Episode 405: The Private-Equity Reckoning Is Here
On this week's Stansberry Investor Hour, Dan and Corey welcome Dan Rasmussen back to the show. Dan is the founder and portfolio manager of asset-management firm Verdad Advisers, as well as a bestselling author. His most recent book, The Humble Investor, came out just last month.
Dan kicks off the show by explaining what motivated him to write The Humble Investor. This leads to a discussion about why savvy investors should be skeptical of forecasts and why they should always consider whether other investors are looking at the same data and reaching the same conclusions as them. One area where this is a big problem is artificial intelligence ("AI"). AI is capital intensive with very little return thus far, yet investors are blindly buying into AI stocks on lofty expectations. Dan points out that the "Magnificent Seven" are riskier than most folks realize, and this overvaluing of U.S. stocks has made foreign investors begin to look at other countries' markets for opportunities...
It turned out that there's more foreign capital in the U.S. than there is U.S. capital in foreign markets these days... It's not like U.S. investors are massively overweight the Nikkei 225... And so, [there are these] global capital flows into the U.S. that now seem to be reversing.
Next, Dan talks about investors mistakenly being underweight gold for years, whether it's possible to predict a bubble, the pattern of credit crises, and the recent worrying signal of money drying up in private equity. He notes that this tendency for investors to take on more risk in private equity than elsewhere is a disaster waiting to happen. Dan then delves into which parts of the market he finds most and least attractive today. For example, he notes that changing corporate governance for Japanese stocks is an "obvious catalyst" for doubling your money, while short-term macroeconomic factors are keeping him away from U.S. Treasurys...
The median Japanese company has 50% of their market cap in cash and 50% of their market cap in cross-share holdings in other Japanese companies, which people don't realize. So [companies] can immediately get to 1 times book [value] by just selling [their] cross-share holdings or using [their] cash to increase dividends or buy back shares.
Finally, Dan discusses diversification versus "diworsification," the often-ignored problem with passive investing, and the "valuation drop-off" between S&P 500 Index stocks and foreign stocks. With the Magnificent Seven officially in a bear market, Dan declares that "the turning point seems to be upon us" for U.S. stock valuations to come down. And he concludes with a stark reminder for listeners...
Growth rates don't persist. Take the top 10% or the top quartile of growers and look at how they grow over the next three or five years. And there's no relationship, zero. It does not predict anything... Earnings growth is completely unpredictable.
Click here or on the image below to watch the video interview with Dan right now. For the full audio episode, click here.
(Additional past episodes are located here.)
This Week's Guest
Dan Rasmussen is the founder and portfolio manager of asset-management firm Verdad Advisers, chairman of the investment committee for Plymouth Rock Companies, and a New York Times bestselling author. Previously, he worked at investment firms Bain Capital Private Equity and Bridgewater Associates. Dan was even named in Forbes' "30 under 30" list in 2017. He graduated summa cum laude with a bachelor's degree from Harvard College and earned his Master of Business Administration from the Stanford Graduate School of Business.
Dan Ferris: Hello, and welcome to the Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and The Ferris Report, both published by Stansberry Research.
Corey McLaughlin: And I'm Corey McLaughlin, editor of the Stansberry Daily Digest. Today we talk with Dan Rasmussen, founder of Verdad Advisers and author of The Humble Investor.
Dan Ferris: We've had Dan on the show before. He's a very smart guy. I read his stuff just about every week. I want you to get a load of what he's got to say because some of the material in his book is absolutely essential, must-read investor material. So, let's talk with Dan Rasmussen. Let's do it right now.
Corey McLaughlin: For the last 25 years, Dan Ferris has predicted nearly every financial and political crisis in America, including the collapse of Lehman Brothers in 2008 and the peak of the Nasdaq in 2021. Now he has a new major announcement about a crisis that could soon threaten the U.S. economy and could soon bankrupt millions of citizens. As he puts it, there is something happening in this country, something much bigger than you may yet realize and millions are about to be blindsided unless they take the right steps now. Find out what's coming and how to protect your portfolio by going to www.americandarkday.com and sign up for his free report. The last time the U.S. economy looked like this, stocks didn't move for 16 years and many investors lost 80% of their wealth. Learn the steps you can take right away to protect and potentially grow your holdings many times over at www.americandarkday.com.
Dan Ferris: Dan, welcome back to the show. Good to see you again.
Dan Rasmussen: Thanks for having me on.
Dan Ferris: Yeah, we kind of had to. I got this book delivered to me recently that had your name on it, so I thought "Well, we should get him in here and talk about that." I get a lot of good –
Dan Rasmussen: Thanks, Dan.
Dan Ferris: Yeah. Yeah, you bet. I get a lot of good e-mails from you and so I thought, "Well, if he puts this stuff in a book form, it's probably pretty good." The book, just so everybody knows, is called The Humble Investor: How to find a winning edge in a surprising world. And it's got little notes in the jacket by people like Patrick O'Shaughnessy and Michael Mauboussin, who we've had on the show as well. So, why do a book? Why do The Humble Investor at all?
Dan Rasmussen: Yeah. I've been writing my weekly research e-mails since 2015, and so it's been about 10 years. And I wanted to put them together in a book of my sort of best ideas and also try to summarize sort of the theme and the logic that governs all of what I've been writing. You write a lot of short weekly pieces but I wanted to step back and say, "Hey, here's the argument or the perspective that's underlying all of this content."
Dan Ferris: Well, if I had – actually, if we were just sitting around a bar and I was saying, "Well, OK, what is that? What is the arc? What is the – what kind of investor are you?" is what I would ask.
Dan Rasmussen: Yeah. My favorite motto in investing is that investing is not a game of analysis, it's a game of meta-analysis. And if there's one thing that defines my approach, it's that. And I can walk through a few different illustrations of that or what that means in practice. I'll start with one of my favorites, which is Ken Arrow, who was the youngest economist to win the Nobel Prize, was assigned to the weather service in World War II, and he was responsible for producing long-range weather forecasts. And after doing this for a few months, he looked at the results and he said, "Well, gee, this is worse than just using an almanac. This is a complete waste of time. No one knows if it's raining four months from now. Why are we doing this?" So, he wrote up a memo to his commanding officer and said, "Hey, these forecasts aren't worth anything. You should fire the entire weather service and just use an almanac." And he got a telegraph back from his commanding officer and it said, "Well, the commanding officer knows that the forecasts are worthless but he needs them for planning purposes."
Dan Ferris: [Laughs]
Dan Rasmussen: And I love that story because I think so much of investing is focused on planning purposes and we miss the fact that the forecasts are worthless.
Dan Ferris: Right. That's the joke – this is the joke about the drunk guy who's looking for his keys under the streetlight and somebody comes along and says, "Where did you drop them?" "Well, I dropped them over there," he says. "Why are you looking over here?" "Well, this is where the light is." Exact same story. Right? Anyway, go ahead.
Dan Rasmussen: Exactly. That's a great story.
And so, I think that if there's one sort of first instinct that sort of informs my work, it's a skepticism of forecasts. Let's be skeptical of our own analysis. Investing is a game of betting on forecasts. So, I think we have to start with this sort of radical humility or even nihilism about our ability to predict the future. And that's why I love that Ken Arrow story, because it shows that sometimes the smarter you get, the more you realize you don't know anything. If Ken Arrow thinks the forecasts are worthless, probably our forecasts are worthless or close to it as well.
Now, the second story is one that I think sheds light on the efficient market hypothesis, which is − there's one of my colleagues, Sam Hanson, who wrote this beautiful paper about Greek shipping. And it's fascinating. And what he finds is that when shipping prices are really high, what tends to happen is that the shipping companies go and order new ships. So, they run a discounted cash-flow model and they say, "Hey, current shipping rates, I could make a fortune building new ships. If I had twice as many ships, I'd be making so much more money. And so, all the math pans out and I'm going to go call up the South Korean and Chinese shipyards and I'm going to order a bunch of ships to add to my fleet."
The problem is, it takes two to three years for the ships to get built. And so, two or three years go by and then the ships are delivered and all of a sudden they find that shipping prices have cratered. And they look around and say, "Well, why have shipping prices cratered?" And they say, "Well, there's a glut of new ships on the market." And then they realize "Oh, it wasn't just me that ordered the new ships when shipping prices were high. All my competitors also ordered ships at the exact same time because they saw the same thing that I was seeing."
And Sam Hanson calls this competition neglect. We forget that we're competing. We forget that other people are looking at the same data that we're looking at and making the same type of decisions. And so, you can't just be wary of your forecasts. You've also got to be looking and thinking about the data you're using to make decisions and thinking "What are my competitors doing with this data? Are they coming to the same conclusions? And therefore are markets being driven in this sort of recursive way by everybody looking at the same set of data, coming to the same conclusions, taking the same set of decisions? And is that really what's contributing to a lot of market volatility?" It's this swing of correlated beliefs and the way those correlated beliefs can drive cyclicality in markets.
So, those are sort of the twin underpinnings of my philosophy. Radical skepticism about forecasts and then a hyperawareness of thinking not "What's the right analytic thing?" but "What conclusion is everyone else coming to?" And therefore, what should I do if the forecasts turn out to be wrong, and therefore everyone else has correlated beliefs, and the more correlated the belief, the more everybody agrees on something, the more likely it is inevitably to go bust.
Dan Ferris: I thought you did a great job of using your ideas about forecasting and the specific example of the shipping paper that you just mentioned in discussing AI recently. And I thought "Yeah, for me –"
Corey McLaughlin: Yes, me too. I read that note as well. Yeah.
Dan Ferris: For me, it's like mining. That's the thing I'm familiar with. Because it's the exact same dynamic as shipping. He could have used mining and it would have been the same thing. "We've got all this money. We just made a bunch of money and we think we have more prospects that we can build more mines." And they get the thing built in that case, five, ten years later, whatever it is, and the industry is – the prices are in the toilet. And it's the same thing.
But to talk about that in turn – in reference to a technology, I thought, was a little smarter because most people don't think about that way. They just get so optimistic about the forecasts and the new technology and they don't see the tens and tens and hundreds of billions – Goldman Sachs estimates, I think, by 2030 or sometime in the near future, a [trillion dollar] total investment going into AI. It's the same thing. And nobody's really made a dime yet.
Dan Rasmussen: Yeah, and –
Dan Ferris: Just like with the ships and the mines.
Dan Rasmussen: It's like, yeah, those of us who are familiar with these old economy things where there's a return on investment and there's capital spending, the software guys have been out of that game for a while. They've been in the game of, you write a line of code and the marginal cost of selling that code is infinite. And there's no capex because all it is playing software engineers and that's all in the income statement. And so, for years – and in some sense, that's why software is one of the best businesses in the world, if not the best business in the world. It's infinitely scalable. It's zero marginal cost with no capital intensity.
And I think what's sort of fascinating is that all these stocks have gone massively up on the news about AI. But I look at it and say, "Well, AI is a capex game. They've gone from the best business in the world to a highly capital intensive – they're turning knowledge work into a manufacturing problem where you need to have all these GPUs and servers and a data center that's powered by electricity." You've gone from the best business in the world to the worst business in the world and investors have somehow rewarded you for it, that the capital intensity of Meta and Google and Amazon is now double that of the industrial sector in the United States. How crazy is that? Not only this massive increase in capital intensity, but around the competition point, they're all betting on the same thing. They're building the same type of model. They're building the same data centers. They're totally – how can all of them win? That's not the story of the past. The past has been MySpace goes out of business. Yahoo goes out of business. There's one winner in search, one winner in social. And I just – I wonder if we're not making multiple mistakes here with AI.
Dan Ferris: And you'd think at some point, somebody would say that the poster child for this optimism is a semiconductor stock, of all things. Nvidia. It's a semiconductor stock. Has that industry been a little cyclical here and there over the years? I mean, when that industry gets killed, it gets killed. Have you heard of the dot-com bust? The semiconductors were getting crushed before the rest of it. Yeah. Yeah, good analogy.
Corey McLaughlin: Well, and this is where the human nature comes into it too. Nobody wants to be the one to be left behind or perceived as not knowing what they're doing. I guess you heard some of that with Apple during this run the last two years and even they were forced to kind of – it seemed like they were forced to just "Hey, we're going to put AI on our phones now" and then – and here we go. So...
Dan Rasmussen: Yeah. You have this sort of interesting dynamic where the beliefs become correlated when they become – they sort of happen and they become true multiple times. So, if you sort of say, "Hey, my belief system is that international stocks are better than U.S. stocks," for example, and you go out with that in 2018 and U.S. stocks outperform and you go out again in 2019 with your belief system and U.S. stocks outperform… By the end of that you've been totally discredited. Nobody believes that your worldview is the right worldview.
Conversely, if someone said, "You know what? You shouldn't just own U.S. stocks, you shouldn't just own U.S. growth stocks, you should only own the biggest U.S. technology stocks," and that was your belief system, it's been right over and over and over again. And the more that you're right, the more credible you become, and the more people's beliefs move into alignment with yours. And so, the international investor, no one's listening to them by the end of the five years. And at the other hand, everybody's listening to every word that comes out of the guy's mouth who thought that you should put all your money in the five largest growth stocks.
And that is where this sort of recursion of belief starts to happen in markets because the minute everybody starts agreeing, that creates this huge problem. Where people's beliefs are too correlated, it creates exactly the types of cyclical shifts and valuations. And then when the future is surprising, which it inevitably is, the rug just gets ripped out of from – and then all those people who had these shallow belief systems get destroyed. And then some new fad happens. And what we've seen in the U.S. market, again, is this the sort of surpassing amazingness of technology shares for years and years and years. And people have just gotten so pushed into owning that or overweighting that type of stuff, if that's where they thought they were going to get returns. And if the market changes, as it inevitably will, and the cycle turns, gee, that's going to be problematic.
Dan Ferris: And it could very well be turning as we speak. If you had told me when Trump got elected that "OK, now Europe's going to outperform the U.S. starting right now," I would have said, "That doesn't make any sense. He's going to put tariffs up and all this business." But that's exactly what's happened. So, cycles turn at funny times, don't they? Potentially here. I'm not saying it necessarily has, but this feels like that kind of moment, doesn't it? In early 2025, it feels like the market has gone up and up and up. Those biases, that narrative, it's been reinforced again and again and again and again and again. And it's probably time for my – Corey just told me before we got going here that the Mag 7 is kind of officially in a bear market, down 20%. It feels very – like a big moment here, like a big cycle-change moment.
Dan Rasmussen: Yeah, and I think there's also – there's a number of things going on. I think there's been a lot of neglected risk. You look at any of those individual Mag 7 names; they're very high-volatility stocks. They are. If you look at the standard deviation, they're risky stocks. Now, they've only been risky on the upside and so people don't think about it. But gee, these are not like low beta stocks. They're very high beta stocks that just happen to do very well.
On the other hand, if you go to, say, Europe or Japan, you find a lot of stocks, very low-volatility stocks with 5% dividend yield or something. I can show you dozens of those, if not hundreds of them, in international markets. Some international markets are now lower beta and much cheaper than the U.S. market. And so, it's sort of – there's sort of a variety of dynamics that have occurred in this market, one of which is that I think people have looked at cheaper valuations abroad and they've gone there. Another is there's de-risking. People latch on to what they perceive to be safer, which are higher dividend-paying, lower-beta stocks, which happen to be disproportionately these days in international markets.
And another thing that I didn't realize, and I was trying to piece it together, Dan, because I had sort of the same question, Trump's "America First, America First," shouldn't that have favored U.S. equity markets? It certainly did in his first term. Tariffs, shouldn't that favor U.S. equity markets? But I think what it turned out is that there's more foreign capital in the U.S. than there is U.S. capital in foreign markets these days. And so, once you start to erect trade barriers and once you start to create that sort of salience, actually the U.S. capital markets have more to lose than the international capital markets. It's not like U.S. investors are massively overweight in the Nikkei 225. But if you look at the top holdings, for example, in Japanese NISA savings accounts, it's like Palantir and Microsoft. The Japanese guys aren't like "Oh, I'm going to put all my money in wagering that Japan Post is going to have a great month. They want to bet on Palantir just like you do. And so, there's these global capital flows into the U.S. that now seem to be reversing.
And I think the other point is on this meta-analysis thing. The valuation gap between the U.S. and international has reached such crazy levels, the optimism around the U.S. – and if there's just one simple rule, it's when there's too much optimism, you've got to take the other side of the bet.
Dan Ferris: You're also reminding me of another area. I just happened to listen to a presentation by a friend of ours, Rick Rule, and he's talking about how underinvested folks are in gold. And very similar. When you are paying more attention to big-cap mega tech than anything else − when everybody in the world thinks that's the absolute best trade there is, a lot of other stuff gets neglected. And you talk in your book about how to build the account or cyclical portfolio. I think you have a chapter on that, don't you?
Dan Rasmussen: Yeah. And I think gold is so interesting. It's a funny asset class. It's very hard to predict gold. What moves gold? Is it central banks? Is it people loading up on gold at Costco? Is it real interest rates? I don't know. And I've done a lot of research on it. It's really hard to know. But what I do know is that gold has very valuable portfolio characteristics. So, I think every investor needs a low risk asset. You need low risk to balance out your high risk investments. You need diversification. You can't put all of your money in the best-returning things. OK, maybe in your 20s in your retirement account, yes, you can be 100% equities. But everyone else needs some safe assets, some buffer assets.
And I think there are really two. There's Treasurys and there's gold. And I think that gold was, for many years, kind of neglected. People sort of lost interest in gold as a safe-haven asset because Treasurys were doing so well. Interest rates had gone down for 30 years in a row. People had forgotten there could ever be inflation. And I think one of the key things is that when there's inflation, Treasurys go down and gold goes up – or, certainly in dollar basis. And so, you should think of diversifying your safe assets. You shouldn't just own Treasurys. You should own gold as well. But not enough people do.
And so, I think what's happened is that gold had been really under allocated. It's probably still really under allocated. We own in our – in one of our multiasset portfolios, we have 25% of the book in gold. Probably an extreme level. But gold's a very useful tool in portfolio construction. And I think people have neglected it. A lot of people have been focused on crypto, which is not a safe-haven asset. And gold is – gold has stealthily done just remarkably well over the last two years.
Dan Ferris: Stealthily, yeah. It's right there in front of everybody but nobody pays attention to it. And people say – I mentioned our friend Rick Rule, and one of one of people's favorite questions for him, since he's kind of a natural resource guy, is, "When's gold going to move?" And he said, "Well, it's gone up 8% per annum over 25 years." You know what I'm saying? It's done its job. As you as you point out, it's been a great portfolio holding and done its job.
Dan Rasmussen: And there's a wonderful story. There's another paper I really like by Campbell Harvey. And he found that the price in gold that you pay a U.S. Army captain today is the exact same price in gold you paid a Roman centurion. So, gold has preserved its purchasing power over thousands of years. Think about even Treasurys or something. U.S. Treasurys look like bitcoin relative to that in terms of how long they've been around. Gold has been a store of value for so long that I feel like you can know that it's – you can trust that – a thousand years from now, will U.S. Treasurys exist? Who knows? But gold will exist. And it'll probably be roughly as valuable.
Dan Ferris: Yeah, I like Cam Harvey.
Corey McLaughlin: Yes. Yeah, that was great.
Dan Ferris: We've had him on the show. I'm writing that down. I've got to find that paper.
Corey McLaughlin: Yeah, to which I say let people keep forgetting about gold or not paying attention to it.
Dan Ferris: Yes.
Corey McLaughlin: It's great. If you own it, you're happy.
Dan Ferris: Yeah, very happy. Very happy gold owner.
Corey McLaughlin: Yeah.
Dan Ferris: There was another section of the book, and I hope you don't mind. I'm just going to hit on a few ideas of the book because I think it's really great. And I've been reading your stuff, the weekly stuff for a while now too. But there was a great question in there about predicting bubbles and about how you know when we're in a red zone, which – and you mentioned Hyman Minsky too, which – who I think is a really interesting figure when discussing bubbles. Maybe talk about that a little bit. The question stands: Can you predict bubbles?
Dan Rasmussen: Yeah. So, first, I think – one of the ways I looked at this question is I went and read through most of the great investors, or at least the ones I could think of and could find their letters from the '90s on – because I wanted to know – we know, in retrospect, that the '90s were a bubble, but "Did it appear to be a bubble at the time?" was sort of my question. And it looked like almost every single one of my favorite investors knew that we were in a bubble. The only problem is they knew it in '95, '96, and '97. So, by the time the bubble actually burst, they'd been making bubble calls for two, three, even four years, and been wrong. Like "I think it's a bubble." Then the market goes up 50%. "I still think it's a bubble." And the market goes up another 50%. So, they've been so thoroughly discredited in some sense by '99, 2000 when it actually turned. And yet if you looked at their returns through 2001 or 2002, the bubble went up and then it went down so dramatically that they ended up ahead of the market even if in 1999 or 2000 they looked like the world's biggest idiots and the most conservative, boring Pollyannas.
And so, I think that there's huge psychological challenges in a bubble. And the biggest psychological challenge is that the bubble is inflating. And the smarter you are, the earlier you realize it's a bubble, and the longer you have to deal with this cognitive dissonance of watching something you think is overvalued or crazy get even more crazy. And so, I think that we should move back to saying, "Hey, we don't know with precision when a bubble will burst or even if we're in a bubble, but we can assess that there are conditions that make bubbles more likely." And the biggest thing that is a hint of a bubble or increases the probability that a crash is going to come is the easy availability of borrowing and the massive expansion of borrowing.
My favorite metric for looking at credit markets is the high-yield spread. And the longer the high-yield spread is very low, which means that borrowing is freely flowing into corporate America, the higher the risk of a crash. And we've had credit spreads that have been so low, they're below 300 basis points, which is just crazily low, and they've been that way for like a year now, maybe even longer. And what that means is that people have been able to massively lever up. And you don't always know where are the borrowing is happening. I can point to a few places. But that availability of credit is one of the preconditions to a bubble and one of the preconditions to a crash. Because crashes, as Minsky points out, they come at these moments where leverage just gets called and people realize "Oh my gosh, I can never repay this debt; I've borrowed too much" and you have this kind of crisis of beliefs and everything kind of goes out all at once.
Dan Ferris: Credit. Yep. It's always credit, isn't it? The crisis is always about credit, it seems.
Dan Rasmussen: It's always about credit. And it's always – it sort of has this pattern to it where you say, "Oh, why would I hold Treasurys or why would I hold cash? The yields are too low. I want to reach for a little extra yield."
Dan Ferris: Every time.
Dan Rasmussen: And you lend to something. And then, that thing doesn't go bankrupt. And so, you say, "Wow, I earned a little bit more return. And there wasn't any added risk because it didn't go bankrupt. I should lend more." And so, you lend a little bit more. And then now – and then people start to supply you with things to borrow – to lend to − because they see that there's demand.
And I'd say the sort of obvious example in today's market is private credit and private equity, which has just been this massive expansion of low-quality credit, massive expansion of low-quality credit, to the point where private credit dwarfs the high-yield market in terms of size. And all of this borrowing is at pretty high interest rates and it's generally to very small, very levered companies. And I think if there's a place that's the most likely center of problems, it's private equity and private credit, where you've just seen this massive increase in leverage.
And I think there's this dynamic of the wealth effect, which people have written about. And it's a cool idea, which is that if you think of credit as secured equities in front of the credit – and so, on the one hand, if you said, "Hey, I want to lend someone eight times EBITDA of debt" without knowing anything else, you'd say, "Well, that sounds like a lot. That sounds really risky." But then if you said, "Well, a private-equity firm is paying 16 times for the business, so we're only putting 50%, so they'd have to lose all their money for us even to get impaired, and that's a billion dollars of equity in front of our debt," all of a sudden, you say, "Well, those private-equity guys are pretty smart and they're putting in that much equity. I should feel pretty safe with my lending."
And so, what you can see in the U.S. equity market is because valuations have gone up so much, it's creating this wealth effect. And that wealth effect is then allowing for the expansion of credit, especially in the private-equity world. And the challenge is when that reverses, if there's an unwind, gee, it can be painful because it's built on a fantasy, which is these very, very high valuations, which don't necessarily need to persist.
Dan Ferris: Yeah, and it seems like –
Corey McLaughlin: Yeah, I really enjoyed the chapters on private equity in the book. I've been listening to it because – well, it's a little self-serving because to me, the last year or two especially, you're hearing "Private equity, private credit, private equity." You just hear it constantly. It's where everybody wants to be. And to me, I'm like, "OK, well, you can't really tell what's going on, first of all." Or a normal person can't. And so, I mean, to you, if things unwind there, what does that look like? And what are the scenarios you kind of see possibly playing out in private credit if things go south for private equity as well?
Dan Ferris: Yeah, I mean, they're the same thing. Just one is the debt and one's the equity, but it's the same business. And the business is fundamentally taking very small companies, very small private companies, and changing their capital structure to a mix of debt and equity that's funded by pension funds and endowments through these private-equity funds, and that's the business. And these days, there's this whole market where 40% or 50% of the transactions are sponsor-to-sponsor. So, one private-equity firm sells it to another private-equity firm and it just creates this sort of cyclical thing where the more money in the asset class, the higher the valuations and the higher the trailing returns, and so everyone sort of benefits as long as this sort of closed system keeps taking in new money.
And I think the challenge is that, what happens when the money starts drying up? And that's what's been happening. So, we've had the first decline in private-equity assets under management ever. Private equity AUM is down about 2%. And the driver for that is that there haven't been many exits. The hold period on these private-equity deals is getting longer and longer. And when you say, "Well, why aren't there any exits?" the reason is that they paid too much for them and so they can't get a good rate of return if they sell them at current prices, and so they're holding them.
And the same thing is happening with private credit where there's more what's called PIK interest, or [paid-in-kind], where someone says, "Well, instead of paying you interest, I'll just give – I'll just increase the amount of size of the debt that I owe you. I'll just pay it at some point in the future." And so, you're seeing increased hold periods, delays in selling, and you're seeing increased PIK interest. And I just think, well, both of those are really bad signs. And the more that you see – you can extend and pretend, you can hold an asset at the same mark and hope no one notices, but at some point your investors are going to want their money back. And they're going to want cash, not more debt or not an extension fund. They want cash.
And I think that that's the problem that private equity is facing right now. And I'll note that I've been critical of private equity probably since 2018, and the 2018 through 2021 or '22 period was fine. Nothing bad happened. In fact, it was sort of roughly equal to equity returns. And so, you can accuse me of being either early or wrong on private equity, but I look at the data right now and I say, "I think we're here. I think the reckoning is here. And it's just a matter of how painful it gets."
Dan Ferris: Yeah. AUM being down first time sounds like a big hint. It's interesting to me that these private credit and private equity, you don't get – you mentioned that they don't mark – one of the problems, they don't mark the asset down and hope nobody notices. That, to me, Cliff Asness has a point about this that he likes to make. It's like it's – I forget the term he used but it's basically –
Dan Rasmussen: Volatility laundering.
Dan Ferris: Volatility laundering. Thank you. So, you just sit there and you leave the mark and you say, "Well, it's worth a billion dollars. It was worth a billion dollars last year. It's worth a billion dollars this year. Every other similar asset is down 30% in the public markets. But hey, ours is better." Even though it's probably 10 times more levered. That is such a weird state of affairs.
Dan Rasmussen: Interestingly, the private-equity stocks are down massively since Trump's election. So, hey, their funds are marked at one, but the share price of KKR, they're plummeting. And you sort of think about that and what that might mean.
But I think this – one of the real sort of problems with this is that – someone calls it the "phony happiness of private equity." And I think one of the challenges is that understanding risk is really important to making good investment decisions. Yes, OK, we all want to invest in the highest-return thing, but we also need to manage our risk. Risk management matters. You don't just put all of your money in the thing you think has the best return because no one's that perfect and things inevitably blow up. And so, you want to be diversified. You want to manage risk. And one of the challenges of private equity and private credit is because they haven't – the marks don't move. So, corporate private equity has about the same volatility as investment grade bonds if you look at the marks.
And I think the problem is investors' experience of private equity. Private equity doesn't feel particularly risky to them. Why? Because it feels sort of like corporate bonds. It feels less risky than the public-equity market. Public-equity market is down 10%; private equity has been not down at all. And I think that as a result of that, it's enhanced the amount of risk people are willing to take in private equity. They're willing to put larger shares of their money in it and they're willing to allow the underlying managers to put on more debt because it just doesn't occur to them that there could ever be a bad outcome or that it could ever be all that problematic. Nobody's really thinking about that private-equity fund that blew up, whereas they all are aware of some asset class or hedge-fund strategy that blew up.
And I think the fact that they don't think that levered microcaps are risky is a danger sign. It's just a clear correlated belief that's clearly wrong. Levered microcaps are more risky than liquid public markets, period. End of story. And if you are putting 40% of your portfolio in them thinking it's less risky than publics, you're nuts.
Dan Ferris: The definition of nuts for an investor right there. So, what – we know you own some gold in your portfolios. What does the rest of that allocation look like for – I mean, do you have a flagship portfolio or do you just have many different strategies? How do you do things at your shop?
Dan Rasmussen: Yeah, we have a bunch of different strategies. Speaking from real-world experience and being long international, we are big investors in Japan especially and Europe, in small-cap value in both of those regions. We have some strategies that focus on those. Japan's a really cool place to invest. We love investing there. It's very uncorrelated. And a lot of what's going on there is these corporate governance reforms where you're trying to – the Tokyo Stock Exchange is trying to get all Japanese companies to trade at greater than one times book value. And a huge swath – call it over a thousand Japanese companies trade at below one times book. And so, there's all this sort of corporate reform going on. And what you – sort of your first reaction might be, well, if you told a company that's trading at 10 times P/E to trade at 20 times P/E, well, there's not much the company can do. What are they going to do, put out a new IR presentation or something? It's kind of silly.
And so, the first reaction of this price-to-book guidance is "Well, gee, that sounds kind of silly. How are you going to get a company to change their valuation?" But in Japan, it's actually strikingly easy because the median Japanese company has 50% of their market cap in cash and 50% of their market cap in cross-shareholdings in other Japanese companies, which people don't realize. So, you can immediately get to one times book by just selling your cross-shareholdings or using your cash to increase dividends or buy back shares.
And so, you're just seeing, as the companies sort of figure this out and they sort of have this moment of enlightenment where they say, "Oh, this is not a hard problem. It's an easy problem. I just increase dividends and pay the dividends out of my cash pile or out of my public share – cross-shareholdings. I'm going to see stock price appreciation." And we're sort of remarkably in the early innings of that, where Japanese management has – the first phase was saying, "Oh, I'm going to grow my company more and improve return on equity" and sort of these empty promises. And then the next stage was, "I'm going to sell 5% of my cross- shareholdings and that'll satisfy you." And now, sort of the third wave is people saying, "Ah, I'm going to triple dividends. And the way I'm going to do it is through the balance sheet." And that's what's finally working. And so, Japan is a really interesting place to invest because they're such an obvious catalyst and it's so clearly a path to getting to – doubling your money on some of these microcaps that trade at half a book. So, that's a big portion of what we do.
We also do a bunch of high-yield credit. And then we have a multiasset portfolio where we're dynamically optimizing a market-neutral portfolio based on return projection, volatility projection, and correlations and trying to say, "Gee, what's the right portfolio given the current macroeconomic conditions?" And it's in that portfolio where we own a lot of gold at the moment, which is symptomatic of being relatively concerned about the market, at least in the short term.
Dan Ferris: How much of that portfolio is Treasurys?
Dan Rasmussen: Zero.
Dan Ferris: Oh, zero. Twenty-five percent gold, no Treasurys.
Dan Rasmussen: We have no Treasurys right now. Yeah, we own some corporate credit, about 30% in corporate credit, but no Treasurys right now. We were – we've been short Treasurys and then we took that trade off this year, which was good timing to take the trade off because Treasurys have done well this year. But we haven't gotten comfortable being long Treasurys either because there are still some inflationary risks in the economy that people are probably underpricing.
Dan Ferris: I see. And how about – well, there's Treasurys and then there's T-bills. Do you care about –
Dan Rasmussen: Yeah, very limited exposure right now. And then I'd say within our equity book we're short a lot of highly volatile small-cap U.S. growth stocks. And we are long a lot of high dividend-paying international value stocks. And that's been a wonderful trade so far this year. And I think right now we own almost no [Magnificent Seven] exposure, maybe 1% Mag Seven exposure. We're just neutral-to-not-interested in those names at the moment.
Dan Ferris: Right, because the whole world is still pretty interested, even though they're not performing so great. I mean, they didn't do great –
Dan Rasmussen: Yeah, I don't think there are that many people that own more in gold than in the Mag Seven. So, count me amongst –
Dan Ferris: That's right. Exactly. Nobody owns more gold.
Corey McLaughlin: That's why you're doing so well right now. Yeah. Sounds like you just ticked off about four or five things that I think are all working probably as best as you can imagine.
Dan Rasmussen: Yeah, Corey, I'd either say a broken clock is right twice a day, or all the things I've been saying for years and was wrong about last year and the year before, I'm finally right about. So, who knows? You can look at it differently. But hopefully we'll continue to be right because it's been a very good year for us so far.
Dan Ferris: I was – I heard the comment you made earlier about all your favorite smart investors being early to call the bubble and I thought "Well, from now on I'm going to go around saying. 'Dan Rasmussen says I'm really, really smart.'" because I'm wrong on these things again and again and then all of a sudden I'm right and they say "Hey!" We have an annual conference that we do and they say, "Hey, Dan, you were right this year." Literally, that's what they say.
Dan Rasmussen: Well, it's, I think, better to be right in the end. Better to be right now and wrong early. It seems like perhaps that's Trump's approach. Take the bath early and then hope that things rally later on.
Dan Ferris: Right. And it's not like when we're saying we're wrong about calling the bubble – it's not like we abandon – in my case, we don't abandon equities. We don't stop making long recommendations and allocations and things. That's not it. It's just the level of concern, you wind up allocating differently and you underperform the bubble. That's the problem.
Dan Rasmussen: And it's almost inevitable –
Dan Ferris: You underperform the bubble and you erode your credibility.
Dan Rasmussen: Yeah. And it it's so funny because I wrote a lot last year about diversification and the benefits of diversification. And people kept saying "It's deworsification. It's not diversification; it's deworsification. Diversification doesn't work anymore." I got that response so many times. And you're not – you're even like – forget even like making alpha calls or saying "Hey, here's my market view." There's just like "Hey, be sensible. Don't put all your eggs in one basket. Don't anticipate that the thing that's been working best last year is going to be the thing that works this year." The sort of like old wisdom. I'm – I know a lot of older investors who I love talking to who are in their 60s or 70s. And you talk to them and they say, "Well, I've been through this cycle. I've seen that before." Or "This feels a lot like that time when things got overheated. And just stay the course and don't get wrapped up in the fad."
That's sort of like basic old-school logic. You're trying to say, "Hey, gee, maybe you should own some international equities and maybe you should own some gold and maybe you should own – maybe you should have some bonds as well." They don't look all that bad right now. But you couldn't talk anyone out of the S&P 500 at all. It's been just – you're talking to a wall. People only wanted to own the S&P 500 and I think you're seeing people pay the price for that this year. The sort of pain on Twitter or on TV suggests to me people just weren't properly diversified, because properly diversified investors are doing fine this year.
Dan Ferris: Yeah, and that – the dynamic too in the S&P 500, as another previous guest of ours, Mike Green, has been talking about for a few years now is, he contends, made worse even by so-called passive investing, which is not really passive at all. It's just a simplified active algorithm, get a dollar of capital, buy a dollar of equity with no reference to fundamentals whatsoever. It's not just buying the S&P 500. It's the S&P 500 regardless of fundamentals whatsoever.
Dan Rasmussen: Yeah and I think the sort of frightening things about that − I think the first is that when investors go passive. You could have one form of passive where you say, "Hey, I want to own the market portfolio at zero fees." That's sort of like an ideal academic version of passive but that's not what people do. They don't own the market portfolio at zero fees. Rather, they're 80% concentrated in the S&P 500, if not more. Passive is the S&P. And I think that people miss that dynamic. Passive in terms of owning the market portfolio at zero fees, great. Putting all your money in the S&P 500, obviously bad.
And if you had to say why is it bad or what are the signs − if five years from now we're right, if Mike Green is right, the five – what would you say were the signs of it? And I'd say one of the signs that I've written a lot about is: Is there a valuation premium to being included in the S&P absent – controlling for all other factors? So, control for where the company's listed, control for where its revenues are coming, control for its quality, control for its profitability, control for its growth. And the answer is yes. And the premium is massive today. Companies that are traded in the U.S. and included in the S&P 500 trade at a massive valuation premium to equivalent companies that don't have that benefit. So, you go from P&G to Unilever, Exxon to Shell, even very comparable companies, and you just see this huge valuation drop-off, much less if you go to something like small-cap Europe or something where you're looking at paying probably a fifth of the price on a price-to-book basis of what you do in the S&P.
Dan Ferris: Wow. And so, then we're back at the "When does the bubble pop?" discussion. We're back at the "Well, we have the disparity. Unilever's making money. How long until I stop underperforming by owning it?"
Dan Rasmussen: Right. And I think – I mean, so far, this year seems to be – at least so far the turning point seems to be upon us. I mean, I think that the Mag Seven are in a bear market, which is the first time that's been true in a while. And I think there's also just a catalyst for why they've become worse businesses, which there wasn't before. Before, it was hard to argue that Google search was a bad business. You could say how that should be valued but it's clearly a great business. But this AI stuff, I'm not sure. I'm not sure we've seen the business model. It's just distinctly more risky. And yet they're wagering 100%-plus of last year's net income on building out AI data centers. And you're just like "Well, that's an obvious reason. If they're wrong, they're screwed."
Dan Ferris: Yeah. Yep. That's an obvious reason why the expectations baked into these valuations since the last just couple of years here are insane. People are – it's like they're – you know what I think, Dan? It's like they're valuing the 30th year of earnings at a full present $1.
Dan Rasmussen: Yes.
Dan Ferris: It's like it's undiscounted. And then, in the bear market it's just – that year gets lopped off to zero and then lopped off again and lopped off again to bake in all the losses that eventually materialize. And the outright failures like WorldCom and all the other – the failures of the dot-com era. Same thing. Tons of capital.
Dan Rasmussen: Yeah, I think there's a study that I talk about in the book that – it's an old study that I updated that looks at the persistence of growth rates. And one of the striking things is that growth rates don't persist. You take the top 10% of the top quartile of growers and look at how they grow over the next three or five years. And there's no relationship. Zero. It does not predict anything. And I think this is one of the hardest, hardest things conceptually to get your head around, which is that earnings growth is completely unpredictable. Completely unpredictable. And the longer – and then there's another thing, just like with the weather forecasts. Our intuition should be that short-term things are easier to predict than long-term things. If we can't predict tomorrow, we probably can't predict next month, and we certainly can't predict next year or 10 years from now. There's sort of things that we can predict, we tend to be able to predict really well tomorrow and not that well five years from now, like the weather.
And I think where you start to see these crazy valuations and they're based on earnings multiple years into the future. And you're just like "Come on. You can't predict any of this stuff." And you should – think about how often you're surprised. And I think – in the book I quote my friend Woody Brock, who said the phrase "Forecasting mistake doesn't show up in any economics textbook."
But I think people just aren't taking into account how likely forecasting mistakes are and how likely these crazy multiple-year DCF models that are required to justify owning some of these stocks are so likely to be wrong. And you're exactly right. When it starts to be wrong, you lop off your 30 and your DCF. And if that's having a material impact on the stock price, then, gee, you've got a long ways to fall.
Dan Ferris: Yes, that's where you get to down 90% on Tesla or something eventually, something like that, which puts – is on no one's mind. It's on no one's mind. It's insane how things can be. It's just like the Nifty Fifty, or you could say dot com. These are the no-brainer things. It's not like it's the risky stuff. It's not like people are saying, "Well, Tesla's kind of risky, but whatever." No, they're saying these are the no-brainers. The Mag Seven are the no-brainers. Of course they'll continue to grow. They're gushing cash. They're the greatest businesses ever. Low capex, most of them. So, nobody expects them to go south. Nobody expects them to be down 80% or something in a few years. But that happens. And I mean, Cisco still hasn't eclipsed its dot-com era high. It's continued to be a cash-gushing business, just generating tons of cash. It did grow revenue – a lot slower than before the before the peak. But the expectations baked into valuations, you can't – if you don't think that way, you can't convince anyone. You can't talk to them. It's like you said, you can't tell them not to buy the S&P 500. Same thing. We just – we don't get it. Investing is like – it's an unnatural act – isn't it? – done well.
Dan Rasmussen: Well, I think it's because of this meta-analytic thing, which is that you're – Demis Hassabis, who founded DeepMind, says that the same neural mechanisms that underlie our forecasts are also the thing – are the same neural circuits involved in memory. When we make forecasts, we're actually remembering into the future. And that's in some sense the great problem of investing and sort of the simple-minded investor, is just forecasting whatever happened over the last year is going to happen into the future. And then you get one order more sophisticated, the guy who's saying that the last three years are what's going to happen into the future.
And so, you've got huge swaths of investors, that's just the way they invest. They just rush into the thing that's doing the best. And maybe they do it over the last three years and maybe wisdom is doing what's done over the past 10 years. And when all those things align, when you have just total consensus, that's when you have bubbles. And I think in order to invest, you've got to be willing to diversify and take the other end of that trade. And the great investors have been the ones that have said, "Gee, that's just totally wrong; I'm going to go in a totally different direction," and have been right. You can't go in a totally different direction and have been wrong and be a great investor. But the people who have gone in a totally different direction and been right, who have resisted the crowd – this is a story as old – you can go read investment books back in the 1920s. You don't just invest with the crowd and win. Good investing is going against the crowd. It's being meta-analytical. It's disagreeing with consensus. It's rejecting optimism. It's saying "I have a differing viewpoint." And I think what's been sort of fascinating over the past few years and sort of is a symptom of a bubble is that the right answer has been to go along with the crowd. And the more you go along with the crowd, the better you've done. And I think that that creates a lot of risk because beliefs are too correlated.
Dan Ferris: This is a good place for us to address the final question, which is the same for every guest no matter what the topic, even if it's a non-financial topic. But the question is simple. If you could just leave our listeners with a single thought, a single takeaway today, what would you like that to be?
Dan Rasmussen: Yeah, my single takeaway is that investing is not a game of analysis. It's a game of meta-analysis. It's not what you think. It's what you think relative to what everyone else thinks. And so, take that barometer. Instead of saying, "How positive do I feel about this stock or its prospects or this asset class and its prospects" and flip it and say, "How positive does everyone else think about this?" and then look for the places where you're most likely to disagree, and that is that place where the best investments are found.
Dan Ferris: Brilliant. Totally agree. Yes. That's one of the reasons why we wanted to have you back on the show, because I knew you would say a lot of things that just had Corey and I nodding our heads and our listeners too, nodding their heads. So, thanks a lot, Dan. I really – it's – I wish we could talk for another hour. Maybe we'll do that –
Dan Rasmussen: I know. This was so much fun. I'm sorry I have to go to this meeting, but thank you for having me on and let me know when the podcast comes out. I can't wait to share it.
Dan Ferris: We absolutely will. Thanks again for being here.
Well, that was a great talk. I enjoyed talking with Dan. I haven't finished the book yet but I will do so because I've enjoyed reading all the weeklies, and putting it all together in book form and kind of updating it and stating the big ideas, including his idea about meta-analysis, not mere analysis, is a very, very good one. I just – I really enjoy talking with this guy. He's so smart and he speaks well too. Smart and speaks well − it doesn't always necessarily go together. But he's a lot of fun to talk with.
Corey McLaughlin: Yes, I know about that. Yeah, I think. It's – yeah, I feel better just – he's one of the guys that I kind of just feel better after listening to for a while, just about the big ideas of investing and what works over the long run. And I think the lessons that he has in this book, The Humble Investor – that says a lot, the title. He's not over – he's kind of taking advantage of people who are overconfident and even, don't know what they don't know, is a lot of the lessons in it. I'm listening to it, too, which – and I was pleased to see that one of the things he centered on about risks today was the private-equity, private-credit market, which no doubt there's good investments there. I'm not saying that, but just to be aware of the popularity, and what you can learn about history, to not repeat similar mistakes from other fads and whatnot. There's a lot to be said for that. So, and it's a great book.
Dan Ferris: Yeah. And to apply the meta-analysis question that he told us, it's sort of like, where are investors not at all humble? Where are they way overconfident? And then, what's the humble asset? What's the place where nobody's confident? It's really – it's a smart exercise. It really is. If people had done it in 1999/2000, they'd have bought gold and they'd have done great, for just one example.
Corey McLaughlin: Yeah. No, I have gold in my portfolio and it's almost near new all-time highs and – basically there – and nobody, still nobody's talking about it. Or by nobody, I mean nobody in the mainstream is really talking about it.
Dan Ferris: That's right.
Corey McLaughlin: So, yeah, I mean, that's fine. That's fine with me. The other half of this, obviously, it's easy to say now when these big stocks are down and everything, but the other part of it is the way up, and having the – you're going to feel pain along the way if you're leaving some gains on the table. But again, during times like these, that's OK. It's OK.
Dan Ferris: It is. Nobody – Warren Buffett used to say "You can't kiss all the girls." You can't have everything. And you can't be a perfect investor. You can't make perfect entries and exits. That realization too requires a little humility. Or a lot.
Corey McLaughlin: For sure.
Dan Ferris: Yeah. All right. Well, that was a wonderful conversation. I enjoyed it immensely. I know you did too. That's another interview and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we really, truly did. We do provide a transcript for every episode. Just go to www.investorhour.com, click on the episode you want, scroll all the way down, click on the word "transcript" and enjoy. If you liked this episode and know anybody else who might like it, tell them to check it out on their podcast app or at investorhour.com, please. And also do me a favor, subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts. And while you're there, help us grow with a rate and a review. Follow us on Facebook and Instagram; our handle is @InvestorHour. On Twitter, our handle is @Investor_Hour. Have a guest you want us to interview? Drop us a note at feedback@investorhour.com or call our listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my co-host, Corey McLaughlin, until next week, I'm Dan Ferris. Thanks for listening.
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