Quantitative Investing, Inflation and the Macroeconomy

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>> Jon Hartley: My name is John Hartley, I'm chair of the Economic Club of Miami. We got started just over a year ago, and I know a number of you have been to our events so far.

We just had an event last month with Ken Griffin and Mayor Francis Suarez, which was a very popular and well attended event. I'm the chair of the Economic Club of Miami, and as that would suggest, we are a membership organization. Those of you who are not members here, we highly encourage you to come to our website, economicclubmiami.org.

And to check out some of our programming and what's involved with completing a membership application and saying that to us. Without any further ado, I have the pleasure today, the very special pleasure of introducing in interviewing Rob Arnott. Rob is the founder and chairman of the board of research affiliates NASA management firm.

Research affiliates develops investment strategies for other firms like the famous research affiliate fundamental indices that are value tilted indices. And research affiliates oversees 166 billion in asset under management using their strategies and their indices, which other asset managers manage to. In addition, Rob has also served as a visiting professor of finance at the UCLA Anderson School of Management.

He's also on the editorial board of several finance journals, including the journal portfolio management. He's also served on the product advisory boards of the Chicago Mercantile Exchange, the Chicago Board options Exchange, and to say the least, Rob is one of the most prominent quantitative investors in the world.

And I say this having worked in quantitative asset management for quite some time. Thank you so much Rob, for joining us.

>> Rob Arnott: Thank you.

>> Jon Hartley: All right, so I think we'll just dive into it here. So let's get into inflation here. What has the Fed been missing here?

What a policy been makers been missing? How do you think inflation came about?

>> Rob Arnott: Well, inflation is just a matter of supply and demand. If the supply of goods and services is constricted and demand for goods and services is elevated, you're gonna get inflation, it's really that simple.

And during the pandemic of course, we had lockdowns. Many people continue to work from home. Many of those who work from home continue to pretend to work from home, meaning supply of goods and services is diminished. Supply chain disruptions are widespread. No real light at the end of the tunnel for that.

And in addition to all of that, money's been helicoptered into people's bank accounts, creating a step up in demand, and we're at full employment. So stimulus checks really shouldn't be needed. But anytime you have aggressively stimulative fiscal and monetary policy and exogenous shocks that reduce supply, you're going to have inflation.

I was shocked when Jerome Powell coined the expression transitory inflation back, I believe it was April of 2021. Inflation was already 4%, and half of that inflation had happened in just 3 months, so that it was 4% over a year, 8 annualized over 3 months, and he says transitory.

I wondered what he'd been smoking. In November, he decided to retire the term transitory, although they still talk about it as if it's transitory. And at that point it was already 6%. So one of the things I found just fascinating was in December of 2021, with inflation already above 6%.

The Fed dot plot, which shows what Fed governors believe the Fed funds rate should be at year end of the next year, end of the next year, and as a permanent equilibrium. The forecast then was that Fed governors thought that inflation, that Fed funds rate should be 0.8%, that was last December.

They were saying 0.8% for this year end, and inflation was already over 6%-

>> Jon Hartley: 7% at that point.

>> Rob Arnott: Was already over 6, it might have been 7 by then. It's astounding how far behind the curve they are. And I'm fascinated at the obsession with listening to their forecasts for the macro economy or for inflation, when their track record is unbelievably bad.

 

>> Jon Hartley: Yeah, I mean, it's fascinating just how quickly the Fed is pivoted just beginning somewhat later this year in around March, when they started tightening, and they've tightened very, very quickly. So it seems like a very about face from the Fed of 2021 that was very resistant to start increasing rates amidst what seemingly became entrenched inflation after October.

When became more than just a story about used car prices going up, but really also about housing, which is 30 or 40% or so of the CPI basket. I'm curious, pivoting this a little bit to forecasting and capital markets, how do you think sustained inflation in this 5 to 10% range over the next 2, 3 years?

How does that, in your mind, affect the economy and capital markets?

>> Rob Arnott: Let me break that into two questions. 5 to 10% over the next several years is inflation that's not transitory. We did a study, we published it about a month ago, in which we took the 14 OECD countries that have been developed economies for the last 50 years.

I mean, there's a lot of newcomers, leave those out, they're not our peer group. Focus on the ones that have been developed economies going back to 1970. And we then ask the question, how transitory is inflation? What we found was that if you get 4% inflation, half the time it's transitory, which by our definition means it goes below 2% within 2 years.

Half the time it's not. So basically, when you get an exogenous shock that creates a small burst of inflation, then as soon as the shock passes, so does the inflation, which is great. When it goes above 6%, you start to have more daunting odds. Only about 30% of the time, is inflation transitory above 6%.

Only about 15% of the time above 8%, less than 10% above 10 or higher. And this is based on surprisingly large numbers of cases, cuz we're looking at 14 economies spanning 60 years. And what we find is that there have been 28 times that one of these economies has seen inflation above 8%.

Now 8 of those 28 are underway right now, so we don't know how they're gonna play out. The other 20, only 2 came back down in reasonably short order. 18 lingered for anywhere from 2.5 to 26.5 years, median of 13 years. So this is not to say we're forecasting a long bout of inflation.

What it is to say is anyone who uses transitory return to normal within 2 years, as their central expectation is being very naive. That is well within the realm of possibility, that's the optimal best quintile. The worst quintile is 10 years and beyond. Back to the second part of the question.

What does this mean for investments? Right now, breakeven inflation, which is the difference between the tips yield and the treasury bond yield, stands at 2.3% for 10 years. What that means is that if inflation is less than 2.3%, you're better off holding treasuries. If it's more than 2.3%, you're better off holding tips.

So one immediate takeaway that's very simple is do you really believe it's gonna be 2.3% from now for the next 10 years, or do you believe it'll go 7, 6, 5, 4, 3? Our forecast is 4% inflation for the decade, 5% inflation for 5 years. And if you get 4%, then tips will produce 1.7% more return per annum, working out to 17% more wealth after 10 years than if you used treasury bonds.

That, to me, is a slam dunk. That's a simple strategic bet that, for the patient investors should work out beautifully.

>> Jon Hartley: Wow, so in your mind, likely entrenched inflation or good potential for entrenched inflation averaging about 4% over the next 10 years. I'm curious, sort of pivoting to investing specifically here, what asset classes do you think investors should consider to help them amidst this sort of potentially sustained period of inflation in the coming years?

I know some people talk about I bonds, there's sort of a 10,000 limit per person on that, so you can't really scale that up. But things like tips or treasury inflation protected securities, real estate, short-term interest rates, what asset classes do you think should be part of an investor's portfolio in this new era of inflation?

 

>> Rob Arnott: Well, I've been called a perma bear for the simple reason that I don't things that are fully priced or expensive. I like holding things that are cheap. And that created some difficulty in the late 2010s because value was having its worst drawdown ever. But viewed within equities, the spread between growth and value is still the largest quintile of spread ever.

It's no longer the largest percentile, as it was in the summer of 2020, but the largest quintile. That's pretty good. So for starters, if you're gonna hold stocks, hold value stocks. If you're going to hold stocks, don't be focused on US trading at Shiller PE ratio price relative to 10 year smooth earnings of 30 times.

 

>> Jon Hartley: That's a CAPE ratio?

>> Rob Arnott: That's the CAPE ratio. Where was it at the peak in 2007 and 8? It was 28 times. So it took a 6 year bull market to get to 28 times back in the mid 2000s, and it's taken a bear market to get it down to 30 now.

Now, what about Europe? Europe's at 14 times, AIFA is at 15 times, emerging markets are at 14 times, they're half off. Are their prospects for growth worse than the US? Of course they are, prices are set based on narratives, and those narratives have the wonderful advantage of usually being true.

They also have the daunting disadvantage of being utterly useless because they're already reflected in share prices. So you want to figure out where the narrative may be exaggerated or may have room to change. The 2.3 breakeven inflation rate is beautiful example. The notion that, AIFA and emerging markets deserve to be half off relative to the US is one where there's ample room for change.

Emerging markets local currency debt currently yields more than us junk bonds, and the default rate historically is much, much lower. So there are pockets of opportunity out there, and the backdrop on all of this is the inflation surge. Inflation is wonderful for value. If you go back historically and look at decades over the last 100 years, anytime you had inflation above 4% for a decade, value beat growth by 6 to 10 percentage points per annum during those decades.

Why should that be? Very, very simple, firstly, high inflation usually means a higher discount rate. Higher discount rate hurts growth relative to value because most of the value in owning a growth stock is the distant future, and that distant future becomes less valuable with a high discount rate.

Secondly, there is absolutely no such thing as high but stable inflation, it doesn't exist. Which means that if you have elevated and turbulent inflation, you have elevated economic uncertainty. Isn't it nice, if you're in a period of elevated uncertainty, to have a low P E ratio, low price to sales ratio, and so forth?

So a foundation of underlying fundamentals that can sustain the value of the assets. So this is an opportunity rich environment, it's just not the opportunities people are mostly looking at.

>> Jon Hartley: That's good to know, so value stocks, so high book to value type, Warren Buffett type investing works well, historically has worked well, in these sorts of inflationary environments.

It's very helpful and good to know. So I guess jumping a little bit deeper into macroeconomics and microeconomic narratives, which you're alluding to. I'm curious, how should investors think about things like rising deficits, national debt, aging demographics in this sort of post-COVID world? This has become seemingly a very important issues when thinking about whether it's inflation or thinking about capital market returns in general.

How do you think these issues are gonna weigh on both figures like GDP as well as long term real returns?

>> Rob Arnott: I wrote a paper in 2009 called the 3D hurricane, the interconnected influence of deficits, debt and demographics. And the point of the paper wasn't that any of these play out fast, but that they represent a strong current going through the macroeconomy.

If you're wanting to swim across the Mississippi river, it's useful to know which direction the water is flowing in order to not wind up too many miles downstream. The same applies for things like deficit spending. John Maldon likes to say there's a bang moment when things go along just fine and then bang, you suddenly realize your wile coyote running off of a cliff.

And that kind of situation happens again, and again in macroeconomy. Deficits, of course, create debt and the debt burden of the US. Interesting, if you think of the country as an individual family is 100,000 and if they have debt of 500,000, they're probably in trouble. The income that the federal government has to work with is just under 20% of GDP.

The debt is ballpark of 120, 130% of GDP, depending how you measure it. That's like the family with 100,000 income having 600,000 debt. But there's hidden debt, there's off balance sheet spending and off balance sheet debt. There's unacknowledged debt, the unfunded portion of Social Security and Medicare and Medicaid are enormous, they dwarfed and the national debt.

Include those and you're looking at hidden government debt that takes you to 80% of GDP as the income for the government to service those obligations. All right, well, that's more akin to having $6 million of debt on $100,000 of income. What can't happen won't happen, and so I don't worry about this.

There will be a reset, and the reset can take any of a number of forms. Default is theoretically possible. But why default when you can do the back door default of reducing the real value of the debt? Inflation, demographics then enters into the picture as a very slow moving macroeconomy and for the future.

Because 30 years an extraordinarily large roster of mature adults, the baby boom generation, at a stage in life when they are valuation indifferent buyers of financial assets. What do I mean by that? Those who think ahead and are worried about their future golden years are likely to be saying I need to set aside money.

And setting aside money means you've got to put it into capital markets. And putting it into capital markets, you're not gonna ask the question, is this too expensive or is this too cheap? Except perhaps on a tactical basis, you're going to set money aside. And this creates a dynamic that permits

>> Rob Arnott: Inflation.

Roll the clock forward 20 years, even 10 years, and you're looking at an environment where you have an enormous roster, the largest ever evaluation in different sellers. If you have assets aside and you want to convert those assets into goods and services during retirement, you're going to sell.

And you won't be somebody who can choose whether to sell based on whether it's expensive or not. The result is valuation, indifferent sellers, rates go up, markets come down. And so I think we will have those headwinds over the coming 10 to 20 years. For people, that 3D hurricane is only a serious issue into a mindset.

Today's economy is what things are gonna look like for the next 20 years. For those with a more flexible mindset, all you have to do is boost your savings 10, 20% per year. Extend your expected work span by 2 or 3 years, and reduce your expected expenditures in retirement by 10 or 20%.

And if you make that mental transition saying I'm gonna work a little longer, I'm gonna save a little more, and I'll spend a little less in retirement, it all of a sudden becomes very manageable. Most people won't do that. And the economics profession in our policy elite are complicit in encouraging them not to think about those things.

 

>> Jon Hartley: Fantastic, I love that 3D hurricane deficits nest and aging demographics. I feel like we're very much in the eye of that hurricane. Or maybe the eye, I guess, is more peaceful, but I guess it's the edges that are the miller. We know a lot about hurricanes in Miami, and you wrote this paper before you moved to Miami or?

 

>> Rob Arnott: I did, I moved to Miami in 2018 when federal tax law made state income tax no longer deductible, so that my state tax burden went from 7% to 14%.

>> Jon Hartley: Well, fantastic, not only are you predicting capital market returns, but you're also predicting your own future location as well, it's fantastic.

I wanna get more, a little bit into the stock markets, specifically here. I know that you've had some pretty famous disagreements with clip as Ness about AQR on the topic of market timing. And I think he's sort of the opinion that you can't really time the market well and I think your opinion is somewhat different from that.

I'm curious, how should investors set their expectations for the future, given where we're at now? Are there any sort of compelling bargains today for a long term patient investor? The S&P 500 is down 15% year to date. We've been sort of in this range this year to date range of anywhere between 25%, 15% for a while.

And I think there's some people out there that say now's a great time to get in if you have dry powder on the side or. Maybe even if you're fully invested, to lever up a little bit and take a position that has an equity market beta greater than one.

I'm curious, what do you think about this kind of reasoning around market timing? Do you think now is a good time to lever up a little bit and get some more equity exposure to harness that long run risk premium?

>> Rob Arnott: First, just a quick observation on the controversies with Cliff.

He and I agree on about 90% of everything, and I think what's going on is he gets annoyed that we agree on so much that what we disagree on suddenly matters more to him than it ought to. It is what it is, the paper that got him really angry was a paper in 2016 called How Can Smart Beta Go Horribly Wrong?

Fundamental index, which we invented back in 2004, was actually the original inspiration for the label smart beta, which was coined by Towers Watson back in 2007.

>> Jon Hartley: These are the research affiliates fundamental indices, which, if you own an equity fund at Pimco or several other asset managers, you're actually invested in exactly what Rob is telling you to be invested.

 

>> Rob Arnott: That's most of our 100 plus billion. And the performance since 2016 for multifactor was terrible. For fundamental index was terrible unless you correctly used a benchmark of value indexes relative to value indexes, we did really, really well. But the essence of the paper was really simple. If you have a stock and its price has soared and its underlying fundamentals haven't, so its valuation multiples have soared, its past return will be brilliant.

And if there's any mean reversion, its future return is going to disappoint. We said the same dynamic holds true for strategies and factors. The value factor, the spread in valuation between growth and value widens and contracts. And when it widens, you have rising relative valuation of growth, and you have a lousy performance for the value factor.

But it's a revaluation alpha. It's from the valuation tumbling, not from the underlying fundamentals softening. And what we observed was, that every single factor and every single strategy out there goes through these cycles. People are drawn into strategies when they've performed well, without doing the added homework of asking.

Did it perform well because it got more expensive or because it has structural benefits embedded in it? And 2016, most factors were expensive. Value was the one, outlier and in 2016, sure enough, value did well. Low volume momentum, quality did badly. And so the point of the paper was, when factor or strategy valuations are abnormally high, you might want to go easy on using them.

I would agree with Cliff that you don't wanna make heroic, huge bets on factors and strategies. You want broad diversification, but just at the margin. If one factor is dirt cheap and the others are expensive, you want a tilt. I'm working on a paper called That Was Then This Is Now, which points out that the situation's changed.

Most factors are trading cheap now, most factors are trading abnormally cheap now. So the fact that multifactor had a dismal 5 years is part of the reason that they're trading cheap now. And so while money was pouring into factor and multifactor and smart beta strategies in 2016, at a time when the valuations for most of these factors was high.

That's just common sense. That, excuse me, that's just human nature. That people will pile into what's given them great joy and profit without necessarily thinking about did that profit come because of a structural advantage of the strategy? Or because it just got more expensive? Today we're in the opposite situation today, money's pouring out of smart beta, out of multifactor, and they're poised to perform beautifully the next 5 years.

 

>> Jon Hartley: Fantastic, so factors are cheap?

>> Rob Arnott: I think is great, value investing, I think is great. Diversification outside the US, I think is great. Particular pockets of opportunity would be emerging markets, value developed ex US value. If you got own US stocks, make sure it's with a value tilt.

And in bonds, yields are still inadequate most of the world, except the emerging markets, where local currency debt is yielding more than US junk bonds. And those currencies are now cheap because the dollar has been so remarkably strong.

>> Jon Hartley: Fantastic, so it'd be a good time to get in the market if you're not already in it and tilting toward these sorts of factors, I think that's a great, very compelling thesis to me.

And perhaps the bottom isn't already. So you may want to act soon if you're totally cash still.

>> Rob Arnott: Well, I like to buy at a period of peak fear, I think in Europe we may be there. You have people terrified that good German citizens will freeze to death this winter because of the difficulties getting oil and natural gas at a time of great need.

There's a worry of the European economies cratering because the industries also need energy to function. Usually, when you have elevated fear, the subsequent reality validates that fear, but isn't as bad as the fear would have suggested. And so if it's not as bad, the narrative shifts and things are pretty bad, but not as bad as I feared, which means that the markets will rise handily.

So I think the US probably will have another leg down. This doesn't feel like peak fear, it doesn't feel like we have had a capitulation. Non US stocks, if US stocks go another leg down, non US will test their lows. But if I'm wrong about the US having another leg down, you wanna be risk on in the markets that are cheap.

And so averaging in now makes sense. Keeping some dry powder now makes sense. I'm often asked if you think there's another leg down, should I be getting out? My response is, you should have been getting out a year ago. The market was a lot higher then. Now you should be thinking about entry points.

 

>> Jon Hartley: Fantastic, I know just yesterday the EU announced this new price cap on energy prices. Very, very interesting to see, it's very much-

>> Rob Arnott: How enforceable will that be?

>> Jon Hartley: Yeah, exactly.

>> Jon Hartley: It's amazing, just this perfect storm of a war in Ukraine at the same time as this biggest inflationary burst since the 1980s.

The timing is-

>> Rob Arnott: Latest NATO estimates are that Putin's killed 100,000 of his own citizens already by sending them to be cannon fodder.

>> Jon Hartley: So tragic, my thoughts and prayers are with everyone in Ukraine and affected by this conflict. I just wanna get into shift here to tech, cuz I know when we talk about value, I feel we're implicitly talking about growth.

And usually, when we're talking about growth, we're usually talking about tech, these days.

>> Rob Arnott: These days.

>> Jon Hartley: These days or at least the past decade. And so I wanna talk just a little bit about Bubbles. And so what's been happening to tech scene? There's been a lot of announcement about tech layoffs recently, something really, really we haven't seen in over 20 years.

It seems like we're almost potentially at the end of this second TechBubble, the last being ending in the early 2000s. We've had these acronyms over the past decade that I feel like have really emerged. FAANGs, Facebook, Amazon, Netflix, Google. I'm curious, given that some of these companies now, Facebook, Netflix, have seen 70% more sell-offs in their stocks, how can one identify Bubbles or maybe anti-bubbles in real-time?

Is that a possible thing? There's a huge debate, folks like Robert Shiller have a very certain view on one side, and I know efficient market folks like Eugene Fama have a very different view on the other side. I'm curious, what your thoughts are on the sort of behavioral economics and behavioral finance question of being able to identify bubbles.

 

>> Rob Arnott: Yeah, people bandy around the term Bubble very liberally, usually without defining their terms and usually in retrospect. TechBubble.com bubble 2000, FAANG Bubble. I'm starting to hear people say FAANG Bubble. In 2018 we thought, wouldn't it be nice if there's a workable definition for the term Bubble that can be used in real-time?

We came up with one that I think makes good sense, and that is, if you're using a standard valuation tool like discounted cash flow, you have to make implausible assumptions for the future growth in order to justify today's price. And as a quality check on that part of the definition, the marginal buyer doesn't care about valuation models at all.

And if you use that definition, then for quite some time, FAANG stocks have been Bubble stocks. I was debating Cathie Woods a year and a quarter ago at Big Morningstar Conference. And at one point I briefly described that definition and I said so, given your fondness for Tesla, what justifies a $3,000 target price in terms of actual future growth?

And she said it's gonna grow 89% a year the next 5 years, and then it'll be priced pari-passu with today's FAANGs stocks. And I had been asked to play nice.

>> Rob Arnott: So I bit my tongue, what I wanted to say is 89% growth for 5 years is 25 fold growth.

So you're saying, Tesla will be 25 times as large in 5 years? Amazon over the last 10 years has grown 25 fold. You're saying it'll have, excuse me, yeah, has grown 12 fold. So you're saying that Tesla will have twice as much growth in half as many years as Amazon?

I bit my tongue and I said, well, that just sounds pretty impossible. Anything's possible, but that sounds impossible, and let it go at that. But using that definition, there's plenty of Bubble stocks out there even now. So I view this as a deflating Bubble, much like the 2000 to 2003 unwind of the TechBubble.

 

>> Jon Hartley: Well, I mean, I've watched some of that interview with Cathie Wood from over a year ago. I feel very prescient, and I mean, it's fascinating just to see this tech collapse. And it feels very much like the end of a Bubble too, seeing all these issues around fraud and FTX.

I don't think it's quite a coincidence that perhaps the Enron scandal of the early 2000s sort of coincided with the end of the last TechBubble. And the fact that we see these both frothiness and sort of arguably fraudulent things going on at the same time, and crypto controversies, and things of that nature.

It's interesting that the timing of these things seem to occur together and that's not in a way that's coincidental. Maybe mania sort of comes and drives in a sense. We talked a little bit about growth in tech stocks. Let's get back to the value side of things here.

The idea that investors should invest like Warren Buffett, finding good deals like stocks that are high book-to-market values, what gives you confidence in the long-term prospects of value investing. Value investing has had a really difficult past 15 years or so that I think has been humbling for a lot of value managers and a lot of quants that are big into value investing.

What's the thinking and the evidence behind your outlook? I think you're very bullish on value. And how have I know you spoke a little bit before about how value stocks have have fared fairly well in inflationary times, but say maybe we are end up able to get out of inflation over the next few years or so and the Fed is effective in achieving that goal.

I'm curious, what's driving your thesis behind value investing being a big winner in the coming years?

>> Rob Arnott: Well, firstly, value has two main sources of alpha long-term. One is what Fama and French call migration growth stocks, high valuation multiple companies. One or another of them falls out of favor, drops off the list and is replaced with a new high flyer.

So that means something with a more moderate valuation multiple is replaced with a higher valuation model multiple company. Which means that with every rebalancing, there's less and less earnings, dividends, sales for every hundred dollars you invest. The value side has the other opposite happen. Stocks percolate up out of value, come back into favor and are replaced with new, unloved, deep-value names.

So you get this constant rebalancing out of companies that are no longer cheap into companies that are deeply cheap. And in so doing, you get more earnings, dividends and book value for every hundred dollars you invest with every rebalance. Now this Matters because growth stocks do grow faster than value stocks.

That difference historically has been about 12 to 13% per annum, pretty big. The migration effect has been about 18% per annum, enough to swamp that with room to spare. In addition to that, you have a yield difference. And so yield is an important part of returns for value stocks.

And that yield kicker is real. So the advantages of value are structural and powerful. The disadvantage is that there's a cycle, it falls out of favor. We wrote a paper, reports of value's death may be greatly exaggerated, which came out at the beginning of 2021. And that paper won Graham and Dodd recognition as one of the two best papers of the year.

So I was really pleased with that.

>> Jon Hartley: It's one of the biggest finance practitioner journal awards out there.

>> Rob Arnott: Yeah, Graham.

>> Jon Hartley: Named after two founders of value investing for the big Warren Buffett aficionados here.

>> Rob Arnott: Yeah.

>> Jon Hartley: It's actually Ben Graham was Warren Buffett's sort of professor at Columbia, grandfather value investing.

 

>> Rob Arnott: Right, so in any event, in that paper, we made two points, one minor, one major. The minor one, although it's not all that minor, is that book value is an antiquated measure of a company's assets. If I spend $1,000 on a desk, the book value of my company goes up 1,000.

If I spend 1 million on R&D, it doesn't. And I wouldn't spend 1 million on R&D if I didn't think I was gonna get it back in reasonably short order over, let's say, a 5 year span or something like that. So it turns out that if you use price to book value, if you just add in R&D to the book value and then amortize it out over 10 years, you have about twice as much efficacy as conventional price to book.

So that was an interesting finding. The more important one was that, value becomes cheap or expensive over time. And when it's expensive, it often doesn't perform very well. People are paying as much for value as they ought to, and they're not pricing growth stocks at frothy extremes. Then you get to a point where values dirt cheap.

Summer of 2020, the spread between growth and value was 13 to one on a price to book value basis. Peak of the TechBubble, it was 10 to 1, The norm is 5 to 1. So we were saying, we've just seen the most extreme relative valuation for value ever.

How much of it was because the value companies were doing badly? None, that wasn't a contributing factor at all. The value companies were doing as well relative to growth as they historically normally have, they were just out of favor. People thought the narrative again that the COVID lockdowns would lead to rolling bankruptcies across the macro-economy, and those of course would be the value stocks.

So a lot of these companies wouldn't exist. Well, trillions of stimulus made sure that didn't happen. Bankruptcies in 2020 were only modestly above 2019, shockingly little change. And as people began to realize that the value cycle turned, people stopped pricing value stocks as an option on their future survival and started pricing them as going concerns.

That's all it took to have that first massive leg up. So I'm a believer in value structurally because of the migration effect and the yield difference. I'm a believer in value when value is cheap, which it was extremely cheap summer of 2020. Here's a fun factoid, Russell value underperformed Russell growth by 4,000 basis points in the first 8 months of this decade.

It's now within 2% per annum of being in the black decade to date. To recover a 4,000 basis point drop, you got to outperform by 6,700 basis points, we're almost there. And the Fama French value factor is already in the black decade to date, and fundamental index is already ahead of the cap weighted markets decade to date.

So when things change, they can change very fast. I'm often asked, did I miss my opportunity? Is it too late? My answer is for now, no, it's not too late because the gap between growth and value, while it's come in considerably, is still in the cheapest quintile ever.

And there's still 4,000 basis points needed for value to recover relative to growth in order to just get back to historic norms, 4,000 basis points is worth making the trade.

>> Jon Hartley: Well, I know that despite this not so great period for value and starting maybe from around the time the global financial crisis to just 2021.

I know this year, especially early in the year, was just a huge rebound for value and I think that may bode particularly well in an inflationary environment for the reasons you've outlined. It's very interesting to hear your thesis and thinking behind why value investing is great prospects in the long run.

I wanna pivot next a little bit more toward your business and kind of what makes research affiliates different from even other quantitative investment managers, and that you're all about indexing and creating thoughtful indices. And what I think is so interesting is we've seen this massive shift over the past really 40, 50 years in investment management away from active management toward passive management.

And we have things like index funds and ETF's. Now what I think is so interesting about your business is that, you have a slightly different take on the pure market cap weights of, say, the blackrocks and vanguards out there that are just weighing every stock by their market capitalization weight.

And you're using things like value weights and accounting and book value type weights. And I think that's a very different way to try and capture value than, say, traditional hedge fund equity long short stock pickers who are picking value names that they, it's very different. And also just from a format perspective, you're able to offer your investment products through things like ETF's and index funds.

I'm curious, what do you think is right about index investing in general, investing through ETF's rather than sort of do it at home yourself, finding value names in the newspaper and so forth, or doing your own homework? And what do you think are some of the also underappreciated travails that indexers may face?

What ideas going forward might improve index fund management going forward?

>> Rob Arnott: Absolutely, well firstly, two answers to your question, each of which deserves some discussion. One is RAFI versus cap-weight, and the other is can you do cap-weight better? Let's take the first one first.

>> Jon Hartley: And RAFI is Research Affiliates Fundamental Indexing.

 

>> Rob Arnott: Correct, fundamental index basically means you look at each company and you ask, what are its sales as a percentage of all publicly traded companies? What are its profits as a percentage of all publicly traded companies? What are its dividends plus buybacks as a percentage of all publicly traded companies?

What's its book value plus intangibles R&D as a percentage of all publicly traded businesses. So ExxonMobil might be 2% of all sales and 2.5% of all profits and 2% of all book value and one and a half percent of all dividends plus buybacks. You can argue endlessly about whether it's 1.52 or 2.5% of the economy, or you could just take an average of those.

And if you take an average of those, you get accrued approximate measure of the footprint the company has in the macroeconomy our footprint on the beach has multiple measures, length, width, depth of the footprint. Same thing can be said about companies in the macro economy.

>> Jon Hartley: 3D footprint, like the 3D hurricane.

 

>> Rob Arnott: Yes, yes, except this is 4D because we're using 4 measure.

>> Rob Arnott: Anyway, if you weight companies by their fundamental footprint, a growth stock will be reweighted down to to its economic footprint, a value company will be reweighted up to its economic footprint. And the market loves the growth stocks, pays a premium, hates the value stocks, prices them at a discount.

The market is shockingly prescient in determining which companies deserve a premium multiple and which don't. There's a 50% correlation between the premium paid for a stock and its subsequent future growth. That's cool, except the market overpays for these and underpays for these. So there's a minus 50% correlation between the premium that's paid and the subsequent IRR of the stock.

So the market does a good job of picking the companies and a lousy job of picking the same stocks. The implication of that is the value tilt of fundamental index is structural and large. The average value tilt is very similar to that of the value indexes. It differs from the value indexes because it includes the growth stocks, it includes the value stocks and the deep value it overweights a lot and the extreme growth it underweights a lot.

It also contra-trades against the markets constantly changing opinion. So as the market is changing its mind on what a company is worth you're gonna concentrate against those largest moves unless they're ratified by changes in the underlying fundamentals. Now what this means is that you have a rebalancing alpha, a value tilt alpha, and an index.

An index that studiously mirrors the look and composition of the macroeconomy, much like cap-weighting mirrors the look and composition of the stock market itself, because it is cap-weighted. So when we first thought of this idea in 2003 and back tested it, we first did it with book value and with sales, both of which more or less can't go negative.

And by using those measures, we found that over the prior 30 years, choosing the companies by fundamental size of the business and weighting them by fundamental size of the business would give you, historically, a 2.5% alpha per annum. 1% of that came from the value tilt, one and a half from the rebalancing alpha.

 

>> Jon Hartley: 2.5, that's a lot.

>> Rob Arnott: Yeah, now, since we went live, values underperformed, but we've continued to beat the value indexes by about 1.5% a year, 2 in the more volatile markets, like emerging markets and small companies. And that's been persistent, 7 out of 10 years, we win.

8 out of every 10, 3 year spans, we win, 95% of all 5-year spans we win, relative to the value indexes. So it's a powerful concept. But I like to think of it as indexing to mirror the look and composition of the economy. So you have an economy weighted index, and you have a market weighted index.

Both represent perfectly reasonable core holdings. Now that brings us to the second issue, can cap-weighting be smarter? Cap-weighting has two Achilles heels, one, which RAFI addresses. Cap-weighting guarantees that any stock that's above its future fair value, is weighted too heavily, the majority of your holdings will be in overvalued companies, minority will be in undervalued companies.

RAFI fixes that not by knowing what the fair value is, but by randomizing the errors. A stock that's big in RAFI could be over or underpriced. The errors cancel, instead of being systematically overweight, the overvalued and underweight the undervalued. The second Achilles heel of cap-weighting is the way they add and delete stocks.

Stocks are added cuz they've soared, they're dropped because they've tanked. And so you're magnifying that effect of overweighting the overvalued by adding stocks when they are extravagantly expensive. We went back historically and found that stocks that were added were quite literally at 4 times the valuation multiples of the stocks that were dropped.

What if you neutralize that? You can do that in a lot of ways, you can do that by not adding a stock until it has let's take S&P 500 until it's been in the top 500 for 3 years back to back, okay? By then it's no longer necessarily on a tear and you'll have missed turnarounds, companies that soared and crashed.

Don't drop a company until it's been out of the top 500 for 3 years back to back. It will no longer be in freefall and you'll not have dropped companies that cratered and bounced back. So you reduce the turnover, you reduce the sensitivity to price on your additions and deletions.

And by the way, even though you're still cap-weighting, even though Tesla is still one of your 5 largest holdings. You add 50 to 60 basis points per annum to conventional cap-weighted indexes because you're not chasing the latest frothy fad and fleeing the latest unloved stock. So we're coming out with a paper I hope FHA will accept it should hear in a few days or weeks in which we basically say, hey, indexers, get smart about how you add and delete stocks, you can make a better index.

And give your customers a better experience. And if they won't, we will.

>> Jon Hartley: I like that, so we're gonna open it up to questions now. I think we're gonna pass around a microphone. If you could state your name and a brief question. More questions than comments are preferred, but also understand that folks need some background as well.

I think we have a question from Greg over here, you'd like to?

>> Greg Ferreira: Thanks, Jon, thank you again for being here, my name is Greg Ferreira. So there's a little bit of a debate going on right now to where the Fed's going and how high they're going to raise rates.

So they get to what they call and how long they're going to rate this. My question to you would be, if you were chairman of the Fed, and based on what you said earlier about inflation and how you think, how you studied it in the past, what do you think you would do in terms of how high you raise the rate and how long you keep it there, and what tends to be more effective in fighting inflation?

Is it going higher in the shorter term, or is it going up to a maybe more moderate levels of keeping it there for a longer period of time?

>> Jon Hartley: Yeah, so I think, just to repeat the question, I think the question is, if you were chairman of the Fed.

 

>> Rob Arnott: What would I do?

>> Jon Hartley: What would you do?

>> Rob Arnott: Believed that during the good times, you run surpluses and get the debt reduced, he'd be shunned. A fellow named Ian McDougall was wandering the countryside in Scotland and goes up to a local and says, how do I get from here to Inverness?

And the local says, well, if I were you, I wouldn't start here. You don't start with a decade of free money. That was a catastrophic mistake and a catastrophically failed experiment. We're gonna be paying the piper for that for 2, 3 decades to come. They claim to be data dependent, but the data that they focus on changes from one meeting to the next.

It's whatever is the latest hot data point that they find interesting, the data point that they pay no attention to. That should be the central and most important data point that they look at is the long bond yield. Long bond yield is still set by the market, not set by the Fed.

And the long bond yield tells all of us what a market clearing price is for those who want to borrow at a risk free rate, for those who are truly risk free borrowers, or for those who wanna defer consumption and get paid for it by deferring consumption, by providing capital.

And viewed from that perspective, the idiocy of negative real rates becomes self evident. Why should they pay attention to that? Cam Harvey is an advisor to our firm, he was the first to notice that an inverted yield curve predicts a recession. He published it in his 1988 PhD dissertation.

And I would argue that an inverted yield curve doesn't predict a recession, it creates one. Because what you're doing is saying to those who are willing to defer consumption, defer consumption for a long time, you're gonna get paid less than deferring consumption for a short time. Or conversely, if you're a borrower, you wanna borrow money long-term will charge you less than if you want to borrow money short-term, which means, shut down new initiatives that are remotely questionable.

The result is that whenever the yield curve inverts, growth is stifled. Now to a person with a hammer, everything looks like a nail. The inflation is caused by elevated demand, diminished supply. Fed can do nothing about supply. So their view is, and they're very explicit about this, crush the demand until it equals the supply.

All right, what does crushing the demand look like? A recession, Australia was called the lucky country because for 30 years it had no recessions. What was the central bank policy during most of those 30 years? Was to have short term rates pegged, whether deliberately or just by happenstance, at about one to 2% below the long rate.

And they had no recessions. And they grew from being half the per capita GDP of the US to being about 80% the per capita GDP of the US, cool. So I think if I were chairman of the Fed, I would set the Fed funds rate at 1% below the long yield, adjusted every meeting to keep it about 1% below the long rate, and go spend time with my family.

 

>> Jon Hartley: So I guess, follow up on that. Do you think like a soft landing is possible that we could potentially, I guess that the Fed is, potentially wouldn't have a Fed induced recession.

>> Rob Arnott: If the Fed is not determined to crush demand, yeah, if it's not determined to crush demand, then, yeah, we could have a soft landing.

But they are determined to crush demand. So I think the likelihood of a soft landing is remote. I think we're in the early stages of a recession. If you look at GDP growth, we had two negative GDP prints in a row that used to be defined as a recession.

They changed the definition of recession to say falling GDP and rising unemployment. When you have two job openings for every job seeker, rising unemployment is difficult. But they're gonna do it, they're gonna make sure it happens. And with that determination, it creates very high likelihood that we have a recession next year.

It doesn't have to be a bad recession, it doesn't have to be a deep recession, but it's very highly likely that we have a recession and businesses have to act accordingly.

>> Jon Hartley: Well, it's fascinating, and there's, I think in general, there's sort of three different causes of recessions over the past 100 years.

The three most popular causes have been pandemics, financial asset Bubbles, like the TechBubble or housing crisis of 2008. And then I think the most popular one, I think people tend to forget this is actually Fed induced or central bank induced recessions. And these are, I guess, coming back in vogue now that we have inflation back.

Well, it's very interesting to know what a potentially future Fed chair Arnott would do.

>> Rob Arnott: It's never gonna happen.

>> Jon Hartley: Well, yeah, a lot of people said the same thing about president Trump and I'm not sure.

>> Rob Arnott: Okay, let's not go there.

>> Jon Hartley: Not a wise.

>> Rob Arnott: I liked his policies, but I think he's a lousy human being.

 

>> Jon Hartley: This would be Rob's last interview with the Economic Club Miami. We've got a question here from Adam, feel free to yeah, just shoot it.

>> Adam: We've just come to the end of a 30 year period of massive disinflationary macro trends. So globalization, outsourcing, technology impact, that has basically come to an end.

Globalization has ended, outsourcing has ended, or it's now at a static level. So going forward, and we've seen at the same time interest rates coming down systematically throughout that 30-year period. So what is going forward? What do you think is stable state or the equilibrium ten-year yield? And what is the corresponding equilibrium P/E multiple for the S&P 500 as a result?

Because they should be related to one another, right? So it's been 17 and a half times over that period. Should that contract 15 and a half times on the forward basis?

>> Jon Hartley: So just to repeat the question for our friends online in the microphone here, the comment, globalization seems to have ended.

What is the long-term equilibrium ten-year yield and P/E ratio?

>> Rob Arnott: Let's start with real yields, because the 10 year yield will be real yield plus ten-year expected inflation. Let's assume that the economics profession consensus settles in at 2.5% inflation. I don't think a breakeven inflation rate of 2.3 today makes any sense at all.

But 5 years from now, hopefully it does. I wish they would aim for price stability, meaning zero inflation, but that's an outlier view. It's very out of favor these days. So if inflation is in the 2 to 3% range and the real yield is in the one to one and a half percent range, then you're looking at, let's say about a 4% yield right about where it is now.

So that's a good end point. If you have 2% real yields on treasury bonds, then a valuation multiple, I don't like using PE, I like using CAPE. The price relative to 10 year smoothed earnings, because PE, based on trailing earnings, is often extraordinarily high just because earnings are depressed, or extraordinarily low because earnings are peak earnings.

So the 17 times that you're alluding to is 17 times peak earnings. The CAPE ratio right now is about 30. And historically, when you get real yields of around one to 2%, you find that the natural CAPE ratio is pretty good, it's about 20 times. Well, that's a third off from today.

And so I think yields, the Fed will push rates higher. So treasury yields will rise from current levels, though not necessarily very much and not necessarily very long. But the eventual equilibrium level would be not dissimilar to today. Equity valuations would be lower and real yields would be in the one and a half range.

What that means is that, we're not that far from equilibrium except on equity valuations. With the important caveat that between now and then, the Fed is determined to create a recession.

>> Adam: So get used to 6% mortgage rates.

>> Rob Arnott: Yeah, which makes sense on a long-term basis. Blowing housing Bubbles by creating an environment of 2 and a half percent mortgage rates really doesn't make good macroeconomic sense.

 

>> Jon Hartley: Getting used to 6% mortgage rates sounds horrifying to a young prospective homebuyer going forward. But I agree with you, maybe we've been in this period of 0% interest rates for so long that we've all become so accustomed to it.

>> Rob Arnott: Exactly, it was aberrantly low rates.

>> Jon Hartley: All right, do you have any more questions, gentleman upfront?

And please speak loudly if you can.

>> David: Okay, my name is David from your comments, it would seem like a stagflation scenario is very likely in your view. You could expand a little bit on that. And also, what are your thoughts on China for the next decade or so

>> Jon Hartley: Sounds like about an hour.

The question is thoughts on inflation on China. Okay, safe, sorry, thoughts on stagflation. So GDP contracting, economy contracting, and inflation at the same time. And what Rob thinks about China?

>> Rob Arnott: Well, firstly, our work on inflation suggests that there's reasonably good odds that the burst of inflation we've had is only the start of an inflationary episode, not the end of it.

There's a 20% chance that it recedes over the next 2 years, but there's also a 20% chance that it lasts a decade or more. I don't like those odds. That sounds like a formula for stagflation. If we wind up with a short, mild recession and the Fed backs off and Fed funds are back down to 3, and the 10 years back at 4, and equity valuations are a healthy multiple, but not a lofty multiple, then we can entertain a period of relative tranquility.

But I would say stagflation is kind of the 30% bad news case. With Fed ineptitude it's not unlikely. And the Goldilocks scenario is a 20 or 30% benign case, in which case you really want to be getting back invested outside the US in particular. Now not wait, the China question, I feel for the people in China, you've got an autocrat at the top.

He's unreconstructed monolist. He believes in absolute control. His having Hu Jintao, his predecessor, marched off at the end of the party congress suggests how far he's willing to take things. The zero COVID policy. I'm sorry, everyone in China will be exposed to COVID, it's gonna happen. Show of hands, how many people in this room think that they have had COVID?

Or know that they have had COVID? Okay, that's about 80%, I'm guessing half of the rest of you didn't have any symptoms. My wife's had it twice, no symptoms either time. She was tested because of travel, in both cases, and found, I have COVID. So zero COVID policy is stupid from the get go.

It's gonna spread, you want to protect the vulnerable and just recognize that everyone's gonna get it. Let's not blow up the economy over this. In China, isn't it interesting how every time there's a massive protest, they find a COVID case somewhere nearby and lock them down? It's about control, it's not about COVID.

It's about punishing enemies, it's not about COVID. And so I hope China has more enlightened leadership within the next decade. The current leadership is scary.

>> Jon Hartley: Any other questions from the audience? We've got one from Michael, yep, we can hear you.

>> Michael Corkery: Michael Corkery, my question is about, what do you advise investors who are making their investment decisions based upon information from a sort of neoclassical or Keynesian theoretical approach or evaluation approach?

But you're seeing an administration which has fiscal monetary policies that are being more and more dominated by modern monetary theory? And how that continues if there's a reelection and those policies continue to ramp up over the next 4 years, how will those models reflect reality? And if they will, and then what advice do you give to counteract that, or at least certain time?

 

>> Jon Hartley: So to repeat the question, I think the question is, how does neoclassical and Keynesian sort of thinking around economics and some degree that that influence on investing, how does that work in an era of MMT, modern monetary theory? Seemingly inspired-

>> Michael Corkery: Okay, so, if you're using the wrong map there's lots of inflation happening, but yes, it's COVID.

But a lot of it is that they believe that they can print as much money as they want to as long as they can control their short term interest rates. It may not be universal yet, but you have a system where all of us were trained in neoclassical or Keynesian economic theories and things of that nature.

And you see the world through that perspective, but they don't. And so what they're doing doesn't make sense. And if you're an investor looking at financial protection or a model that is based upon neoclassical economics, and you are in a regime change that is now modern monetary theory, whether we like it or not.

Then how does that, 5 years from now, what's that return on investment going to look like? What's the real value of the returns that you've got, based upon the fact that if they continue this for the next 2 to 6 years? What is the economic reality for the average investor?

 

>> Jon Hartley: Got it, so, I think the question is, living in a paradigm where sort of policy has sort of shifted away from sort of neoclassical, long-term structural growth, pro-growth policy, or Keynesian demand management. But where you're running deficits in bad times and surpluses in good times, maybe like in the 90s, in the Clinton era.

How does shifting away from those traditional paradigms to one where we're just always running deficits and presumably always having very accommodative monetary policy, that's maybe changed a little bit recently. How does that sort of regime shift weigh on investing going forward?

>> Rob Arnott: I view geopolitical shocks, stupid policies, which is another form of shock, as a means by which mispricing is introduced into the markets.

And those willing to countertrade against them will usually win, though it can take a while. So MMT, one of the premises of MMT is when you do start to see inflation, you'd better raise your taxes to rein in inflation. And that's an area where I would actually agree with the MMT crowd, that if you are determined to keep spending and you've got inflation and you're not willing to cut spending, that you have to raise taxes.

Or as Milton Friedman famously said, the correct measure of the level of taxes is the level of spending, because if it's not-.

>> Michael Corkery: What does it mean for the investor, though?

>> Rob Arnott: What it does for the investor is create disruption and dislocations. So you get stupid policy leading to 0 interest rates for multiple years.

Betting on rates normalizing upward eventually wins, and did win. Betting on equity valuations faltering wins, and did win. And so, geopolitical shocks likewise create opportunity. And so I would say, be nimble, look for opportunities. And when you see a shock, ask the question, is this still gonna matter in 5 years?

Is COVID still gonna matter in 5 years? No, COVID will still be around, it's endemic, not pandemic. But while COVID's not done with us, we're done with COVID as a driver of policy.

>> Jon Hartley: We have a question from Rodolfo here. Would you mind saying your name?

>> Rodolfo Milani: Yes, my name is Rodolfo Milani, and I just have a question about energy stocks.

There's no question that 12 to 18 months ago, many of these stocks were definitely in the value camp. Now with many of them having doubled or tripled, I mean, they still may have low PEs and they still may have decent dividends. I mean, is an Exxon or a Chevron still a value stock to you after the kinds of movement they've had?

 

>> Jon Hartley: So the question is energy stocks, which not so long ago were thought of as value stocks. With the recent run up that they've had, should they still be considered value stocks? Or maybe should they be thought more of as growth stocks?

>> Rob Arnott: I view them still in the value camp.

Firstly, I'm a believer in global warming and climate change, I'm a believer that it's human-generated. I'm also a believer that it will change the world very gradually, that it will take a long time. I've been asked, why did you buy a house on the water in Miami Beach?

And my response is, I'm 8 feet above high water mark, or high tide mark. And with sea levels rising about one inch every 5 years, as is the current apparent pace, I may have to move in the next 150 years. It's gonna take time. And those who want to deal with it, with multi trillion dollar transfers and with multi trillion dollar spending programs, they're overlooking a very important reality.

And that is fossil fuels are currently, for now, and for at least 2 or 3 generations to come, central to a well functioning global economy. 83% of energy used worldwide is from fossil fuels. The most optimistic projection I've seen is that that drops to 60% by mid century.

But the 60% is on a larger global economy, so the actual extraction of fossil fuels in mid century would be the same as it is today. At PIMCO's Secular Forum, they had a climate person speak, and it was more moderate than most. But I asked him the question, if this is the trajectory for fossil fuel consumption, without collapsing the global economy, how do you get to zero fossil fuel use by mid century?

And he didn't have an answer. So you don't, without killing the world economy, killing billions of people, and creating a world war unlike any we've seen in the past. I view this as just and is, we have no choice. We're gonna continue using fossil fuels for decades to come.

In that context, yes, these stocks are still value stocks. No, they don't have stranded assets, the assets will be used. And I'm also a big believer in technology. We will find technological solutions to global warming in the coming century. Look at how the world is different today from a hundred years ago.

It is breathtaking, people a hundred years ago could not imagine many elements of our current life. The notion of asking Siri your probing question and having this little handheld thing tell you the answer.

>> Jon Hartley: Let alone commercial air travel or air conditioning too, I think are 2-

>> Rob Arnott: Yeah, absolutely.

 

>> Jon Hartley: Of my favorites, you didn't have a 100 years ago.

>> Rob Arnott: So at the end of this century, I'm a believer, and this is based on zero knowledge of what technologies will be developed. I'm a believer that technology will answer the climate change problem, but it'll take generations, not decades.

 

>> Jon Hartley: One last question from the gentleman over here.

>> Jones Torres: Jose Torres, Interactive Brokers, one thing the Fed talks a lot about is long-term inflation expectations remaining anchored. At what point do you think inflation expectations become unanchored?

>> Jon Hartley: So the question is, at what point do you think that inflation expectations will become, re-anchored?

 

>> Rob Arnott: Unanchored.

>> Jon Hartley: Unanchored, aren't they kind of somewhat unanchored right now?

>> Rob Arnott: No, they're very anchored.

>> Jon Hartley: So it's long-term, okay, sorry.

>> Rob Arnott: Yeah, break-even and inflation rates are still 2.3%.

>> Jon Hartley: Yes, so the question is, at what point will long-term inflation expectations become unanchored?

>> Rob Arnott: I think BEI very high odds can't stay below 3 until this inflation cycle winds down.

 

>> Jon Hartley: Break-even inflation?

>> Rob Arnott: Break-even inflation.

>> Jon Hartley: At the 10 year or 30 year?

>> Rob Arnott: That's the 10 year.

>> Jon Hartley: Okay.

>> Rob Arnott: And if I'm right about that, I would say we've got 80, 20 odds that a bet that inflation expectations become less anchored. I wouldn't say unanchored, less anchored in the coming year is highly likely.

>> Jon Hartley: Okay, Rob, thank you so much for joining us, if you could please give Rob a round of applause.