Pod Insights The Prof G Pod with Scott Galloway Prof G Markets: The Merits of ETFs, Boring vs. Sexy Investments, and the UK’s Monetary Crisis About this episode This week on Prof G Markets, Scott discusses what makes a good ETF, and shares his thoughts on why investing in boring companies often leads to greater returns. He then explains why the markets had such an adverse reaction to the U. K. government’s latest tax breaks.
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Transcript Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
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1:18 Scott Galloway? This week's number, 500 billion. That's the value US office buildings stand to lose due to lower tenant demand. Also, that's how much the UK's stock and bond markets have lost in the first three weeks of Liz Truss's tenure as Prime Minister. Prime Minister Truss's legacy? Simple. No G7 leader has fucked up this fast.
1:40 Speaker 02 I will not rest until the British apple is back at the top of the tree.
2:01 Scott Galloway? Welcome to Prop G Markets. Today, we're discussing ETFs and K-pop. What a thrill! Boring versus sexy investments, and the UK's monetary crisis, and how bad I'm feeling about my new London mortgage. Moves to London 60 days too early. That's right. Buys a house, pays cash for it, and 60 days later, my house is worth 20% less. That's right! Donald Trump, minus the real estate acumen. Actually, he doesn't have any real estate acumen. So, right now, I am Donald Trump, minus the wig, the misogyny, and just the general fucking weirdness and ridiculously entitled children. Although I do have entitled children, but they're not little bag of shitheads. They're not awful people. Too much? Too much? Here with the news is Prop G Media Analyst Ed Elson.
2:46 Scott Galloway? Ed, what's going on?
2:48 Ed Elson? Still in LA. I'm loving it here. Playing volleyball every day, which is kind of nice.
2:52 Scott Galloway? Little Top Gun? Little homoeroticism on the beach?
2:56 Ed Elson? That's right. Me and my boys.
3:09 Scott Galloway? Alright, what's the news, Ed? Stop stalling.
3:11 Ed Elson? Let's start with our weekly review of market vitals.
3:20 Ed Elson? Despite a small midweek rally, the S&P concluded its September slide deep in bear country. The dollar remained strong, particularly against the plummeting pound. More on that later. Bitcoin and Ethereum were stable, and the 10-year yield briefly climbed above 4% for the first time in a decade in what was a wild week for the bond market. Shifting to the headlines, there's a theme this week and it's that prices across assets, as you predicted last week, are coming down. Home prices fell for the first time in a decade in the top 20 US cities. That's a clear indication that mortgage rate increases are lowering demand. Lumber prices fell to their lowest level in two years.
4:03 Ed Elson? Prices for cotton futures dropped more than 25% since August. Retailers are warning that demand for clothing is slowing. And the cost of shipping containers has halved in the last three months as demand for Chinese imports wanes. Scott, what are your thoughts here?
4:18 Scott Galloway? So earlier in the week, we spoke to Professor Danny Blanchflower, who's a professor of economics, and he said that in any modern economy, inflation is self-correcting, that prices go up, people start buying less, and then prices come down. When you think about what's going on, prices across the world are starting to deflate a bit. I think we're going to see energy prices come down. They've come down, I think, 85 of the last 90 days. It looks like commodities are coming down. And shipping containers, right? The cost to send one container from Shanghai to LA one year ago was $12,000. Today it's $4,000. So it'll be very interesting to see what the inflation print is in the next month or two months.
5:00 Scott Galloway? And here in the UK, which just makes no goddamn sense, they're both cutting taxes on the wealthy, which is supposed to be stimulative, put more money in people's pockets, they invest, they buy things, that's supposed to be a growth move. And at the same time, there's a rumor that they're going to increase interest rates by 175 basis points, which is meant to dampen demand. So that's like when the dog goes out and orders his favorite drinks, a Kappa and Coke. This Akapa takes me down, it's a depressant, I want to deprive my brain of oxygen so I'm less in touch with the reality of who I am and the world in which I exist. But at the same time, the Coke with its caffeine keeps me up. A little driving the wrong way down a one-way street. And it feels to me that's what they're doing here in the UK. They're both stimulating and dampening demand, which makes absolutely no sense to me.
6:01 Speaker 04 ETFs, or exchange traded funds, are known as a safe, efficient way for investors to diversify their assets. And for the most part, that's true. But recently, we've been noticing some ETFs that don't fit that description. For example, one ETF launched about a month ago, under the ticker K-pop. It invests in firms with exposure to K-pop, or Korean pop music.
6:28 Speaker 04 Now, this is not what we mean by safe and diversified, right Scott?
6:32 Scott Galloway? So the question is, is this just a marketing moniker? Similar to ESG, as soon as Wall Street saw it was something people wanted, they labeled everything ESG. When ETFs got a reputation for cheap and safe, Wall Street started pushing expensive and risky investments as ETFs. So one ETF is not like the other. You want to look at the fine print and make sure you're getting what was a component of ETFs, and that is low fees.
6:53 Speaker 04 This seems like a good moment to define what an ETF actually is. ETF stands for Exchange Traded Fund. And it's essentially a basket of assets, usually stocks, but also bonds and commodities. It trades like a stock on exchange, and you can buy them through any brokerage app. And it's similar to a mutual fund, except that with a mutual fund, you buy shares directly from the fund company, and not on an exchange. So there are two types of ETFs: passive funds and active funds. Now, in a passive fund, the assets that make up the basket are managed by an algorithm. Often, the algorithm simply tracks a popular market index, such as the S&P 500 or the NASDAQ. And those are known as index funds.
7:38 Speaker 04 In an active fund, the assets in the basket are managed by humans, analysts, and they're trying to maximize their returns by buying and selling those assets. And they're also expecting to get paid for their efforts. So usually, active funds charge much higher fees than passive funds. And the fee is called an expense ratio.
7:56 Ed Elson? So K-pop, for example, that's an actively managed fund. And the company behind it collects a 0.75% fee. That's quite high. It doesn't sound like much, but it compounds into a significant cut over time.
8:08 Scott Galloway? So keep in mind indexed ETFs often, but not always are safer, lower cost investments. You want to look for, in my view, established reliable returns and low costs. SPY, which tracks the S and P 500, is down 22% year on year. 10-year average annual return has been greater than 10%, however. The expense ratio on this one, and we love this, is just nine basis points. Always lean towards diversification and lower costs.
8:54 Ed Elson? We often talk about sexy companies like Apple and Tesla. These are the kinds of companies that attract a lot of retail investment and media attention. But professional investors know that the most rewarding and lucrative businesses are often the opposite. Boring. Let's take two examples. First, funeral homes. There are about 19,000 of them in the U.S. And they form the backbone of the more than $20 billion death care industry. To put that in perspective, death care in the U.S. generates more revenue each year than the streaming music industry globally. And recently, death care has gotten special attention from private equity firms. 80% of funeral homes are privately owned. So the private equity industry has consolidated these businesses and raised prices.
9:39 Ed Elson? Now the word is out. Funeral homes used to sell for five to six times revenue. They're now selling at roughly seven to nine times revenue. Another example is utilities. One of the highest premiums paid this year in U.S. M and A was for the municipal septic and water system of Tower Mensen, a small town in Pennsylvania. Next Era Energy, the world's biggest utility company by market cap, announced in June it would buy the wastewater system for $115 million at a multiple of 21 times revenue. That's $14,000 per customer account and four times the average for these types of deals. So Scott, can you speak more to this boring versus sexy dynamic? And maybe how that's played out in your own life?
10:24 Scott Galloway? So this is one of the key dynamics or constructs I try and proselytize, educate, convince my students of. And that is there is an inverse correlation between your ROI and sex appeal. And what do I mean by that? There are hundreds of thousands of people in Hollywood chasing thousands of jobs in the world of acting. There is too much human capital chasing too few opportunities. The result is your return on investment, your headache, your effort, even if you make money in that field, you have to be an outstanding actor just to make a shitty living, to make any living at all. And there's some false signals because we read about people making $10 million for a movie. But the average actor is somebody who maybe works very hard, is trained at it,
11:08 Scott Galloway? gets some roles and has trouble paying their rent. Why? Because everybody wants to be an actor. Everybody wants to be an athlete. Everybody wants to own a nightclub, a restaurant, go to work for Vogue magazine. So the sexier an industry, the more human and financial capital it attracts. And when an industry becomes over invested, the returns get driven down. So what do you want to do? In my view, you want to think about industries and investments that are boring. And boring equals sexy because the sexiest thing that can happen to you in your life, or one of the sexiest things that could happen to you in your life and will likely make you sexier is if you pick investments that show a great ROI. So how has this affected my investment life?
11:50 Scott Galloway? I have a friend who's starting a members only club for artists and people in the media industry. That could not be cooler. I'll be a member, but I'm not investing in it. I have another friend who started a software company focused on healthcare maintenance workers. I hear this thing, I want to put a gun in my mouth, it sounds so boring. Boom, I will write them a check. So just be mindful, if you're investing in something cool, if you're investing in a nightclub, if you're investing, I don't know, in a sports team. That's fine, but realize that's consumption and hope that you get a lot of psychological return out of owning a small piece of a nightclub or a small piece of a restaurant. Best investment I've ever made was I bought a bunch of single-family apartments out of foreclosure from the Palm Beach County courthouse, literally go to the steps and then bid on
12:35 Scott Galloway? these condos where everyone was sending in their keys and bought these things that originally cost a quarter of a million dollars, bought them for $80,000 and they're probably worth five times that now because nobody wanted these things. When everyone is running from something, take pause and think, okay, is that the time to run into the fire and invest? Boring is sexy.
12:56 Ed Elson? When did you buy those condos?
12:58 Scott Galloway? 2011 to 2012.
13:00 Ed Elson? What was your thinking? I mean, I know boring, but how did you know to buy them?
13:05 Scott Galloway? It was really fairly easy at the time when I had some capital. And by the way, that's the hard part. Typically, when shit is cheap, you also don't have capital. So I was fortunate enough to have a little bit of capital. You could buy a condo for $80,000 and rent it out for $1,000 a month. So you're getting 15% cash on cash. I do not know real estate. I'm not a real estate guy, but I can do math. And I thought, that's just a great deal. We're going to be fine. And so I bought a bunch of these things, put a little bit of money into them, put my in-laws to work. I love cheap labor. I love the cheap labor of the in-laws. After they're watching my kids, they go and they install an air conditioner that's broken down in one of these apartments. If I had to do it again, I think I would have put more money into real estate earlier
13:47 Scott Galloway? because what you have with real estate is a tax-advantaged asset class. If you buy real estate you're not living in, it's a business. You get to depreciate it 2% a year, even if it's going up in value. If you look at the Forbes 400, generally speaking, there's three groups of people. One, the smartest group of people inherited wealth. If you're not smart enough to inherit money, it breaks down the two other cohorts that populate the Forbes 400 are entrepreneurs and people in real estate. It's a great asset class.
14:23 Ed Elson? We'll be right back after a quick break with a look at the state of the economy in Scott's new home, the UK.
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16:55 Ed Elson? We're back with Prof G Markets. Last week, the British pound fell to a record low relative to the dollar. At one point, the pound was worth $1.03, almost at parity. This came after the UK's new Chancellor of the Exchequer, Kwasi Kwarteng, announced a new fiscal budget that included the biggest tax cuts in 50 years.
17:15 Speaker 05 Corporation tax rate will not rise to 25%. It will remain at 19%, and we will have the lowest rate of corporation tax in the G20.
17:26 Ed Elson? After that speech, two major things happened in the markets. First, investors started dumping the pound, hence the record low. And second, there was a massive sell-off in long-term UK government bonds, otherwise known as gilts. The sell-off was so drastic that eventually the Bank of England had to intervene and committed to buying 65 billion pounds' worth of bonds to prevent further slide. Scott, why do you think the markets reacted so badly to these tax breaks?
17:55 Scott Galloway? So the crashing of the pound and the bond sell-off are kind of equivalent to a vote of no confidence. The cost of the tax breaks will be almost 2% of GDP, and the government gave no explanation regarding how they'll pay for it. And they're supposed to be fixing inflation, not adding to it, not having debt-fueled parties for the rich. UK inflation is, get this, 9.9% of 40-year high. Prime Minister Trust wants to emulate sort of the Thatcher-Reaganomics, but during the Thatcher era, the UK debt was 40% of GDP. Today, the UK debt is greater than 100% of GDP. So they just don't have the bullets to fight this war with tax cuts right now. Our guest on a pod last week, Danny Blanchflower, is bearish on UK monetary policy.
18:38 Speaker 06 If you look at what happens in the UK, we've seen complete and total meltdown and chaos. And we're in the position where the Bank of England is having to fight to say this is so bad that we probably need to have an emergency meeting to raise rates. And the government doesn't want them to do that because it would be an indicator of what's coming. So I think we're in chaos. I think recession is going to be much deeper than people think.
19:01 Ed Elson? Yeah, the International Monetary Fund criticized these tax cuts, and they recommended the government, quote, "reevaluate the plan because it threatened to worsen inflation." The agency also said it's, quote, "important that fiscal policy does not work at cross purposes to monetary policy." Can you explain what the IMF means by that?
19:22 Scott Galloway? So fiscal policy is the government's job and monetary policy is the central bank's job. The Bank of England is trying to tame inflation by raising interest rates and selling bonds. Tax cuts counteract that, right? So when you, one is growth, tax cuts grow the economy and are inflationary. And then raising interest rates and selling bonds is meant to dampen demand and bring down inflation. The gilt sell-off, which is these long-term bonds, British bonds, made things worse. The Bank of England had to intervene. They had to go in and start buying bonds. So this really is a catastrophe. Just as in the US, we're going to really enjoy this downward sucking sound of prices going down because the dollar's so strong.
20:07 Scott Galloway? Imagine what's going to happen to prices for UK consumers when the pound is trading at an all-time low. I mean, Toyotas, everything from Toyotas to Parmesan cheese is about to get very, very expensive here, which is not going to do the British people any favors who are already dealing with really incredibly high inflation. So this was seen as just, okay, how do we shoot ourselves in the foot and then take the gun and put it in our mouth?
20:32 Speaker 02 We import two-thirds of our cheese. That is a disgrace.
20:40 Scott Galloway? All right, Ed, what's on tap for the week ahead?
20:45 Ed Elson? We're watching the unemployment report on Friday, which is expected to show another slowdown in hiring. We'll also be looking at earnings from Levi's and Conagra. Conagra's brands include Hunt's Tomatoes, Ready Whip, and Slim Jim. And we'll see if those falling commodity prices are starting to affect their bottom lines. Do you have any predictions, Scott?
21:04 Scott Galloway? My prediction is the gift that kept giving for the last 13 years, and that is residential real estate prices that have basically been on a tear for 13 years are about to see a pretty significant decline. And it was this one stat that we found that really kind of rattled me, and that is for a $2,500 a month payment and 20% down, in early 2021, you could buy a house for $759,000. Now, with mortgage rates above 7%, that same monthly income, in other words, that same couple, that same income.
21:40 Scott Galloway? They can afford a house that's worth $476,000. So if you've had a decline in purchasing power of residential real estate because of skyrocketing mortgage rates of almost $300,000, which says to me that the middle market in real estate is about to get crushed. But I think an actual correction in bringing the prices of houses down makes a lot of sense. And I think there's a lot of young people that just need a certain amount of forest fire here amongst asset classes, such that as they come into their prime income earning years, things are a bit more affordable. Now, if you're caught on the wrong side of that, you get laid off, or you just bought a home and you overpaid, or you have a variable. You know, there's no free lunch. People get hurt with this stuff.
22:24 Scott Galloway? But I think long term, we need housing prices to come down. It has become unaffordable. As a multiple of your income, I think housing is now trading at near an all time high. So an adjustment down, as painful as it is along the way, I think is overdue and long term is a good thing. That's all for this episode. Our producers are Claire Miller and Jason Stavers. Special thanks to Catherine Dillon, Ed Ellison, and the PropG Media team. If you like what you heard, please follow, download, and subscribe. Thank you for listening to PropG Markets from the Vox Media Podcast Network. We will catch you next week.
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