Brother,tzker, sorry, i think you could be out of the job. I need to get to the news feed. Johnson johnson are rise shares of Johnson Johnson are rising today. They raised their forecast in 2014 after firstquarter profits rose 34 . Came frome sales products introduced in the last five years. Generaloff may leave electric sooner than expected. Expectingecting leave sooner. Militaryas started a backed off for asian military backed operation. Those militants have been occupying Ukrainian Government buildings. President obama and vladimir phone, but on the remained at odds over who is at fault. Bring in my guest post. He is the founder and chief rnvestment officer at aq management. Man has degrees in economics, engineering, an mba, and a phd in finance. Welcome. I am glad you are here. Few times we have spoken, i pushed you on headlines. You have said, i do not stay awake overhead lines. When i look at the geopolitical situation, makes me wonder, does all of this going on in the world affect how your investing . Affects how you invest. We are quantitative. We tend to take different positions. We take risks. We try very hard to succeed more often than we do not. Not always. Do aboutke what we what happens in ukraine, to have offsetting positions. For me, when something happens in the ukraine, it will affect my portfolio, but this is a weird concept i should not know how. Neutral, yourket think these things are better than these. If the world is good, youll make money. If the world is bad, theyre going to go down. If something happens, it is going to scramble the whole thing. I still hope to make money. I was not betting on that thing. Look thatving me that aboutwhen i talk to women stuff. I am ringing a foul ball. Two minutes in and i am getting sexist by accident. Just to be clear, that was making fun of me in college. What does influence you the most . Most concerns me the the longterm outcome for architecture in i mean in the next 5, 10, 20 years. Funds,vestors, pension are going to make longterm on stocks and bonds going forward. We brought along some graphs. It is going to be harder for ,verybody, not necessarily us but for everyone to make a lot of money going forward. We start with what the market gives us. If we can launch into it, i have something called the schiller pe. Walk us through what this is. We have bob shiller coming on later. That is a fortuitous coincidence. I have been looking at his construct for almost 20 years now. What he does is, we know what a priceearnings ratio is. Even some girls know that. I am not going to live that down. I deserve it. I will take it with good spirits. What bob did was said there was a problem looking at these. Earnings are volatile. Sometimes they go to near zero. Price divided by zero looks very expensive. Sometimes, times are really good. Earnings are maybe above trend and pes look cheap, but maybe they look to cheap. Too cheap. Lets not look at price divided by one years earnings, lets look at price divided by the last 10 years. They are not particularly biased in any direction. It is always price divided by 10 years. Youre not cheating. The simple answer from that 25, whiche are at a is higher than about 87 . It is not techbubble. That really high number above 40 back in around 2000, that was the techbubble. One, the whole market is not nearly as expensive. Is a contentious word. It implies markets are horribly wrong. I am in the middle. I think there have been a few bubbles, but they are rarer than the markets tend to think they are. Where do you think we are . A differencei between an expensive market and a bubble. I think we are poised for lower returns over the next 10 to 20 years. You invest through that . Go to your investors and say things look modest the next few years, ride this out with me . You say that if you think it is the truth. This to be a good boy on one and not get too commercial about what we do. We think there are plenty of things for investors to do, cheap versus expensive stocks. Trades, low risk investing tends to lower stocks. Arbitrage batteries arbitrage arbitraged strategies. If you have a portfolio of cheap stocks, jean would call them high risk stocks. A thousand stocks that have the lowest price in the books and you went long on those and you and short on portfolios in the thousand stocks with the highest rice to book in the world. Over time, that is making money. Might seem obvious, but it is not. If it is expensive, it was expensive for a darn good reason. Explain this chart for me. Walk me through exactly what that means. As a girl, it helps me in pictures. Can we start over completely . The chart back. I will explain it to this very smart person next to me, who if i met in college, would not talk to me if i tried to talk this way. Genesmes from coauthors website. Hml, i wrote an article with a means highl, minus low. That shows youct the return spread, the difference in return between a broad, diversified port folio. It works for more than price to book. To book and sure, it is a return spread. I joke with them that they do not call at this. They built a little hedge fund. You might notice, from when the graph was up, it goes up a lot more than echoes down. Over time what should i read into this . A few things. One, all else equal, that is where a lot of the danger lies, all else equal, i would be long cheap and short expensive as part of my port the leo. Part of my portfolio. Came todo that when i countries, i would do it when it came to bonds and currencies. The chart can look a little too good. ,nyone that looks at the chart and i think, tell me if you disagree the chart mainly goes up. We circled a part of that chart. We circled right around when we started our firm. Depression that was a crazy time. It was about three weeks before the tech bubble. If you went long cheap and short expensive, 1999 was not the year to do it. Is a pretty good thing to have as part of your court folio, but it does not always work, because nothing does. It should be part of your portfolio, you should look to add it. It is not an arbitrage. Academia, arbitrage is worthless profit. In wall street, we mean it as a trait we do not like. That is not the same thing. At a time when populist opinion hates wall street, i tend to think if you took he worked arbitrage away and read many,finition of it, too they would say what is that . That is illegal. At the end of the day, it is the basis of capital markets. Likes arbitrage means two of the same thing selling at similar races. Prices. The trade i showed you, i love. It is far from riskless. Is selling for seven year and i can sell it for nine here at the same exact time. I want to talk about an efficient use of time. If i am running money and i am following all of these charts, believing in everything that you say, highpriced, low price, is it a smarter use of my time to do that kind of evaluation, or spend my time but being up to uddying up to underwriters . If i am running money, how do i want to spend my time . Buddyingever a fan of up to underwriters for ipos. I feel like the nice guys, the guys doing their homework are going to finish last. Less,yre going to make but so was everyone else. Ipos underperform in the market, not outperform the market. Verdict f you camp predict those times, not thinking about big picture and not trying to get the hot ipo, i predict you finish second to the guy doing his homework. We need to take a quick break. What a great start to the morning. Coming up, this allstar day continues on market makers. We will be speaking to jack fama, bogle, eugene and robert shiller. Stay with us. Welcome back to market makers. Consumer prices rose in march, but it is below the feds target rate. I want to bring in Michael Mckee to break this down. Ness, ishor, cliff as still here. This is not a level or magnitude of change, but direction of change. The fed has been worried about this inflation. Wall street has been worried about disinflation on one hand and inflation on the other. Prices have been going down slowly for a while. They continue to rise . There is a debate after these numbers came out on twitter. This mean we have turned the corner on inflation . That brings up another issue. Are we going to see inflation, the normal price rises, or will acceleration that everyone is worried about because of the fed . Concerned about hyperinflation. If anything, one thing people talk a lot about we have a real bondhis called yield. If anything, it is a little more scary than the equity chart. Expectedd yields minus inflation. Bonds are more complicated than equities in one way. The equity chart tells you where you are in price terms, but also it is pretty similar to where you are in dividend yields terms. Bonds can give you a low real yield, but the curve is steep right now. In wall street geek speak, that is high carry. If we end up in this world of uncertainty, where we all fight about where Interest Rates go, but they dont go anywhere, bonds r. O. K. Bonds are ok. Term, if we do not get a big pickup in inflation, you can do ok in bonds. What does this term mean to you . This is a fun one. Favoriten charts and regressions. We will talk about that later. It takes twos is of the prior charts and puts them together. This will be the most mass we will do in this segment. And its the schiller p flips it over and makes it an earnings yield. That is a pretty good forecast on what you make on stocks above inflation. It over,25, you flip theres your math, you get four percent. Four percent over inflation has indication. We subtract off the real bond yield. This is the spread. If i had to guess, over 10 , how stocksomorrow are going to do against bonds, this is my guest. By 3. 4 . Ll beat bonds on one hand, there is good news they are expected to win. On the other hand, they should win. Stocks are riskier. We hear that stocks are cheap compared to bonds. We do not find it to be so. We find it to be a little bit below average and write about medium, 50th percentile against history. Stocks are expensive. Bonds are expensive. They are about equally as expensive as each other. I occasionally make silly comments. Do at the moment . Wall street is not expect in inflation. The break evens are about 1. 8 over the next five to ten years. You are really betting on the economy and how quickly it will improve. At this point, which side you come down on . The side of diversification. The middle. In stocks versus bonds are a lot of things. Strongly about a lot of those things. We do not feel strongly about market timing. Michael mckee, thank you for giving us the latest. Cliff, i am not letting you go anywhere. Youre watching marketing. You are watching market , writing on bloomberg television. Welcome back to market makers. It is time to take you on the markets. U. S. Markets gave back already. After the you Inflation Numbers came in higher than expected this morning, nasdaq and dow have turned negative. We have been saying this for a week. This is a difficult time. This kind of choppy market is difficult for managers. If you have big that song, all of the classic big thats seem seem going the big bets to be going the wrong way. Thanks to my guest sness. , cliff a we will be back with more. Stay with us. Live from bloomberg headquarters in new york, this is market makers, with Erik Schatzker and stephanie ruhle. Welcome back to a special edition of market makers. Ruhle. Ephanie Erik Schatzker is off. My cohost, closiff asness. Eugene fama. Ng in he is a professor at the university of chicago and once was professorliff famas student and teaching assistant. The idea behind it is. Reflect all available information. Part of it is constructing tests to see whether that is true. In order to test it, you have to Say Something about what it means to say that prices reflect all available information. Does that mean professor, is going to put you out of business . Various people in finance can disagree about efficient markets and agree about how to invest in a portfolio. In an efficient market, you should only be rewarded for risktaking. What he said was to test efficient markets, you need a model of how risk gets into prices. In an inefficient market, behavioral things matter. A lot of the things we may agree , you can find the believers in either camp who end up investing in a very similar way. I would like to take you through, we are going to have bob schiller on later. I am pretty sure he is going to prices that stock move too much to be justified by future cash flows. I think i know what you might say, but what is your responsibility . He is right. It is clear that stock prices vary more than expected cash flow. Inre are two Ingredients Stock prices. One is expected cash flows and the other is the discount rate, equivalent to the expected return. The fact that prices vary more justdividends cash flows, says there is variation in the discount rate that generates variation in prices. This is all well documented in the literature. Something about that is irrational you are taking a stance on how much rational variation that can be in an expected return or discount rate. What does this mean to me . Prices vary more than dividends. If the stock market is more volatile than it should be under one model, the model that professor shiller would have would say that future cash flows are back at a constant rate of return. Is saying isr fama that price flows may vary because cash flows very. The expected returns are the price of bearing a risk. There is no reason to expect that price to be constant through time. That generates variation prices. If risk is priced in or we know what to expect, how does one explain market crashes . Occur, if youhes look at the occasions when there are market crashes, they almost always proceed recessions. The crash tends to be bigger the bigger the subsequent recession. The markets are addicting bad times and that is what you would expect an efficient market to do. Why dont investors seem to know this . Professor fama has been great at pointing this out. There is a difference between saying and i said it earlier prices are high. They can go higher or lower. I can go bankrupt between now and then. Average. Profitably you can predict when they will make money from that. I do not have a secret that i some guys sayck they have a billiondollar algorithm but decided not to use it. I do not have a billiondollar way to predict the markets. I do think you can expect returns to move through time. Making money in the market is still hard. Fama, do you believe investors can define the markets . No, they cannot. The predictability and market returns is tracked by things like earnings price ratios, dividend price ratios. Risk that yourt prediction return prediction turns out to be incorrect. Risk does for bearing very through time. It is not an accurate prediction. Mireda prediction that is in much more uncertainty than the value of the prediction. Should investors be putting there . Oney there is a simple proposition called the apprentice arithmetic of active management that was published in 1992. Active management is a zerosum game before costs. Some active managers win, but it has to be at the expense of others. The game is zerosum before costs, then it is a big negative sum game after cost. This is well documented. There are a bunch of things to comment on. To what yout back do with this information that prices are high on the market. Quakes when i hear it is time to buy, is that baloney . Yes. The second thing, and i think it is a legitimate use for things like stock and bond returns being high, planning. How much money do i have to put away . You can be an individual with a spreadsheet or a pension fund. How much money do i have to put away to generate x for retirement . I think these numbers are relevant, not for timing the market, but for how much you have to put away. When it comes to active management, the professor is right. The average cannot outperform the average. We get into real semantics. Both the professor and i believe would tilt towards value stocks. Cannotough the average beat the average, cheap can beat the risk year. I do not think it is quite as nihilistic as saying you have to be completely passive. It does mean that this is a lot harder to do and of all the things, timing the market is the hardest. The fact that many hedge funds today have to offer their investors quarterly and monthly liquidity, is it impossible for them to perform knowing they are up against those time constraints . They are part of the active management industry. They are just a lot more risk year in mutual funds. Some of them will win and some of them will lose. It is difficult to tell if winning is due to luck. The customers absorb the high fees and expensive. If you want to play that game, that is fine. I think my professor is being nice. , and i willave made make it again. There has been a lot of research on showing the average mutual fund manager doesnt outperform a stock picking. Broadly speaking, what hedge funds has done is figured out that we figured out the problem, were just not charging enough. It is an on way to solve the problem. What is the right way to solve it . One subtlety we have not gotten into is markets cannot be literally, perfectly efficient. Somebody has to make himself. Imagine a world where everyone believed gene and no one bothered to look. There is room for the possibility of limited skill. You have to believe you can find the skill before the fact and after the fees. Some research should go on. Certain things over time offer a return that may be due to real risk in a rational market, due to the hague ural issues, but if you had to choose one, trade a lot. Pickur own stocks your own stocks. If you have to choose, go with jack. Professor fama, thank you for joining us. When we come back, what really sets this guy off. Were going to see about some of his pet peeves. Dont you want to know what they are . I do. Stay here. You are watching market makers. Welcome back to market makers. I had the good fortune that you shared with me some of your pet peeves. One of them after the start of today, you have made them you may have made it. When we look at managers, we look at the three to five year timeline, what they have done. You think that is not the right track record to look at. This applies to hedge funds and active management, the no standard loan, single measure is a strong predictor of the future. One of the few things we found over time is three to five year performance tends to be a little indicative of the future. If if i am looking to invest in a fund, i want to start my fun today, how do i market myself . People should look at that, but they should look at that in context. If someone shows you a track record, how do you make your money, what did you bet on, what do you do . Those are relevant. Answer, to besy honest. It is statistically, three to five years as a tiny drop of time. Warren buffett, i saw an article that he had a bad five years. A great investor. He is one of the exceptions to my roles. I did not change my view because he has had a bad five years. If anything, if you think you have someone with a great investment process, it could be Something Like professor, and i were talking about professor fama and i were talking about, but it is still viable like stock picking. Buying a great manager that has a below you would choose someone that has had an enh three to five years then someone that was stellar . If i like the process and i understood what they were doing id i thought they were good, would prefer someone that has had a rougher time. They are not tremendously backwards. We would be great predictors the other way. People latch onto it for the same reason you looked at me and said what else you have to do . A number andp with somebody else got nothing, you win. Help me understand what makes a great investor. We talked to economist that would say i am not a great investor. What makes a great investor . I can only give you an answer from my perspective. I do not know about individual stock picking. I believe it is the exception, not the rule. There are people that are great at that. A great investor has a process that is ultimately rooted, on the quantitative or academic side, two of the biggest things that have worked over the long term our Value Investing and, oddly enough, momentum investing. Combining those works a ton better than either one separately. If you are a Value Investor and , more momentum investor often than not, we disagree. Not you and me personally, but the hypothetical. Not always. Stock markets,s, currencies, lets stick with stocks as an example. They are cheap stocks that have started to get better. Is academic findings is that the place to be. Our style of going after those is to be diversified. For a longa theory time that one day i want to try to write a paper on. Some of the great track records. Ut there are the rare managers you do not have to keep these in your head at the same time, you just have to put them in your computer at the same time. You just have to put them in the computer at the same time. Youre going to bring up High Frequency trading. Hugeneed to know, it was a one for me last week. When Michael Lewis came out across the world with the headline the stock market is that statement, for me, it is an issue for me. Was it an issue for you . You are stealing my thunder. I want to be the angriest person on the table. That was a horribly, irresponsible, stupid thing to say. The stock market is anything, it is a wonderful place for the small investor. They can sidestep me and go to jack bogle and a trade if they want to do it very cheaply. To learn more about this and that it has some dangers and i have written a book exploring that, good for you. That does not sell enough books, but screaming rigged, somewhere between idiotic and allied, that sells books. Do you think people might say term of what same an arbitrage is . Some will always have an edge. People do not like the idea that someone has an edge. To get over. E the Grocery Store do not buy the corner, they bought it. There was a middleman. If you want to buy a stock and the someone that wants to sell it at the same time, it has always been very hard. They charge more than the computer guys charge. Thosere are cases where seeking an edge are doing it illegally. If that is found, they should be stopped. I will not defend illegal behavior. I have no evidence that goes on more and a highfrequency world, nor does anyone else, then it goes on in the regular world. I for illegal behavior . I am going to go with no on that one. That is part of the issue. If it is anything, it is the opposite of rigged. Stay with me. Cliff asness is with me. Jackll be talking with bogle. Market makers will be back in a moment. Incredible conversation about what it takes to be married. When we come back, we have jack shiller. Robert it is a allstar day here on market makers. We are talking with some of the smartest guys in business and finance. My guest, lucky for us, Hedge Fund Star cliff asness. In a moment we will speak with nobel prizewinning economist bob schiller, the founder of the case shiller housing index. Later in the program, the father, the granddaddy of index funds, vanguard founder jack bogle. Welcome to a special edition of market makers. Cliff asness is here with me now. It has been a great first hour. A lot to cover in the next hour but i have to get to the newsfeed. Top business stories from around the world. Inflation at the consumer lame level picked up last month. That was due mostly to higher costs for food and rent. All this is seen as a sign that demand is improving, positive for the u. S. Economy. One of those items you are paying more for is shrimp. Prices have risen 61 in the last year to a 14year high. The reason, a disease devastating young trip farms in southeast asia. In italy, former Prime MinisterSilvio Berlusconi will pay the price after being convicted of tax fraud. The billionaire has been ordered to a year of Community Service. He is 77, and his age is keeping him out of prison. I want to know what kind of Community Service he is doing. I do not see him on the side of the highway picking up trash. It would be fun to watch. Toin the last hour, we spoke professor eugene fama, who won the nobel prize in economics last year for his efficient markets theory, which all that all information about a security is already priced in and it is all but impossible for an individual investor to beat the market. Of thethe other side rain, Yale UniversityProfessor Bob schiller has a different area of how the markets work. Professor shiller, thank you for being here with us this morning. Professor shiller, first, like me, i hope that you are also long on trip last month. That is a joke. We do not time the market, that includes the shrimp market. You know myself and john lew wrote an article about recalled the split nobel prize, on you and professor fama. In our view it was a good thing. We come out somewhere in the middle of you guys. We think you both have advanced the literature and the knowledge of this so much. We spoke to gene just now about efficient markets. Give me your version of the inefficient market case, if you can sum it up, why are markets not efficient . First of all, i am an admirer of eugene fama. His theory is a half truth. He is half right. The fundamental thing is it is not easy to make a lot of money trading. It is a competitive game. There are a lot of smarter people than you out there as well. Do you mean me personally . [laughter] the universal cliff again. Beforele knew that long fama. Evidence that look very favorable, like these event studies that he did, which gave an exaggerated sense of the perfection of the markets. When you get down to the truth, what is driving the whole stock market . Apparently, news about important, real things that matter. I do not think so. I think the overall market is probably driven mostly by psychology. Possibility of a meeting in the middle on the longterm, where prices are eventually right . We spent a lot of time, gene week, talking at the nobel , and more or less, we do not agree disagree that much, except for interpretations. He keeps coming back to the idea that markets are perfect. Being a fundamentally oriented investor for the longterm, Something Like that is what we call Value Investing. By the way, that is substantially what eugene fama does, at least the company he advises. It is largely a difference of interpretation. He does not seem to think that we should all be completely diversified. Are you saying people can beat the market . I want to get an understanding to where you see the biggest challenge in this hypothesis. Example, one could go into a value stock. Over the long haul, value stocks have outperformed the market. There are a number of anomalies is not soerature, it hard. It will not make you suddenly rich but you will beat the market in the long run. I do not know if stephanie believe me when i said we would get two people, somewhat known for disagreeing just split the nobel prize investing us on how to invest in a similar way. Tell me if you disagree i will go back to what you said. Staying relatively passive, keeping costs low, and tilting toward what the academics call anomalies. In english, stuff that beats the market. Value investing is the most premier one. I would also mention omentum investing. Is that a reasonable way to invest, would your portfolio and the looking similar to eugene famas . There might be a high fee, which concerns me, but in terms of the general strategy theiraqr can beat measures by one basis point i am joking about that. We hear about highfrequency trading and whether markets are rigged against them. Should they be trading at all . I do not like this rigged story that michael is telling. That is being a little sensationalist. Thing fore a good people to trade occasionally. You do not want to trade too often because you will lose transaction costs. Occasional trading. . Isnt that a positive for are theion costs lowest they have ever been. I would not worry about millisecond trading. From time to time and no one should trade their portfolio, at least to rebound. More generally when the market is looking crazy, we have to have people willing to get out of the market. That is what makes markets efficient. S efficientith fama market hypothesis, if it were true, it would be no one enforcing efficiency. That is partly what caused this financial crisis. Too many people wanted to be free riders on everyone else and they assumed the markets were right. I alluded to that earlier. I will try to be a bit of a peacemaker here. In mentioned gene believes perfect markets but sometimes he gets pigeonholed that way. He told us in the 1980s that markets are almost assuredly not perfectly efficient because of exactly when you are saying, information costs, reasons like that. Someone has to make them efficient. This may not work for the world, but for me and bob, we can just say grossman and stiglitz, and we can act like we just said something. I think you would agree that they are more efficient than you do, and im not pretending then help me understand, what would a perfect portfolio consist of . If everyone has different theories but the same take away, robert, if you were to put together a portfolio, what would be in it . It would have to remain fairly diversified. The question is what it means to be diversified. That can be difficult. You also have to consider your own situation. This is not done very often, but if you are an executive at an automobile company, you should be short, not long the automobile stocks, as a way to hedge your self. If you do that, stephanie will do an expose on you. Is it a good idea to be diversified . If i think cliff asness is the smartest guy out there, but you do not have a history in asset classes, do i want to invest . First, it is a good idea to be diversified. Anything you are not doing yourself if you are running your own portfolio, which i do not recommend, and you know you are diversified, you do not need to diversify from yourself. But when it comes to other people, there is no other person that i would put all my money with. Think, aboutg, i owning the world indexes of bonds and that sort of thing. Then we all agree on the value affect. We probably all start with a pretty diversified world of portfolios, stocks, and bonds. And then tilting towards cheap stocks. My portfolio, i would do more than that. There are other things i believe in. Bobs would look Something Like that to begin with. Of course, he is allowed to comment for himself. About justhink before the financial crisis, when all these managers started to get into products that were not their expertise, and the markets turned on them, they were frozen and could not get out. So maybe just stick to your knitting and dont diversified. That is another theory, for your but all your eggs in one basket. Who said that, mark twain . Me big difference between and eugene fama, having penned a week with him, is not any concrete difference about portfolio diversification. It is what jean does not say. What i have never heard him say maybe he has, but he does not refer to psychology or sociology. He does not think there are fads and fashions. They be he doesnt bring them up. It is not in his genetic profile to ever bring up Something Like that. When i look at markets in the real world, i see fads and fashions and i feel skeptical about them, especially if they are related to traditional measures of overpricing, and i want to downgrade those things in my portfolio. That is not in eugene,s vocabulary. Eugene famas vocabulary. Gene. An play the role of it is a combination of being riskier and not perfectly rational markets, which are fads and fashions. I wrote my dissertation for gene on the success of the price income strategy, which he was kind about, and it is hard to justify that one. Maybe one day we will, but to justify why winners keep winning in the short run, over six to 12 months, that is a hard one for efficient guys. But playing gene, i have heard them say this behavior lists are great about telling stories about behavior. He believes them. Humans are not perfect. But they are not as good saying about how they get into prices. I would have to say, my sense is they do get into prices when extreme, but we are still fairly imprecise in our knowledge of how the process works. Im curious how you would respond. I teach efficient markets. I like gene fama. I think he is a brilliant academic, but he does not always say things exactly right. A lot of what happens it is just my view of world history. Not just finance. It is in politics. We have these crazy wars from time to time. Go back and look at any one of them in history and you think, what were they thinking . It in futureagine times. Stock market movements are like that. They are still hired to forecast, and that is because there are a lot of people trying to forecast the craziness. That is part of the job of being an analyst. People are doing the job, so the market has discounted into it optimal expectations of future craziness. But the craziness does not go away from that. It still remains. I think we are ending here, but he likes you, too. Joining us, Yale University professor, robert shiller. When we come back, we will talk about fads and fashions with cliff asness. Be talking with jack bogle, founder of the vanguard group. Welcome back. Chalk this up as another round in the battle between companies and moguls in san francisco. Union workers will march to twitter headquarters with a building one but and they want twitter to pay, 50 6 million, for the tax breaks they got from the city of sentences go. Megan hughes has made the trip. She is with us outside of twitter headquarters. Why are san franciscans so dam that damn mad . Theyey are upset because say this is taking a big bite out of the city budget. These are Service Workers, sei you you you know organize protest. They will start at city hall at 4 00 today, rushhour. Expecting about 1000 people to march here to twitter headquarters which you see behind me. And it is not just twitter that got this tax break. The unions say it is 56 million that shouldve gone to the city. That is just from twitter. 100 million for these other Companies Getting the same tax breaks. We are talking about payroll taxes for new workers. These Companies Moving to this midmarket area which was once a blighted neighborhood come up are exempt from paying payroll taxes on new hires for 6008 years. 8 is a big boon 6 to years. It is a big boon to these companies. Twitter has not been paying because they do not have to. What are they protesting . Playerhis is hating the not again. Twitter is well within the rules. There is a lot of animosity between the sweet deals the Tech Companies are getting in the average worker and what this is doing to neighborhoods, what it is doing in terms of pushing the working class people out. It is a much bigger philosophical debate, like we see with the Obama Administration ocean for a higher minimum wage. These are workers that are saying by the way, the Service Workers are negotiating their contracts with the city. They are being asked to give concessions for things like paying more for health care, at a time when the city is giving these tax breaks to these Tech Companies. How many jobs since twitters inception have they created, brought to the city and the bay area . Say since its inception, but since the tax breaks, they have added 2600 jobs. You look at all the companies that have been growing, adding jobs, and that is the argument that city leaders make. Aside, people who are being paid well that are staying in the city, which means newer apartments going up, restaurants coming to the area that would not have been here, which means other kinds of jobs, and those are the arguments that city leaders are making here, that having these Tech Companies here is an economic boon to the city. I want to bring in cliff asness. I have a freemarket kind of girl. I am sure you are a freemarket kind of guy. Not knowing the background on this, what is your take away . I will be careful because i do not know the details. It seems like a deal that the city made with twitter. I will simply say this. As a freemarketer, libertarian person, most of the tech executives would call themselves progressive. And can i admit to a sure fair amount of schadenfreude to the protests . Join in anothers pain. Watching them being protested about inequality has a certain poignancy but one has to relish if they are on the freemarket side. Industriesacross all are saying income inequality is the Biggest Issue plaguing us. Do you believe that . I do not. I think it is growth. They can be related. If we are not growing for the average and low income workers and we are for the high income, then they are related. Inequality growing at the same time as growth. But if we have a world where everyone is doing better, inequality is not our Biggest Issue. Our issue is in a world where not everyone is doing better. What needs to be done to address that . Long list thatry sounds and looks like a Milton Friedman textbook. Take about half the government and chuck them. Give us the cliffs notes, so to speak. We do long prep sessions where they say, cliff, whatever stephanie says, do not talk about politics. Every time we build regulation, we had a financial crisis, so we came up with. Frank come in which promises we will not have another one again by saying we have a council now that will outlaw financial crises. It will not work. It is a giant bureaucracy, age cost on business, antigrowth. We have a problem with not enough healthcare coverage for individuals in the country. That is a real problem. I do not think anyone was to see people without health care. Instead of saying lets cover them through humanitarian aid, we created obama care. I think government is out of control. I do not think everyday people wake up and think i will not hire that new guy because i do not like the government, but i do think it has an impact longterm. Adding back to laissezfaire principles, pretty much what makes this country exceptional. We are not genetically exceptional. You are a crazy person do think that. Do you think people are trying to kill the american dream, when we hear people come out aggressively defending this ultra one percent . People may not like there were choices but many will say, i believe in the american dream, i believe in people that have done extraordinary things. Do you believe populist opinion is trying to keep these leaders down . Peoplesrstand emotions when growth is not great and the average person is not benefiting. There will be resentment. Thele who speak out will be tall grass that gets cut. But that is not helpful, that is a motion. We have a big disagreement about whether the solution to our problems is Less Government or more government. And it is a big fight we have been handing and need to continue until we have a winner. And then we will see who is right. To be done to change the branding as far as the financial industry goes, get rid of this selfish fatcat came in the system. That is not what they were called all along. I do not think we have change the prescription of how finance operates, but the brand the first thing we do issued Michael Lewis. That was a joke. Oot Michael Lewis. That was a joke. We are talking about this issue of demonized people. Finance always is demonized. Yet, we seem to need it desperately. It seems to be important to capitalism. The idea that you can finance companies, that entrepreneurs can sell their company to the public. The idea that companies can merge and havent been a growing economy. We cannot do this without wall street. That is not saying that it does not get out of control at times, that the people that get out of control deserve punishment, but this demonization needs to stop. There you go. This is a man who believes, lives and breathes free markets. Cliff asness. When we come back, we will be with the founder of the first index mutual fund, jack bogle. Welcome back to a very special edition of market makers. Im stephanie rule. My cohost this morning is cliff asness, cofounder of a qr. Bogle,t guest is john founder of the vanguard group, the biggest Mutual Fund Company in the world. He is with us from pennsylvania at headquarters. Thanks for joining us this morning. , really want to start on hft High Frequency trading. Cliff came out pretty aggressively defending highfrequency trading. Jeff, i need to hear from you, in on thisou weigh controversial topic when transaction costs are so low and i know that is so important to you . Look,e, highfrequency trading has been the capstone of reducing cost to the market. That is a complete plus, created liquidity, which is easier, price discovery is easier and quicker. It has all those things going for it and a bunch of things not going for it, too. You have to balance it a little bit and i think Michael Lewis forgot about the positive side. The best way to sell books is to take a very aggressive, puck nations position, and that is what he did. It has plenty of risks. There is a question about disclosure. We should know who is making all that money. These exchanges should be filing reports with the sec. We should be very careful about early trading, trading ahead of someone elses order. We should be very concerned about the risks to the markets of this technology. All those things are there. On balance, it is a plus, highfrequency trading. I agree. I find it easy to i wanted to do a few things. First, i want to tell a story that is bragging for me and you at the same time. I have been telling people that our approach at our firm to hedge fund strategies, where we generally charge less and are more transparent, jack has given me permission to say it is the Hedge Fund Strategy he hates least. You know you feel pretty good about someone like i do about you, when they are willing to brag that they hate what you do less than other things. Culpa. A medical mea we wrote this paper on the split nobel prize between eugene fama and robert shiller. Lawrence hansen also won, but he was not on the angry spectrum. In that article, i got something wrong. I said efficient markets were the inspiration for the index fund, at least implied that. You told me all the things you loved about the article, and then told me how wrong i was. So i want to apologize for that and give you a chance to explain what was the inspiration, and how it was not from academic. Where you got it from. That is a fair and good question. It could not have been the inspiration for the First Index Fund because i guess, shame on dad,s clint would say, my i had never heard of eugene fama or the efficient markets hypothesis. The inspiration actually goes way back to the princeton senior thesis i wrote in 1951 when i nod mutual funds can make claims to superiority over the market averages, i. E. The market indexes. Later on, i began to see that in action. I think the past had to do something with the future. It turned out to be the merger mistake of my lifetime when i merged the Wellington Management companies. Experience is different than theory. The real, final, straw that made the camels back was an article in the first edition, first issue of journal portfolio management, 1974, by the great Paul Samuelson called challenge to judgment. He said, would someone please, somewhere, show me any brute evidence that active managers can systematically beat the s p 500 . I thought, if he is on my side, who could be against me . The greatest economist of the 20th century it turns out. We were basically experience driven. Here is what the data shows about how the record is in the past. It does not require any market efficiency. I had toquires is create my own acronym to go with cmh, theand i created crossed matters hypothesis. The less you pay, the more you get, therefore if you pay nothing, you get everything. That is the driving force among the mathematics of the market. Some funds will come in and wind and then lose and then revert to the main, but the great hazard of our business is her version the main. The funny part of it is, in creating the index fund and the total market index fund, they can never revert to the mean because they are the mean. So i feel good about that but dr. Samuelson is the key, and not eugene fama. To pick any Single Person who has done more for investor welfare over their career it is jack bogle, hands down. I also have my own Paul Samuelson story. This is from the peak of the tech bubble, where you wrote an saying that you expect returns to be low from here. Dr. Samuelson wanted to underweight stocks that were so expensive. But hemangle the quote, said i have been telling people that my current new advice is to ittle, which is something i like. Days,n the tech bubble you wrote one of the great pieces of the time saying huger some of dividends and growth, and what valuation you buy them at. I do not think you were predicting a crash but it forecast a decade a lower returns. That does not have to be irrational, does not break the tie between jean and bob thomas do you have a view on those things . If you go back to the tech boom, the information age, the internet as the answer to all problems in the world, then stocks were really expensive. One percent yield, 40 times multiple. We are nowhere near the territory today. Stocks are yielding not as are nowbut dividends two percent. Earnings growth is in the general range of maybe as much as five percent. You have a seven percent investment return. With the p e, by mike aiken relations, running around 19, 20 toes, and i were to revert 15, 16 times, that would take a seven percent investment return, a negative speculative return, maybe a point and a half, so comereturn if the p es down. Not bad of a return and good compared to todays bond yields. Do you believe investors can beat the markets . As a group, absolutely certain that they cannot. They own the market. How are they all going to be each other . It is fair when we compare Hedge Fund Returns to general market returns and make that a reason not to invest in funds . Probably not. Hedge funds are an unusual combination. A great many of them blackstone, for example, one of the biggest and most successful does almost as good as our Wellington Fund which is amusing. It is a balanced fund. It is not 100 in equities. All equity hedge funds are fine if they can head properly. If they cannot, they will do worse. To compare that to the s p 500 is fine, but it is a very diverse universe of different types of funds, and also as everyone must have learned by now with hedge funds, the selection risk is enormous compared to the Mutual Fund Industry because there is no the stocke in to market or bond market or combination of both. Hedge funds can go anywhere. Should people put their money with managers like cliff, should they put them in an etf fund, or do they even have a shot trying to be the small guy investing on his own . Guy investing on his own is, i think, playing a fools game. He may win a little bit and lose a little bit but in the long run he is destined to lose, if for no other reason, that the small investor investing on his or her own does much too much trading, and trading is your enemy. That is a transaction cost against your return. If you want to buy a managed cref, that is fine. Ref,equity part of tiaa c the stock side. They are probably 75 related to the index. They have a correlation with the index of maybe 92, 93 , and pretty low cost. Not quite by vanguard standards, but they ought to get there because that is where the competition is. A middleoftheroad fund with low cost, low transaction activity, focused on the longterm, has a fighting chance of beating an index fund. I do not think the chance is good but there is a chance. I am trying to square a circle here, put your comments together with genes and bobs, this. Entioned it boils down to the average. Therefore, your approach is to accept the average at low cost. Genes approach is to tilt towards certain stocks, in his case, value in small stocks. I am wary about putting words in a low bond Nobel Laureates mouth, but i think i am doing ok, but with the idea that you can do better in the market. Bob schillers approach is approach, gene and my but neither the three of us i am a quant, and i just counted wrong. We can get away from the fact that the average cannot beat the average. Some of us have the hubris and arrogance to think that we will be in that part that does better. Have ao, you should story, reasonable fees, something you can test for 100 orrs, and a guy like fama schiller would argue that there are such things. I think you take more of a show me attitude. I know that if i can get a cheap price, i know what im getting. Maybe these are not imperfect agreement, but they are not inconsistent. Clear that, under the data that fama uses, university of chicago data, it s and small cap that has done better about for the past 80 years. That is the fact. Except when you look at the record year by dear, which i do, you see you can go through 20 years, for example, when the reverse is true for large cap beating smallcap, growth beating value. , trying toonal view look at things that way, is that if everyone knows smallcap is better, and those value is better, then those prices will be bid up. Large caps will go down. Then the future will be arbitraged away, and then there will be benefits the other way. I am also struck by the fact that if you look at value and growth mutual funds, and ive done this going back to 1933, when there were just a few in each category, have not done the same thing as those indexes of fama and chris cliffs. It is different when you look at the real world. I am skeptical. Investors are investing first. Todays investor will be investing for 75 years. How many managers is he going to find, how many mutual funds will he own . Unfortunately, im sorry, we have to leave it there. The commercial is coming. Jack, thank you so much for joining us. Talking to someone with your expertise is an absolute honor. Founder of vanguard. We hope to see you soon. Cliff asness, who i think will be leaving the investment industry, because really his calling is being a television anchor. Sorry, erik. If you missed any of the interviews, you can watch them on amazon fire tv and apple tv. At bloomberg, we are tech savvy. You can watch on demand, streaming, from your ipad. Stay with us. Welcome back today special edition of market makers. We are wrapping up with cliff asness. Peeves in theet financial journal. One of them is something that we sadly in the media use all the time. Guys on the sidelines. I cannot with an editorial and they told me to come up with 10 things that i was mad about. One of them was certain phrases i do not like. The reason i do not like the phrase cash on the sidelines, in the short to mediumterm, there is no such thing. You have money in a Money Market Fund and you want to buy stocks. You buy stocks. What does that person now have . They have cash. They either put it on the sidelines or by another stock. Then that person has cash. In the short run, you cannot leave the sidelines. You do not reduce stocks. There is no such thing. Everyone is fully invested in everything all the time. Geeks would call this equilibrium and market clearing conditions. In real life, it is a little like the matrix. There is no spoon and there are no sidelines. You also do not like a stock pickers market, but i do not get that. A stock pickers market, isnt that where fundamentals guys shine . In principle, you could take the phrase a stock pickers market, and you could make it into a reasonable phrase. What is a reasonable phrase . If you used it for a time when valuation were very different and lowquality companies were very expensive and highquality companies were cheap and you could make a lot of money doing that. But people say it all the time. I do not go through a day of business television, of markets, downmarket, rockets at have been choppy, where someone tells me it is a stock pickers market. When the market is going in one direction and you can buy anything when the central bankers are pumping money into it, that is not a stock pickers market. They say it will be a stock pickers market. I cannot thank you enough, cliff. What a special day for us. Aqr, asness, founder of join me for a special show. We got his pet peeves, his picks, and i know the twitter verse loved the show. Coming up, what options are telling us about where stocks are headed. Bloomberg is getting ready to take you on the markets. See you tomorrow. That is it for market makers. Like cashss does not on the sides, but plenty of our viewers do. To tell you the truth, everyone must do it, even my husband. Everyone watches the show on bravo, whether they like to admit it or not. That is what makes bravo number one when it comes to the most engaged, educated, and affluent viewers in prime time. Bravosbe speaking to president francis birbeck. Is 56 minutes past the hour, which means bloomberg is taking you on the markets. Olivia stearns has much more. Stocks have turned this morning and equity markets are now trading lower as we have headlines coming out of ukraine perhaps rattling investor concerns that the situation is flaring up. We have seen headlines that Ukrainian Forces have clashed with some insurgent prorussian activists in eastern parts of the country, so perhaps that is weighing on the markets. We got cpi numbers out, better than economists forecast in. Fororation coming in at. 2 march, ahead of estimates. Overall annualized rate coming in at 1. 5 going into march, well below the feds two percent target rate. Big losses in the tech sector. The nasdaq down one percent. S p done by. 3 . Lets turn now to todays options and insight. Joining us with a look at where stocks are headed, the lead options strategist at trading block. He joins us from the cboe. Im looking at the markets, the nasdaq, the laggard of the benchmark indexes, down one percent. Also seeing a pickup in the mix. What are options telling you about where stocks are headed right now . The vix. Backe mix is poking him near 20 again. Yesterday we went down to the 15 range. The momentum in the nasdaq, highgrowth names, continue to outperform. The valuation gap has a bit more to go, certainly in the options market, pointing to the implied volatility on names like tesla, green mountain, off the charts, compared to some other names like cisco, intel. Implied volatility skew has widened dramatically between momentum and value. We are certainly seeing that on the nasdaq etf. You mentioned tesla, down four percent today, but up 25 year to date. What is your trade on tesla . The stock was around 200 this morning, taking that it is the highest it has been since may, selling both sides of the market, looking for the stock to calm down. Call spread, a bearish trade. The 190ownside, selling puts. You have about one dollar 65, almost a two dollar tradeoff. They blew up so quickly, we are not able to get the tradeoff. Really looking at this implied volatility environment for some semblance of it sanity to come in and take advantage of options premium. If you are looking at a condor trade, you are betting the stock will continue to trade at a certain range am a but you say tesla has been very volatile. Why do you think we will now see volatile movements inside . When you get to these market levels, usually it signals that things have gone to an extreme. Tesla is around 80, in the past has been around levels with implied and actual volatility leveling off. Also you are getting a much bigger net credit for this. I like the fact that if it settles, it will take off as a function of implied volatility taking off. We do not have that position on but looking to add to it certainly. Thank you for joining us. We will be on the markets again in 30 minutes. In the meantime, lunch money with adam johnson is next. Welcome to lunch money. Im adam johnson. Take a look at the many. In tech, you too could finally walk around with a pair of google glasses. You will get an inside look at Aston Martins new five figure vehicle. Newcomers are so smart, they can catch a crime before it happens. Ripken has Business Advice for you. Learning from years of playing baseball. You think artificial meat sounds gross