average bet for me, and my personality and my goals is to take that passive approach with a focus on endurance.
And Buffett, I think people like that are doing it right as well. Look, I think, if we go back to the athlete example of what – whatever the number is 2% or 3% of college players that make it to the pros, well, Buffett is one of them. Of course, there’s always going to be Buffett’s and Kobe’s and Michael Jordan’s and Bronze [ph], they’re going to exist. And I think Buffett almost more than any other investor has mastered the psychology side of investing.
This is mainly, because he has been doing this. He started investing when he was at 11. And now he is 90 and he is still going strong full-time. Just having that much passion and endurance and the ability to compound like that is a psychological feat in itself. The majority of people in Buffett’s shoes, if they had that investing talent would have quit long ago. When Buffett was 32 years old, he was worth $1 million, with adjusted for inflation is $10 million.
The majority of 30-year olds worth $10 million would say, “I’m going to Vegas and buying Lamborghini, I’m out of here. So just having his mentality that brought him to where he is, is a feat in itself.
I read in the book that 96% of Warren Buffett’s net worth can after his 65th birthday. That’s just how compounding works. The big numbers don’t take place until your later years. So that, again, is just a sense of most people, when they turn 65, they say I’m going to go buy a house in Florida and play golf and I’m retired now.
He kept going – his biggest gains in dollar terms took place in his elderly years after he was qualified for Social Security. So that, again, is another psychological thing that the vast majority of us, including myself, would struggle to have that kind of mindset, but he does and that’s why he in the position that he is today.
SA: Right. And not for not, but his authorized biography is called The Snowball, which refers to that exact thing, right, you start rolling a little.
SA: …piece of snow down the hill and it just keeps getting bigger and bigger and bigger to where the size just kind of engulfs everything over time. And…
SA: …I’ve always called Buffett kind of the Tiger Woods of investing beyond just being great at what he does. It’s kind of the way we all receive that the video of Tiger Woods at age three hitting perfect golf balls on a talk show or something like that. If Buffett had kind of this innate sense from a very young age, I don’t know what it is four, five, six, seven, he understood in his bones compounding and he stuck with it. And as you say, it got most of the gains after the age of 65?
MH: Yes. I mean, so I grew up ski racing in Lake Tahoe and I was on the Squaw Valley ski team. And one of the people on the ski team was Julia Mancuso, because she’s not a household name, because skiing is not that big, but she won the gold medal in the 2006 Winter Olympics. She is one of the greatest female ski racers of all time.
And to me what sticks out from Julia growing up skiing with her, is that from the time she was six years old, you knew she was going to be a phenom. It was not the kind of thing like that kind of natural talent with extreme results is obvious very quickly. You mentioned Tiger Woods is the same way. Buffett was the same way. He was scoring – he was making a hedge fund like returns when he was 12.
MH: …like it’s ridiculous to the kind of talent that he had. So I think that gets back to, look, it should be hard to win an Olympic gold medal. It should be hard to become worth $90 billion. Of course, it’s going to be a tiny, tiny minority of what we do. But it’s hard to individualize that when we become active investors or athletes. Everyone thinks in a rational way. I don’t criticize this at all.
Everyone – virtually everyone who goes into it thinks that they can be the next Warren Buffett. They can be the next Julia Mancuso. And that’s a good thing. I think that kind of optimism in the world is what leads to a lot of growth and productivity. People really trying as hard as they can with almost a irrational sense of over optimism about their own abilities is a lot of where progress comes from in the world.
AT: The trade is good. That brings a book – a few things from the book. And we probably should have you back for a second podcast, because there’s so many things that keep coming with “Oh, yes, I want to ask him about that. I want to ask about this.” But you just referenced something that we were talking about earlier, meaning, things over time, you’re an optimist on progress. But there you have a chapter about the seduction of pessimism.
What does that concept mean? I think I know. But what does it mean to you? And how do you see it playing out right now in the world today as people look at the markets and the economy?
MH: It means that, as we come across news in the world, pessimistic news and pessimistic views on the world are much more seductive than optimism. And the simple reason is this. Pessimism sounds like somebody is trying to help you. Hey, there’s a problem in the world and I’m warning you about it, so that you don’t get hurt. They’re trying to help you.
Optimism often sounds like a sales pitch. Hey, I got a stock that’s going to go up tenfold. Do you want in? It sounds like I’m trying to sell you something. And just naturally, how we’ve evolve as humans, we respond to threats with a greater sense of urgency than opportunities. That’s how we’ve survived over time.
So that’s always the case in the economy. And there’s also another reason I think this occurs, which is that, progress happens slow. It’s powerful. But growing the economy, growing the stock market is something that takes place over years and decades. There are no overnight miracles. But there are overnight tragedies, COVID-19, September 11. Those are overnight tragedies. there is no corollary for overnight miracles in the economy.
So therefore, when the declines happen very fast, you can’t ignore them. They’re in your face, they’re all over the news. There’s this decline that happened today or yesterday, whereas growth progress is this kind of this slow burn upwards over time. It’s much easier to ignore just because it’s slow.
So I think that is why, even if we look at the long course of history, there has been so much progress in real terms, in economic terms or in the stock market and in the standard of living, et cetera. But in any point in time, any month, every – any year, any era, you open up the news and it’s a constant chain of bad news all the time.
So I think that’s why pessimism is just more seductive, even if we are and should be long-term optimists. And this gets back to kind of my own philosophy of, I’m an optimist on the long run, but I’ve always been kind of paranoid about the short run. I think this is kind of how the world works in terms of how we interpret what’s going on with threats and opportunities.
AT: Right. And I think that, that seduction of pessimism explains why some of the people, who haven’t changed their point of view and what the Fed is doing in the last decade plus, still have big followings and big audiences and are still treated with some reverence by certain sectors of the media, where they’ll come on, like, “Oh, the world is about to end and the dollar – buy gold and stock up at tuna fish?”
MH: There’s a famous historian named Deirdre McCloskey, who has this great quote that I love. She says, “For reasons I have never been able to figure out, people like to hear that the world is going to hell.
MH: I think that’s true. It’s true in a lot of fields. It’s definitely true in economics. The people who are always banging the door that hyperinflation is right around the corner, those people have a huge following…
MH: …despite whatever is going on in the world. If you tell people what they want to hear, I think you can be wrong indefinitely. That’s true in a lot of fields. I think it’s definitely true in economics and investing. And the biggest people that gain the most loyal following are the pessimists. People who are long-term permeables like Jeremy Siegel or whatnot, they do not have the rabid followings that the permanent bears do. It’s very lopsided in that sense.
AT: Yes, absolutely. But I was also glad you mentioned the idea that progress happens slowly, because you read about the Wright Brothers and the first man flight and how it really wasn’t that big of a deal at the time, which is amazing to think about, and what a profound impact that had on the world.
And I’m wondering, what do you think is happening today that we’re going to look back in 10 years and be like, well, that was humongous. And we were all sort of like, “Oh, yes – and you work at a venture capital fund. So maybe that’s part of what you’re trying to find.” But what are the things you think today that we’re underestimating their future impact?
MH: I think it’s always in any given period, it’s almost impossible to know what that will be, because as I write in the book, the car, the airplane, the computer, the Internet, going down the list of the most consequential investments or the most consequential new things we have in the world, to a tee, every one of them was belittled or ignored when they first came out, not for weeks, or months, or even years, but often for decades.
I mean, I’ve thought about before, the time between the introduction of the car and the interstate highway system was 50 years, from the time that cars became a thing that you could buy to the point where you could drive across the country took half a century. So there’s always that it happens really slowly.
What are we underestimating today? I think there’s probably – there has been a tremendous amount of progress in medicine and healthcare. Over the last 10 or 15 years, that if you follow how these things work, might take another 10 or 15 or 20 years to fully grasp their importance. That’s not an area that I’m necessarily an expert in. But there has been so many changes in that.
And I think what’s happening with COVID-19 is an extraordinary fuel to that. The long history of innovation is that, you tend to get the most innovation by far, when innovators and businesses and governments are panicked. The biggest innovations don’t come when everyone is happy and everyone is rich, and the outlook looks bright.
The biggest innovations come when everyone wakes up in the morning and says, “Oh my gosh, the world is coming to an end. If we don’t solve these problems, we’re going to die. So the biggest by far period in American history, where we had the most rapid consequential innovation was the period between the Great Depression and the end of World War II. More innovation took place during those 15 or so years that took place during the next 50 years.
I mean, just think about World War II. World War II began in 1939 on horseback, and it ended in 1945 with nuclear fission. And what took place during those years between was just incredible amount of growth and things like radar and the introduction of antibiotics.
And then going into the Cold War, we had nuclear energy jets, rockets, GPS, all these things that were specifically tied to bad things going on in the world, this panic-induced innovation.
AT: Yes, not to mention, packaged foods, which really changed the consumer goods landscape for America in post World War II?
MH: So many things. I mean…
AT: …often, they did for the soldiers condensed milk and all kind of things like that…
MH: …so many things like that…
AT: …it’s amazing.
MH: I mean, virtually, everything that we do today, even back to the interstate highway system that was made specifically in response to the Cold War. So that the U.S. military could travel around the country in a more efficient way. Almost everything that we enjoy and take for granted today has some tie back to a period of history that was tragic and very dramatic.
So I think COVID-19 is one of those triggers as well, where the amount of innovation, the amount of just panic-induced trying new things in the biotech space right now, today, at this moment, is probably more panic-induced, more frantic than it has ever been in the last 60 or 70 years.
I mean, this is the one moment when scientists and governments and investors are saying, we need to solve this massive problem and we need to do it today, because if we don’t, we all – we might literally die and the economy might crumble in the next year. This is very, very important.
This is not, going back to 2019, where someone is trying to build a new app that might add a tiny bit of productivity to your life. This is truly a life and death scenario, where – and that is when you try to get – that is when you tend to get the biggest innovations over time.
So that’s something where I kind of look at it today and think, if you have a respect for how these things work, historically, the odds add another 10 or 20 years. There’s going to be a massive medical breakthrough that fundamentally changes our lives that we can directly tie back to COVID-19 seems very high to me.
SA: I think back to The Graeme Green book and movie, The Third Man talking about in Italy for three decades, they had war, terror, murder, bloodshed, but produced whoever – Da Vinci and the Renaissance and Michelangelo, and Switzerland, they had brotherly love for 500 years and produced what? The cuckoo clock, so…
MH: That’s great. Yes, it was, to me, one of the craziest things is, it was 1929 that Alexander Fleming discovered penicillin. But after that, he didn’t really know what to do with it. And even a lot of scientists that knew that it had antibiotic properties, this kind of thought, this is kind of like a laboratory toy. We don’t know what to do with it.
And it wasn’t to World War II, where the government said, “We have all of these young soldiers who are getting sick, we need to save them.” That people were like, “Hey, what does this antibiotic thing? Can we make this into a drug? Can we turn this into drugs that we can give people?” And the first mass doses of penicillin were delivered on D-Day in 1944.
And, look, if World War II did not happen, we still probably would have figured it out and penicillin would still be something that was with us today. But it’s sped up the process so much during that period in a way that had these unforeseen positive effects on the world.
AT: So can you talk about how these major sort of historical developments and what you just described about the biggest innovations coming during periods of major stress like we’re in now? How you and other folks at the Collaborative Fund factor that into your investing and the kind of companies you’re looking to invest in?
MH: I think, for seed stage VC, it’s always kind of looking for the same thing. It’s big ideas and capable founders. It’s usually not – I feel like it’s kind of the later-stage company that we don’t invest in that much that are more into the thick of what’s really going on right now. And so much of what’s going on in 2020 is biotech-related, which is not something that we have much expertise or interest in.
But I think it’s definitely always the case that a VC should be on heightened alert when the world seems like it’s falling apart. And even if you go back to things where they were not as dramatic as they are today, but how many companies were founded, how many big companies that we admire today were founded in the teeth of the financial crisis? Airbnb, Uber, you can go on down the list, there are actually quite a few.
AT: …were the Great Depression…
MH: …that’s always the case. The Great Depression is making [Multiple Speakers] so many, you go on down the list. And you can also flip that around and say, how many great companies were founded during booms. The one that sticks out is Google, which is founded in 1998, but not many. You go on down the list and there really are not that many.
So that’s when any investor, but I think, particularly at the VC level, you should be on kind of heightened alert for things that are really changing what’s going on is when the world feels like it’s falling apart.
AT: Right now, one of their focus is – focus of the fund, though, is cities. And I’m wondering how you’re thinking about this with it right now what is happening seems to be an exodus from the cities because of COVID. Is that changing your approach and your thesis around cities?
MH: I would say not yet. It’s still way too early to see how that, that plays out. To me, one of the biggest, the closest historical and what we’re going through right now is the 1918 flu pandemic, which was worse than it is right now and so far. And – but that’s the closest thing that we have in history to say like, what – how do people respond?
To me, what’s one of the most interesting things is that, there’s not a lot of evidence. If you look in the early 1920s, the period immediately after the 1918 flu pandemic, that had much impact on consumer behavior. I mean, the 1920s were the era of the jazz bar and the speakeasy and the big growth in city and like that was the biggest booming decade for New York City.
So I’m not necessarily in the camp that cities are dead after this. I don’t think that’s necessarily the case at all. There are pockets, of course, in Silicon Valley in San Francisco and Plant Pots [ph] in Manhattan, where prices got completely out of control. You have $2.5 million starter homes in Palo Alto. Is pressure going to be taken off that probably? But the death of cities, I don’t think that’s going to be the case.
I think during a lot of periods, historically, that has – that case has been made, because the pendulum does tend to swing in one direction or another. And maybe the pendulum was too far in San Francisco and New York over the last decade. But the death of cities or even any meaningful decline that’s going to really impede city’s ability to grow over the next decade or two, it is at best to be determined, but it seems unlikely to me.
AT: All right. And before we wrap up, I want to bring it back to sort of the present day outlook. We talked a lot about history, and I’m trying to avoid the seduction of pessimism, as you call it. And we’ll note that you were recently quoted on CNBC, I believe it was saying that the U.S. economy might be prime, or one of the best years in its history, something akin to the post World War II boom. Explain what that scenario looks like in your mind?
MH: So the first thing I need to preface is that, this is not my baseline expectation. This is not what I expect to happen. I just think it is something that people are underestimating the odds of this occurring and it goes something like this.
Let’s say hypothetically, that in the coming weeks and months, we get positive vaccine news. And as we head into 2021, there’s a widespread vaccine, and we start to be able to reasonably say, COVID-19 is over. This is all hypothetical, let me remind you. Let’s say, that’s the case. Then you take the amount of pent-up demand that so many people around the world, myself, and likely you have, I cannot wait to go back on vacation, I cannot wait to travel, I cannot wait to go to restaurants and do all the things that I was blocked from doing in 2020.
If all this pent-up demand to go out and spend money and then you combine that with the amount of savings that Americans have accumulated this year, because they’re not spending that much money. More – the savings rate right now is higher than it’s ever been by far and the amount of government stimulus money, both from Congress and the Federal Reserve that has all this liquidity and money sloshing around the economy.
If you put those two things together, optimism and kind of rejuvenation from the vaccine, pent-up demand to spend money and the most amount of savings and liquidity and money that we’ve had in a long time, those things meeting up at the same time could create the scenario, where 2021 is just an economic bonanza. And, again, that’s not necessarily what I expect.
But I think it is almost impossible for some people to envision that occurring, because there’s so much trauma in 2020. It doesn’t seem rational or intuitive to think that you’re going to have the biggest epic boom coming after the biggest epic bust. But historically, that’s usually how it works. And I think some of the puzzle pieces are in place for that to have a potential of happening that seems discounted today when I talk to investors.
AT: All right. Well, on that upbeat note, I hope you’re right, for sure. And we’d love to have you back to see how things pan out in the coming months and into next year. Morgan, thanks so much for being with us today.
MH: Thanks, guys. This was fun. Thank you.
AT: Thank you, Morgan. Our guest has been Morgan Housel. He is part of the Collaborative Fund and his new book is the Psychology of Money. I highly recommend it, please check it out, and thanks for tuning in to Alpha Trader.
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