As Good As It Gets? | Meb Faber on U.S. Stock Valuations, Trend Following, and Endowment Allocations To Private Markets
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
In this episode of Monetary Matters, host Jack Farley welcomes Meb Faber, founder of Cambria Funds, for a comprehensive discussion about market valuations and investment strategies. Faber delivers a sobering message about US stock market conditions, noting that the past fifteen years represent one of the best periods in stock market history, with US stocks returning 15% annually - a feat so rare that such periods have names like the Roaring Twenties and the Internet bubble. (01:36) He warns investors to temper their expectations, as periods of exceptional returns are typically followed by mean reversion. (02:21) The conversation explores historical market cycles, comparing today's AI boom to past infrastructure buildouts like railroads, while examining the extreme valuations currently plaguing US markets. (27:03) Faber challenges institutional investment approaches, particularly criticizing major endowments for their complex private equity strategies that could be replicated with simple, liquid ETFs. The discussion concludes with Faber revealing Section 351 of the tax code, a little-known provision that allows investors to exchange concentrated stock positions for diversified ETFs on a tax-deferred basis. (60:01) • **Main themes:** Market valuations reaching historically extreme levels, the benefits of global diversification over US-centric investing, institutional investment inefficiencies, and tax-efficient portfolio management strategies
Speakers
Meb Faber
Meb Faber is the founder of Cambria Funds and a prominent voice in quantitative investing and asset allocation. He has written several books on global value investing and tactical asset allocation, including works on endowment-style portfolios and historical market analysis. Faber is known for his research-driven approach to investing and his advocacy for low-cost, globally diversified strategies that challenge conventional Wall Street wisdom.
Jack Farley
Jack Farley is the host of Monetary Matters podcast, where he conducts in-depth interviews with investment professionals and market experts. His background includes financial analysis and market commentary, with a focus on bringing institutional-level investment insights to a broader audience through accessible yet sophisticated discussions about markets, economics, and investment strategy.
Key Takeaways
Embrace Global Diversification Over Home Country Bias
Faber emphasizes that US investors are dramatically overweight domestic stocks relative to global market capitalization. (16:36) While the US represents only about 25% of world GDP, most American investors allocate 70% or more of their equity portfolios to US stocks. Foreign developed and emerging market stocks, which have underperformed for fifteen years, are currently trading at much more attractive valuations with PE ratios around 20 for foreign developed markets and high teens for emerging markets, compared to the US at 40. (11:19) This year, foreign stocks have quietly been crushing US stock performance, with value stocks outside the US up 50%. (16:15) Professional investors should consider rebalancing toward international diversification as these markets offer better long-term return prospects while trading at historically reasonable valuations.
Recognize When Expensive Markets Can Continue Rising
Faber introduces the concept that expensive uptrends, while dangerous, can be the second-best performing market environment historically. (30:51) The challenge for investors is that bubbles can persist longer than rational analysis would suggest, as demonstrated by Japan hitting PE ratios near 100 in the 1980s before three decades of poor performance. (15:01) Rather than trying to time market tops based on valuation alone, Faber advocates for combining value analysis with trend-following methodologies that provide systematic exit criteria. (33:08) This approach allows investors to participate in the substantial gains available during bubble phases while having a disciplined framework for protecting capital when trends eventually reverse.
Question Institutional Investment Complexity
Major endowments and pension funds, despite having vast resources and access to top managers, consistently fail to outperform simple, low-cost portfolio strategies. (39:07) Faber launched an endowment-style ETF charging less than 50 basis points to provide an investable benchmark against these institutions, many of which have position sheets spanning 500 pages and pay hundreds of millions in fees annually. (40:20) The academic research demonstrates that private equity and venture capital returns can be replicated in public markets using factor tilts toward value, quality, and small-cap stocks, without the high fees, illiquidity, and complexity of private market investments. (48:29) Individual investors should be skeptical of complex investment strategies that promise superior returns but come with substantial costs and reduced transparency.
Leverage Tax-Efficient Strategies for Concentrated Positions
Section 351 of the tax code allows investors to exchange concentrated stock positions for diversified ETF shares on a tax-deferred basis, solving a major problem for those sitting on large unrealized gains. (60:15) This strategy works similarly to 1031 exchanges in real estate, where investors can roll appreciated assets into new investments without immediate tax consequences. The process requires contributing at least 12 different stocks or ETFs, with no single position exceeding 25% and the top five positions not exceeding 50% of the total contribution. (68:32) This approach enables investors to move from dangerous concentration risk into diversified portfolios while maintaining their tax basis, representing a significant advancement in tax-efficient portfolio management for high-net-worth individuals and advisors.
Apply Historical Context to Current AI Investment Boom
The current AI and data center capital expenditure boom follows historical patterns of technological infrastructure buildouts, including UK and US railroad booms and telecom hardware investments. (19:19) While previous infrastructure booms reached 2-5% of global GDP in capital allocation, current AI spending is at only 1%, suggesting the boom may have room to continue. (19:44) However, Faber warns against assuming US dominance in AI development, noting that breakthroughs could emerge from China, India, or other countries, potentially shifting market leadership as demonstrated by the DeepSeek developments that lifted Chinese markets. (22:23) Investors should maintain exposure to global markets and avoid concentration in any single country or theme, as market leadership frequently rotates over longer time periods.
Statistics & Facts
- The US stock market's current Shiller PE ratio is at 40, compared to 12 in 2009, representing more than a tripling of valuation multiples. (04:22) Faber notes this approaches the 1999 peak levels, though institutions frame this as "not yet exceeded" rather than acknowledging the extreme nature of current valuations.
- When any country's stock market has ended the year at a PE ratio of 40 or above, returns for the subsequent decade have never been above average. (24:01) This includes historical instances in China and India in 2007, and the US in 1999.
- The largest stock in any market or sector underperforms the broader index by approximately 3 percentage points per year over the next decade on average. (20:45) This pattern holds across different markets and time periods, suggesting that achieving maximum market capitalization is historically a poor predictor of future performance.
