Cliff Asness on How Markets Got Dumber in the Last 10 Years

The Odd Lots podcast has been around for 10 years. Unfortunately, markets have gotten less rational over the same time frame. At least this is the contention of Cliff Asness, the co-founder and CEO of AQR Capital Management, a quantitative investing firm that's been around for nearly three decades. Asness' approach to investing is rooted in academic theory, having studied under the legendary Eugene Fama at the University of Chicago. In the world of social media and meme stocks, it's tough out there for the academically minded. And that's forced Cliff to adjust his approach over time. On this episode, we talk about the history of quantitative investing, market efficiency, and the emergence of AI/ML in his process. We also talk about the reality of investing other people's money, and the challenge of sticking with one's convictions at a time when temporary forces are working against you. See omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

• 0:26Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 1:08Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

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• 3:15Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alockway.

• 3:19Joe Weisenthal?

  And I'm Joe Weisenthal.

• 3:20Tracy Alloway?

  Joe, it's a big month for us.

• 3:22Joe Weisenthal?

  Big month for us. We've been doing this for 10 years.

• 3:25Tracy Alloway?

  I know. I can't believe it. Do you remember the first episode?

• 3:28Joe Weisenthal?

  Yeah, of course, with Tom Keen.

• 3:30Tracy Alloway?

  Yeah. And then our second episode, I think, was about bananas, for some reason.

• 3:35Joe Weisenthal?

  Yeah, I think it was. You're right. It took us a long time to figure out what we were doing. It took us a long time to figure out what we were doing. And I don't think, at that point, I would have expected that we'd be doing it 10 years later. I don't know what I was expecting. We were just turning on a microphone in a radio studio and talking for a while.

• 3:51Tracy Alloway?

  Oh, we started doing it because we wanted to have a podcast and talk to interesting people. I think we were hashtag blessed that no one was listening for a very, very long time, which gave us a long runway to figure things out. So, we got lucky. That said, you know, 10 years, it is, in fact, a long time to be doing this, and a lot has changed in that period.

• 4:12Joe Weisenthal?

  A lot has changed in that period. Sometimes mind-blowing, and we've talked about this before, for sure. But the things that we were covering is capital N news at the time are now capital H history. And it's like, these things that are, we sort of take for granted, everyone was there. It's like, no, children, let us tell you what it was like in the old days, when people were worried the world was going to come to an end because, you know, Greece's sovereign debt and all this stuff that we just sort of... Part of the landscape is people don't remember it.

• 4:40Tracy Alloway?

  No, one of those things has to be the idea of value or fundamental investing, right? Like, let us tell you about the days when price actually mattered and had a limit to what investors would pile into.

• 4:51Joe Weisenthal?

  Yeah, that's exactly right. Let us talk about the days when people used to talk about P/E ratios and this stock, oh, it's at a 25 P/E, we better sell it and buy the stock at a 15 P or whatever. Yes, that feels quaint. Maybe it'll be back there one day, but for now, given how many things in the market seem to be, the Graham and Dodd kind of stuff, feels a little old.

• 5:12Tracy Alloway?

  A little old fashioned, right?

• 5:14Joe Weisenthal?

  A little old fashioned.

• 5:14Tracy Alloway?

  Yeah, okay. So, one of the big themes that has emerged in the 10 years that we've been doing this podcast is everyone seems to have grown more stupid, I would say. Hopefully, that's not related. That's not like a correlation thing.

• 5:25Joe Weisenthal?

  It might be.

• 5:27Tracy Alloway?

  It could be. All right. But, you know, we have all this gamification of investing, people betting on lines going up.

• 5:33Joe Weisenthal?

  Yeah.

• 5:33Tracy Alloway?

  Or down, people betting on random meme coins, things like that. And I think, you know, we talk about it a lot on the podcast, but this is actually a fundamental shift in the market. If you think about the market as something that's supposed to be about capital allocation,

• 5:47Joe Weisenthal?

  Yeah.

• 5:47Tracy Alloway?

  alignment of incentives, people are investing in something because they think it's going to be profitable in the future at the right price. And now people are just sort of piling into stuff because other people are doing it. And again, line go up.

• 6:00Joe Weisenthal?

  Deep down, I still believe that the value of a stock should reflect the net present value of all future cash flows.

• 6:05Tracy Alloway?

  I know you're an EMH guy.

• 6:06Joe Weisenthal?

  But I've, it's been a little bit hard with some of these things. And, you know, the other thing too, that is sort of changed is that like half of our episodes these days are kind of AI related in some way. And so I think there's a lot of interesting stuff going on, particularly at the intersection of tech and applying tech to, both investing in tech, but then the application of tech to investing and so forth. So, yes, much has changed.

• 6:30Tracy Alloway?

  A lot has changed, and we have the perfect guest to talk about how everyone has grown more stupid over time. We're going to be speaking with someone we've wanted on the show for a really, really long time. I am very excited about this. It's Cliff Asness, the co-founder and CIO of AQR. Thank you so much for coming on All Thoughts.

• 6:47Speaker 06

  Thank you for having me.

• 6:48Tracy Alloway?

  What's it like to be a rational person living in an irrational world, Cliff? Yeah, you've been doing it for a long time.

• 6:54Speaker 06

  Well, a rational person is not always how I'm described. But there's rational investing and then there's rational conduct in your personal life. So let's just distinguish those. You guys in your intro said like, it's a little, it's a little scary for the next hour because he said like a third of the things I want to say.

• 7:10Tracy Alloway?

  Oh, shoot. Okay.

• 7:12Speaker 06

  I wrote a rather gigantic piece in the Journal of Portfolio Management. They were having a 50th anniversary. None of us were quite old enough to have been there in the first issue, but they were looking for the old guys to write kind of retrospectives. And the piece I wrote was called the Less Efficient Market Hypothesis. Now, I think you guys probably know this, but my dissertation advisor was a little known guy named Eugene Fama. We've heard of him. I was his TA for two years. I grew up in EMH. I love that you guys just say EMH and your audience knows. Yeah. What you're talking about. That is not the norm for me when I talk about these things. I was not a perfect efficient marketer even back then. Neither is Gene, by the way. Gene's not a zealot. About third week of class.

• 7:57Speaker 06

  I know this because I took the class three times. I didn't fail, but as the TA, I sat through it. Three full years. And like the third week, he always tells the class, markets are almost certainly not perfectly efficient. Because Gene's a brilliant guy and recognizes that perfection is a really stupid idea.

• 8:14Tracy Alloway?

  He's been on the show, by the way.

• 8:15Speaker 06

  Oh, I didn't know that. Yeah. And I don't know if that came up, but he's always very honest about that. He probably thinks they're considerably more efficient than I do these days. And I think I probably think it's they're more efficient than maybe the active average retail trader. But I wrote a dissertation for him on the success of price momentum. That is not a very Gene Fama dissertation. A Gene Fama dissertation is I've studied price momentum and it loses gobs of money and these idiots on Wall Street do it anyway. That's kind of a fish in markets. Look how silly they are. And he was great about it. I remember I kind of mumbled, I'm like, I want to write a dissertation on price momentum. And by the way, I find it works very well. What was that cliff? It works very well. And he said, if it's in the data, write the paper.

• 8:58Speaker 06

  So I've drifted at least a little bit further from efficient markets, even way back then. Now, price momentum, I'll do a lot of segues. You're going to have to stop.

• 9:07Tracy Alloway?

  No, that's fine.

• 9:08Speaker 06

  I do parentheticals within parentheticals. Price momentum is often thought of as this index of irrationality. It can work for two different reasons. It can work because of, yes, feedback loops, chasing, line goes up, just like you said before, and people pour in, which isn't very connected to reality. It's just chasing returns. But it can also work because of what the behavioral finance people would call underreaction. News comes out that should move the price by so and so. On average, we have found, and I say we, it's the royal we of academia and private researchers, that the price moves the right direction, but doesn't move all the way. So if you trade on that, there's still a little bit to go. That's a quant thing. You wouldn't want to bet on one stock that way.

• 9:52Speaker 06

  But if on average that happens, and you could do that through observing the price or the fundamentals, there's usually a little bit more to go. So it's not always irrational momentum. But here's what I observed. In the very beginning of AQR, AQR launched in 1998, after we had a fabulous run at Goldman Sachs. There's survivorship bias in this. You don't get to start your own billion dollar hedge fund unless you have a fabulous run at Goldman Sachs or something equivalent. We had a good first month. You know how the story's going to go when you say you had a good first month, right?

• 10:22Tracy Alloway?

  And then?

• 10:23Speaker 06

  That first month, by the way, it was August of 1998, when the S and P was down 20% on the Russian debt crisis. And we're doing high fives, like we say we're market neutral and we're up a little bit in a crash. And it was my first of many lessons, never to high five in this business. When you fully retire and divest, you get one high five. No, but, but.

• 10:46Tracy Alloway?

  That's the, well, no, it's the end when you do the high five.

• 10:49Speaker 06

  I'm a quant who is also superstitious, which if that's a contradiction, what the heck? But the next 18 months was the crescendo of the famous dot-comer tech bubble. And that was not kind to us. It was particularly not kind because we decided to start with a extremely aggressive market neutral fund. So momentum helped, as you can imagine, in a bubble, but value was just destroyed. And that was most of the model back then. Things have really broadened out. We hit spreads between cheap and expensive. This is something we invented at the time, and now a lot of people do. People have said, sort stocks on valuations go long, the cheap, short, the expensive. But the very obvious question of how cheap and how expensive, are they sometimes pretty tightly clustered? Are they sometimes wider?

• 11:33Speaker 06

  Does that mean they're better or worse going forward was not asked before. So we invented this measure and the spread between cheap and expensive for 50 years had looked like a well behaved series. It moved around a fair amount. But, and then I'm drawing on my hand if no one can see the video.

• 11:51Tracy Alloway?

  Oh yeah, we should mention this is an audio medium.

• 11:54Speaker 06

  And then in late 99, 2000 went to just way wider than anything ever seen for 50 plus years. We also showed that historically, those were better times. You never saw that before, but when it was wider were better times for value. We stuck with it. We made money round trip. Life was good. If you had asked me after the round trip, which was harrowing, you know, even if we love our process, you never want to start a business with poor returns. If you asked me at the end of that, which was probably a couple of years later, 2003, do you think you're ever going to see that in your career again? No one asked, thank God, because I think I would have gotten it wrong, but I think I would have said, oh, probably not. Hopefully I wouldn't say definitely. No one who does what any of us do for a living should say definitely.

• 12:38Speaker 06

  That's a bad word in markets.

• 12:40Tracy Alloway?

  Forty percent is the favored term, right? There's always a forty percent chance.

• 12:44Speaker 06

  But A, it was the craziest thing numerically in 50 plus years. B, the question presupposes it's built in that I and people of my cohort will still be around. Right? And we'll probably be closer to in charge. So how's it gonna happen again? And then it happened again. Even before COVID, by late 2019, that spread between cheap and expensive was approaching dot com extremes. And then it blew past it in COVID. It went to what I, in a geeky math joke that no one ever gets called 125th percentile. There is no 125th percentile. It's just the new 100th percentile. I'm trying to convey that it went further. And we survived that one, too. We suffered somewhat, and then we made more than all of it back. Round trip, good.

• 13:29Speaker 06

  Most of the time, we really don't look like value investors, by the way. Only in extreme bubbles do we seem to have that property. And I think it's smaller now than it used to be. The last five years have been quite strong for us, and it's not been a very good value market.

• 13:42Joe Weisenthal?

  God, there's so many questions that I have that I want to ask that are sort of embedded or related to your answer. I'm gonna ask you just like a very narrow question, sort of skip ahead and something. Don't you make this spread between the most expensive and the cheapest stocks?

• 13:58Speaker 06

  Yes.

• 13:59Joe Weisenthal?

  How much easier it is to simply compile that spread is it today versus the technology that you're working with when you're starting your career?

• 14:09Speaker 06

  For that, I gotta disappoint you and say not that much easier. We had the databases.

• 14:14Joe Weisenthal?

  Okay.

• 14:14Speaker 06

  A lot of technological advancement is about speed.

• 14:18Joe Weisenthal?

  Okay.

• 14:18Speaker 06

  And new data sets, what Quans will call alternative data, is something we're very into. But the classic data, if you're looking for price to sales ratios. I'm old, but we had telephone. We had telephones in Bloomberg's. But that does bring us to me observing these two episodes. And I stepped back and I asked a question. What the hell happened? Why did we see something crazier than 50 years? And then why did it happen again? And that led to this paper, the Less Efficient Market Hypothesis. I do believe that markets have shown, and I think I have some good guesses as to why, that they are more susceptible to bouts of crazy. Than they used to be.

• 14:59Joe Weisenthal?

  Just before going further, one quick definitional question. Efficient markets, because one way you could define whether a market is efficient is, are these securities disconnected from what you would say the net present value of the all future free cash flows? Another way that I often think about it, but I'm no quant, is are there obvious opportunities for the active manager to make money?

• 15:21Speaker 06

  Sure.

• 15:22Joe Weisenthal?

  Just for our purposes here, how do you define market efficiency?

• 15:25Speaker 06

  Much closer to the first one.

• 15:26Joe Weisenthal?

  Okay.

• 15:27Speaker 06

  The practical question of can you make money from these is if there are big deviations from fair value, and this relates to some stuff I did in a less efficient market hypothesis. If there are big deviations, the classic, and you'll notice a giant caveat, if you can stick with your position, not a small thing, you will make money. There are opportunities, and in fact, I think a less efficient market in that sense, in your present value sense, almost has to deliver bigger opportunities for people who can stick with it. It also makes it considerably harder to stick with.

• 15:59Joe Weisenthal?

  Yeah.

• 16:00Speaker 06

  Because the extremes you have to live through and the length of time those extremes can go on for. One thing that I'm dying for an academic to take me up on this, I'm too old to do the math on this, but I've never seen a model that looks at pain, disutility, the negative of losing money, in terms of how long you've lost money for, not just magnitude. Right? And in real life, I can tell you, a drawdown that is one and a half times bigger, but with six months instead of three years, is ridiculously easier to live through. So the bigger disconnect from reality, again, I haven't even told you why I think it's going on, but if I'm right, that we have these bouts of it, it's not necessarily every

• 16:43Speaker 06

  day things are crazy, but these bouts of it, is a two edged sword. It's a bigger opportunity for people who can stick with it, and it's harder to do. And I find that, not that what I think is fair is particularly relevant, but I find that really fair. Harder to do, but more lucrative if you can do it. I don't think the efficient market idea of buying what is fundamentally mismatched against its future cash flows adjusted for its risk. Forecasting those cash flows, what risk really means, we still have some open issues there. Yeah. But I don't think that will ever go away unless markets are perfectly efficient. But how easy it is to identify and how easy it is to stick with. I think crazy markets make it easier to identify what to do and harder to do. I like that.

• 17:27Tracy Alloway?

  I do want to ask you why you think this is happening, but before we do, this is a very basic question, but sometimes the basic questions are the most interesting. But when you say it's painful to try to stay rational during these bouts of irrationality, why is that exactly? Because I get that there are funding costs, I get that there are carrying costs. But on the other hand, you're a big hedge fund with deep pockets. This is presumably what investors are paying you to do. Is it just the emotional trauma or stress of having to explain to everyone why you're taking the position that you have when it's not paying off yet?

• 18:01Speaker 06

  That is a big part of it. I have a running fight with one of my co-founders who never gets upset. I'm always upset, but I'm more upset when we're losing money.

• 18:09Tracy Alloway?

  This is sort of our dynamic. I have to, I get more upset than Joe does.

• 18:13Speaker 06

  Where he'll come in my office during a bad period and I'll be upset. It'll be a bad day and a bad period. He's like, why are you upset? And I'm like, well, because people are yelling at us and I, we're losing money. And he's like, but you're pretty sure we're going to win, right? I'm like, yeah. He's like, and you have all your own money and your kids' money in this, right? So you're not doing anything different. You wouldn't do that if you weren't. I'm like, yeah. He's like, so we're going to win. It's just a question of when, why do you care? And I look at him like he's from Mars and go, why do you not care? And we finally figured out, it's kind of obvious, that I talk to clients a lot more than he does. It's a lot easier to have that attitude when you're just sitting in your office. Also, we are not immune from this.

• 18:56Speaker 06

  Even if people love you and think you've done well for 25 years, you have a bad. Two years, you get redemptions and sometimes they're of serious size. We fell by like half over about three years. And that's not fun. You have to shrink your firm. You have to let some people you love go. So there is some real pain that goes with it. That period did not shake my confidence in the actual investment process. I feel bad. I think I did better than our investors because I kept adding and saying, take the ball up on what I do. Not everyone can do that and I know more than they know, not in a weird insider sense and just a, I should be more confident in my own process than anyone else's. But it is excruciating. The amount, I remember someone I admire tremendously when Stan Druckenmiller retired

• 19:41Speaker 06

  to run his own money. He's still very active in markets, I think. He wrote a note that resonated with me because I forget the exact details, but the essence was, it's too painful and too upsetting to run client money. The man never had a down year. And I'm like, if Stan can't take it, those of us, and we've had a lot more up years than down years and life's been good or I won't be sitting here. But we've had never three, but two plus years of pain. And I'm like, if Stan can't take it, man, this is harder to do than it looks like. The whole world thinks you're stupid when you're losing money. No matter what you can point to, no matter what evidence you can point to. I should say the whole world. Your mom still likes you. But a lot of your world and no, a lot of investors stuck with us and I love them for it.

• 20:25Speaker 06

  But you do lose a lot of people. So it's not fun for a business to go through that.

• 20:29Joe Weisenthal?

  Intuitively though, it's to your point, measuring the disutility of long drawdowns versus deep drawdowns. This must be a very acute thing for anyone who's not just managing their own personal portfolio for the reason that you've just described.

• 20:44Speaker 06

  Yeah, I've talked about this with other money managers, this idea of length versus severity.

• 20:48Joe Weisenthal?

  Yeah.

• 20:49Speaker 06

  And I've never had one who's not like, yeah, length is much worse. Well, one of the things is when something goes on, it's often a similar story for two and a quarter years. Right? So you go back after six months where rationality is getting absolutely punished. You get a lot of sympathy from people. You show them, look, bigger bargains, we're right, we're going to be right. You go back. Six months later, they're like, oh, okay. You go back six months and six months later, they're like, you're just saying the same frigging thing.

• 21:21Joe Weisenthal?

  And eventually, they must just think, maybe you're a dinosaur. Like, maybe you just don't get this new wave that's going on. Is it possible that we've really had regime change?

• 21:28Speaker 06

  Again, it's not everyone. We have a tremendous amount of investors. Stick with us. We have ones who double up, who get it, that those are often opportunities. But you shrink when you lose money for a while and you grow when you make money for a while. It's the ironclad rule of this business, and sometimes it's just backwards.

• 22:00Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

• 22:27Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 23:09Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

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• 24:50Tracy Alloway?

  So one of the things that has been happening recently that has changed from 2015, when we started doing this, is retail participation in the market. And it just feels like it is such a big thing for retail investors now to use things like options, even, you know, one- or zero-day options, the kind of stuff that you might more traditionally associate with someone running a hedge fund. Now they're trading.

• 25:12Speaker 06

  No, we're not stupid enough to trade zero-day options.

• 25:15Tracy Alloway?

  All right, some hedge funds, then. Does the increased presence of retail in the market change the way that you do business at all?

• 25:24Speaker 06

  I think it contributes to what we're talking about of this dislocation. I hate this because I sound very elitist when I diss on retail. But there's a lot of academic work that shows retail on net loses. Net is important. They go through periods where they win. They go through periods where they win a lot. You know, if you buy a meme stock and it triples tomorrow, you don't always lose. But on average, retail transfers money to Wall Street and to institutions. So if there are bigger force in markets, you're going to have more of that going on. And it jives perfectly because that would raise the opportunity. If they're generally on the wrong side of things. But there are more of them, many more of them than there used to be.

• 26:08Speaker 06

  They can be right, even if they're wrong on the facts. They can be right on the numbers for longer than they used to be. So I do think this is part of it. And I apologize to all the really smart retail investors. Anytime you talk about averages, you're dissing a whole lot of people who don't deserve to be. But on average, retail loses zero day options. My God, they're making exactly the people they claim to despise on Wall Street. Very rich by trading these things. And it's just FanDuel's.

• 26:38Joe Weisenthal?

  I love that. Well, all right, we got to get to the question of why, right? But one last question sort of leading up to it. How do you establish that? What do you look at in the market that right now you say this is a less efficient market than once it was? What is the measure? Or is it just feel or you just it feels sort of crazy like all of us observe?

• 26:57Speaker 06

  Most of it is quantitative. I do start with this thing I've talked about already. The spreads between cheap and expensive. I don't just look at spreads. I wrote a piece back in 2000 during the tech bubble. It's called Bubble Logic. It never got published because I tried to make a book out of it. And the bubble came down too fast for me. That was good for my business, but bad for my author career. Where I didn't just look at price multiples. I looked at it in a more holistic sense. What growth do we need to justify these multiples? Trying to come up, the only time I will use the word bubble is when I've tried very hard. And it doesn't mean we'll come up with the same answer, but this is the framework I use.

• 27:37Speaker 06

  I've tried very hard to come up with assumptions, even if I don't like them and think they're at the outer edge of possible. That could justify these prices. Yeah. And if they don't come close, twice in my career, I've been willing to go, no. I'm willing to use the B word. I should tell you right now, when it comes to within stocks, the whole market is a different issue. The market is quite expensive right now. But when it comes to this spread between cheap and expensive, I'm not using the bubble word. Okay. That same measure, it's not the 125th percentile anymore. It's the 77th percentile. It's wider than on average, maybe making it a little more attractive if you can stick with it, that big if. But I don't use the word bubble for 77th percentile. I use it for blowing through.

• 28:20Speaker 06

  So five years ago, I was saying it's a bubble. Now I'm just saying this is a little bit of an odd market.

• 28:27Tracy Alloway?

  So I want to ask you more about the bubble, but we keep touting that we're going to ask you the why question. So let's ask the why question. Okay, why are markets becoming less efficient?

• 28:36Speaker 06

  Okay, well, first of all, and I say this in the piece, a lot of conjecture going on. This is an op ed. As statisticians. Isn't that like a 50 page? Yeah. A 50 page op ed. A 50 page academic op ed. Look, this is our first time doing this. You will be convinced I could do a 50 page, single spaced op ed. I believe you, I know you can. It's just, as a quant, as a statistician, you'd like to see 100 bubbles, have stats on each one. This where they're all, they'd rhyme, but they wouldn't be exactly the same. You'd tease out what's going on. If you see two in a 35 year career, you're not going to be able to prove this statistically. But I believe in my conjectures. I'm not soft selling them. I'm, I just want it clear that nobody is going to walk away saying he proved it.

• 29:20Speaker 06

  I list a few reasons in the piece why markets might be prone to bouts of bigger disconnects from reality. My second favorite is one I'm sure you've talked about. I know I've listened to you guys talk about it, the rise of passive investing. I am not a passive hater. There are really smart people, Mike Green's out there, the amount that guy hates passive. I don't know, the Middle East has never seen hate like, like the amount Mike Green hates passive. But, but again, he's a smart guy, he makes interesting arguments. I'm not that guy. I think passive has been a huge positive for an investor welfare. I actually was lucky enough to be fairly good friends with Jack Bogle, and he was a hero of mine. We had a podcast briefly and he came.

• 30:00Tracy Alloway?

  Did you really?

• 30:01Speaker 06

  And he came on. I found that. In fact, I'll tell you part of that story in a second. So I'm not a passive hater, but here's what we know. We know the whole world cannot be passive. And when I say passive, I mean in a Jack Bogle market cap weighted sense. Sometimes people use passive for people like us and they really mean rules based. And that's not how I use the word passive. You mean someone who owns the entire market? Yeah, we're long, short and levered. How you get to passive on that, I don't know, but some people do. I own the entire market. We had Jack on the podcast and he absolutely agreed. Everyone can't be passive. Now, of course, being Jack Bogle, he thinks at that point, the marginal investor should still move to passive.

• 30:40Speaker 06

  But he recognizes the obvious fact that if 100% of the people are not looking at prices, nobody's looking at prices. Who's figuring out if Nvidia is worth more or less than the corner drugstore, right? So the market gets very weird there. We don't even understand what happens. It's a singularity. I use a physics analogy. We don't know what happens there. PhD students in finance, and I used to be one of these, will stay up late at night in their cups. Talking about what happens if everyone was passive? What would it even look like? We know it's very weird and I doubt all the weirdness happens between 99.999% passive and 100. So we're on a curve. We're a lot more passive than we used to be. Even that, you're probably aware, it's hard to measure exactly how much is passive.

• 31:25Speaker 06

  Direct passive, true market cap weight you can measure. But what about people who take, you know, 80 basis points of tracking error? They're kind of mostly passive.

• 31:34Tracy Alloway?

  Or people pegged to like custom indices now. It's kind of funny.

• 31:38Speaker 06

  You guys remember the Princess Bride? Yeah, yeah. Remember mostly dead?

• 31:41Tracy Alloway?

  That's right.

• 31:42Speaker 06

  Not fully dead. You're mostly passive. So I think fewer people thinking about prices, fewer people willing to take the other side. When things get a little crazy, if one side really starts to get crazy, there are fewer people out there. That has to exacerbate these swings. My actual number one reason. Though, you talked about the gamification. For me, it's the overall, I'm gonna sound like a very old man yelling at the sky on my lawn right now. You know, get off my lawn, or yelling at the sky, some Simpsons thing. Yeah. I'm Abe, in this case. Old man yells at clouds. Exactly, thank you. Social media and the broader environment that you guys were talking about.

• 32:24Speaker 06

  I don't wanna do politics, except to say, I don't think you find many people, there'll be some, but I don't think you find many people who don't agree with the idea that this environment has made our politics worse and more dangerous. Confirmation bias, we live in our own bubbles. We have algorithms that push us further and further towards, you start out as a moderate belief, but it keeps pushing you towards extremes, and pretty soon you're saying stupid things like, hey, that Tucker Carlson, he's a good guy. Um, alright, I might have revealed a little politics there. Yeah, you did a bit of politics there. So, all of that adds up to making our politics worse. More prone, in particular, to swings and extremes.

• 33:07Speaker 06

  Markets are not arbitrage mechanisms. That's sometimes misunderstood, they're voting mechanisms. The price is a weighted average vote, where the weight is by dollars. I'm lucky enough to get more vote than the average person, and Warren Buffett gets a lot more votes than I get, if we all disagree on opinions. Um, the reason it's not an arbitrage mechanism, and here I'll get a little geeky. Imagine you're reasonably sure this thing is mispriced in that Graham and Dodd sense. And you think it's massively mispriced. Trading enough to make it a third less mispriced. It's not very risky to you, because it's not that big a trade, and it's very high expected return, because it's that mispriced.

• 33:50Speaker 06

  Now you've moved it back to a third, or maybe half. The next part of the trade is much riskier to you because you already have the trade on. So you're just adding more.

• 33:59Tracy Alloway?

  Oh, I see, yeah.

• 34:00Speaker 06

  And it has half the gain because you've already closed it by half. So arbitrage will not take the, if on net more people believe something stupid, stupid's gonna win. And we're gonna be at least somewhat off of real prices. And I find it remarkably easy to believe that this same environment that makes our politics go a little crazy. For markets to be efficient in any degree, not even perfectly efficient. This famous idea of the wisdom of crowds has to be helping us a lot. The hypothesis that we're all geniuses is never gonna fly, right? So the wisdom of crowds, and you know it well, says even if on average, most people don't know the answer. The stupid answers cancel and the right answers don't because they're the same.

• 34:43Speaker 06

  My favorite example of that, and this I might be dating myself, is Regis Philbin and Who Wants to be a Millionaire? Right? Remember the show, multiple choice show?

• 34:52Tracy Alloway?

  It's frightening that you're describing that as old, but I guess it is. Yeah.

• 34:56Speaker 06

  It's been off the air. Sadly, Regis has passed away. It's old. Sorry, sorry. But you had to answer multiple choice questions and if you miss one, you're out. They start off ridiculously easy and they get harder and harder. You had multiple cheats, like three cheats. One was phone a friend, was almost useless.

• 35:14Speaker 06

  A, your friend usually wasn't much smarter than you. And B, people, at least to my eye, I didn't watch every episode, but seemed to choose friends who knew the same stuff they knew. Right? You really wanna choose a friend who's in like a totally different field.

• 35:26Tracy Alloway?

  I think in some countries, the friends also had a tendency to deliberately give the wrong answer because they just didn't wanna see their friend actually win money.

• 35:34Speaker 06

  The most cynical phrase ever is nothing succeeds like a friend's failure.

• 35:38Tracy Alloway?

  There we go.

• 35:39Speaker 06

  I don't believe, I'm not condoning that, but it is out there. The other one was eliminate two of the wrong answers. That's great. Obviously, even if you have no idea, you go from one out of four to one out of two. The other one was poll the audience. And at least to my non-exhaustive examination, I, it seemed to work pretty much every time.

• 36:01Speaker 06

  Even if the question was hard, because imagine you have 100 people in a room, 10 of them know the answer. The other ones are guessing. The 90 distribute evenly over the four. Maybe not perfectly evenly, but roughly evenly. The 10 all land on B. So you pick B because it's bigger. Work pretty much every time. There's a crucial assumption in that. The audience has to be relatively independent of each other. And they did that. They weren't talking. It was silent voting. If the audience all gets to talk, maybe the 10 convince the 90. But maybe they don't. Maybe a demagogue with a better Twitter feed convinces everyone. And if you ruin the independence, and I think, have we ever come up with a better vehicle

• 36:46Speaker 06

  for turning a wisdom of crowds into a craziness of mobs than social media? I'd be hard pressed to describe it.

• 36:55Joe Weisenthal?

  I find this to be very compelling. James Sirwicky at the New York Times, he came out with that book Wisdom of Crowds in 2005. But that was right before social media blew up. And then, you know, there's that famous book in 1841, Extraordinary Popular Delusion and the Madness of Crowds. So we've always sort of understood that crowds can be both mad and wise. And I find this very interesting, the idea that perhaps the linkedness of the crowd is what sort of flips it from wisdom to madness.

• 37:23Speaker 06

  I think that's exactly it. You maybe can come up with counterexamples, but I think most of the time, if the crowd is making independent decisions, and this can go for political voting, it can go for markets, you're going to get some degree of wisdom. When the crowd is all making a unified decision, it could still work out. But you are much more susceptible to what the quant's technical term is cray cray.

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• 41:24Joe Weisenthal?

  I want to pivot a little bit and talk about AI. You've written, or you've talked recently, I forget exactly the word that was used in some of the headlines, succumbing to the machine.

• 41:34Speaker 06

  Surrendering ourselves.

• 41:35Joe Weisenthal?

  Surrendering to the machines.

• 41:36Speaker 06

  I regret saying that.

• 41:38Joe Weisenthal?

  We tried to talk a lot about AI. I still don't know exactly what it means in any context. What does it mean to surrender to the machines in the AQR context?

• 41:48Speaker 06

  Well, first, not every journalist has Bloomberg's high standards.

• 41:52Joe Weisenthal?

  That's right.

• 41:53Speaker 06

  I am reasonably certain I said partially in that, and the word partially got dropped. Even skipping all the details.

• 42:01Joe Weisenthal?

  Yeah.

• 42:02Speaker 06

  If you're going to use AI in your process at all.

• 42:07Speaker 06

  Almost by definition, you are gonna lose a little intuition. And it bothered me for a couple of years. I think I slowed us down on AI by a year or two just by saying, you know, we've always prided ourselves on the balance of we intuitively understand why we think this makes money and the evidence that it makes money. And when you go to AI, you're normally giving up some, not all. We actually do try very hard to figure out why we think this works or doesn't work. But if you weren't giving up some intuition, what the heck is the AI doing? If it's simple and you could have just seen it with the naked eye, it's hard to imagine it's helping. But let me give you a concrete example. We like good momentum. We like it in price. We like it in fundamentals.

• 42:51Speaker 06

  One way people on the quant side have tried to measure this for years is something like earnings calls. Trying to decide if earnings calls are good news or bad news. And if people underreact to good news, you want to buy when it's good news.

• 43:04Tracy Alloway?

  Is this just like how many times people say great quarter, guys? Or are you looking at something else?

• 43:09Speaker 06

  It's gonna sound about as silly as that.

• 43:11Tracy Alloway?

  Okay.

• 43:11Speaker 06

  You build up tables of words and phrases with numerical values. And then you say, what's the numerical score of this? And they can be much more subtle than this. I'm gonna use a real simple example. The word increasing, plus one.

• 43:26Tracy Alloway?

  Right.

• 43:27Speaker 06

  And I'm sure you see the flaw. If the actual sentence was massive embezzlement is increasing,

• 43:33Speaker 06

  you know, we're bad on that one.

• 43:35Tracy Alloway?

  The amount of fraud we're seeing in our private credit deals is increasing.

• 43:38Speaker 06

  Quant can survive looking stupid a lot. If that's 47% of the time, if 53% of the time it's getting it right, fine. And those things had some efficacy, but they weren't great. What we do today is we train ML. It's called natural language processing. It's a subfield of ML to analyze corporate statements. But what it does, and this is gonna be the geekiest thing I'll say. It represents every corporate statement, looks across them and represents them as a set of numbers. What the geeks would call a vector of numbers. Then what we do is empirics to say, all right, we have 50 years of this across many firms. We have different vectors of numbers for every earnings call.

• 44:23Speaker 06

  What combination go long when the first number's good, short when the second number is high, blah, blah, blah? What best combination forecasts? That seems to be correlated to what we were doing before, these word count things, just considerably better. It does a better job than word counts. And that language is very nonlinear. Whether something is good, whether that word increasing is good. AI is not perfect, but its chance of figuring out if increasing was good or bad, especially when it's trained on tons of these, is better than us. Here's where you lose the intuition, though. I skipped a step. I like to do that. It's fun. Sneaky. If you ask myself, or even some of the younger people who are much more tooled up on

• 45:07Speaker 06

  machine learning than I am these days, what does that vector of numbers actually mean? You often get a, eh. We, we really can't tell you that. We can say it, it's summing up, in a mathematical sense, the information content of that. We still get intuition because this indicator acts like a short-term momentum indicator. So it's picking up what we want it to pick up. It's also done fabulously well for us for multiple years in real life. But we are giving up intuition at one stage that we used to not do. So my answer was meant to be much more subtle, that there are give-ups in intuition when you move to something like machine learning. They almost have to be, or else, again, what are you doing?

• 45:50Speaker 06

  I was uncomfortable for that for a while, so I was starting to do mea culpa, saying that, that I slowed us down. And it came out as, well, I used to hate this, but now I have no job, the machine runs it. Which is probably gonna be true in eight years, but not yet.

• 46:03Tracy Alloway?

  This reminds me, actually, of something I wanted to ask, because another big multi-year, decade trend is the rise of the multi-strats. And at AQR, as I understand it, you have a multi-strat model in there, but it's more centralized than some other places? Can you go into a little bit more detail?

• 46:21Speaker 06

  Sure. They get used interchangeably, but I think there's a difference between multi-strat and multi-manager. Okay. Multi-strat just means, I wrote a dissertation on choosing US stocks. We have applied similar things to stocks around the world, to currencies, to commodities, to directional bets through trend following. They are correlated, but low. So we think of these as different strategies. And we think a set of our strategies is better than a single one. Or, you know, it's just the power of diversification. So we're big believers in, particularly if you have a common philosophy. So it's not just fitting the data, it's fitting into an overall theme of what you believe in. We're big believers in multi-strats.

• 47:05Speaker 06

  What we share with MultiManager is that belief in diversification. MultiManager is what it sounds like. It is, we are one team building these. We might, of course, have little separate teams at AQR, but we're one firm building these. They are farming it out to different people. To be frank, if you had told me their business model 10, 20 years ago, I would have been very cynical that it worked. If you told me, A, what the total fees are going to be when you add up everything that's passed through, and a fair amount of them, and they vary in how quick they do this. If something's not working for what I would consider a very short while, Yeah. they stop doing it. And I know there are a lot of low to medium sharp ratio risk-adjusted return strategies

• 47:50Speaker 06

  that are really good long-term, but have bad periods. So if someone told me that model, I would go, "You're going to charge a ton and you're going to throw out people who have a bad two quarters?" No. And there have been people who've obviously proven me wrong, and I'm humble about this. I don't fully understand why. They must be very, very good at actual selecting the alpha.

• 48:12Tracy Alloway?

  Yeah.

• 48:12Speaker 06

  Right? And this is something that I, we don't do. We're, we're internal quants who build our own models. We've never, maybe it'd be interesting one day, we've never tried to apply that to choosing outside people. But plenty of people, by the way, have tried to start MultiManager and failed. So it's not like you just apply this, charge a ton, hire a bunch of active managers and fire them if they have a bad two hours. Just automatically works.

• 48:36Tracy Alloway?

  It does seem, though, that like talent is the, the thing that's like capping multi-strat expansion, right? That's the limiting factor.

• 48:43Speaker 06

  And they vary, but some of the major ones are giving back. Money, even if you believe in this model and I even from afar, I have to be a believer. I've seen the results are too good for too long. In my view, to have a decent chance of of randomness. I don't exactly know what they're doing. I'm still waiting for Ken and Stevie and Izzy to send me their exact process. That would be wonderful. Izzy doesn't share it with you? No, even better if Medallion would send me their exact process. But I respect it. But the amount of individual alpha from teams that can be out there has to, all alphas finite, but has to have a decently tight cap. And the ones I've seen are fairly disciplined about this.

• 49:28Speaker 06

  And again, it varies. I can't speak for everyone. I know we compete for talent with them much more than we used to. They have non quant parts of what they do, but they have quant parts of what they do. And for young quants, they're often considering an offer from AQR and Citadel. To pick just one example, we win our fair share, we lose our fair share. I think we probably pay a little less in the short term, but we don't fire you if you have a bad week. So some people are. That does seem like a stressful environment. On Ken, he's not doing that, I'm just saying.

• 50:00Joe Weisenthal?

  No, but we know.

• 50:00Speaker 06

  It's a more cutthroat environment.

• 50:02Joe Weisenthal?

  We've done a lot of episodes on that environment. We know like they cut pretty quickly if you lose money. I want to go back a little bit to the connection between sort of AI, machine learning and interpretability of the factor. You know, the quintessential, you know, the risk is of course that you find something that works strictly from data mining. Right? Tickers that start with B tend to rise on Tuesdays.

• 50:25Speaker 06

  I usually use the CEO's middle initial.

• 50:28Joe Weisenthal?

  Yeah, stuff like that. We know like, but you know, even when you were talking about momentum and you said, well, there's two reasons, theories for why momentum can work. Let's just go back to the canonical like quant factors. Is there complete consensus about why these factors work?

• 50:44Speaker 06

  Not at all.

• 50:45Joe Weisenthal?

  Okay.

• 50:45Speaker 06

  They, you start out with.

• 50:47Joe Weisenthal?

  Because intuitively like cheap stocks go, but I, my impression is that there's even still disagreement about why.

• 50:52Speaker 06

  Yeah. You start out with the great divide. And when, um, when they split the Nobel Prize between Jean Fama. Robert Schiller, my co-founder and I wrote a piece on the cover of Institutional Investor with that title, The Great Divide. Lars Hansen also won a share of it, I shouldn't leave him out. But Schiller and Fama were juxtaposed as the efficient market guy and the inefficient market guy, which is fairly close to, I don't think either of them is zealots, but it's fairly close to, to true. So you start out, if something has worked historically and made a lot of money over, over a long period, you start out with what you led with. Is it data mining? Let's say you convince yourself it's not. Okay. Let's just put that away. And that's really important that I'm not, you know, poo-pooing that step. You got, you gotta do that.

• 51:36Speaker 06

  Then you gotta ask yourself why. The two main contenders are a rational gene pharma kind of market where some stocks are riskier than others. And whatever you're using to say go long these and short these is loading on that risk. And if something is risky, you should make more for investing in it. One of the problems is identifying, A, there are sub-fights within these fights. What do we mean by risk? Is risk beta like the capital asset pricing model? Finance academics are like every other academic. Define your terms. It's Talmudic at this point, but is risk beta like the capital asset pricing model?

• 52:17Speaker 06

  Well, the capital asset pricing model is a beautiful elegant model that has failed everywhere it's ever been attempted. Is risk more multi-dimensional? Is risk something like what happens in a great depression, which is very hard to measure? The other argument is markets are not perfect, people make errors, and it's behavioral finance. So if a cheap stock beats an expensive stock because it's inherently adding some risk that you can't diversify away. That's a gene pharma explanation. If it beats an expensive stock because people went too far. They went past the Graham and Dodd point.

• 52:49Joe Weisenthal?

  Yeah.

• 52:50Speaker 06

  And if you can hold it, you make money when reality sets in. That's more the Bob Shiller point. I love Gene, he's my hero. I have probably drifted from 75 25 Gene to 75 25 Bob. Over my career. World's complicated. One of the hard parts is everyone wants to win. But both explanations can be true and they can be true at different times. Uh, life isn't so, so simple. But those are the two biggies. But once you get into behavioral finance, now you can fight about why. What, what behavioral bias? Notice the, you could sum up the two reasons I gave you for momentum. As underreaction and overreaction. Overreaction is chasing, right? Underreaction is the information came out, didn't move far enough and I hopped on that.

• 53:33Joe Weisenthal?

  Yeah.

• 53:33Speaker 06

  Bandwagon. You know, you're in a little bit of a dodgy area. When your two best explanations sound a little like antonyms. Now, the, the, I'm being intentionally.

• 53:44Joe Weisenthal?

  It's so funny. We know it works. We're just not sure whether it's literally opposite things or intuitively opposite things. We know it's one of them and there's some debate.

• 53:51Speaker 06

  I'm being a little too negative. You can actually, they're good papers teasing out. The underreaction is easier to show. You can actually show the fundamentals do catch up. I think the overreaction probably kicks in more in bubbles where there is just more feedback trading. Again, both explanations can be true. And they can vary in their intensity over time. The overreaction might have a very small part of it. Except plus or minus two years around a major bubble. When it may be the driving force. So we have to get really comfortable. We don't have to have the be all, end all, single explanation. But if there are a few good explanations and no real counter ones. And we have really strong 50 year empirical results. Yeah, we're okay with taking some bet on this.

• 54:35Speaker 06

  You never want to put all your money on one thing. That's not a quant thing.

• 54:39Tracy Alloway?

  I'm going to try to connect a bunch of the sort of decade-long mega trends that we've been discussing, but I'm thinking behavioral finance, gamification of markets, big data, AI, all those fun things combining into sports betting, which seems to be getting bigger and bigger than ever. And the reason I ask is because I was talking to someone in a bar the other day, and they said that AQR was doing more sports betting stuff.

• 55:04Speaker 06

  Someone in a bar was talking about AQR doing sports betting?

• 55:07Tracy Alloway?

  Yeah, I know. Well, it probably says more about the bars that I'm in and the people I'm talking to than anything else. But yeah, they mentioned that.

• 55:13Speaker 06

  I'm picturing the Star Wars cantina right now. I gotta tell you.

• 55:16Tracy Alloway?

  So I'm just curious, is that a thing? Or are you maybe interested in the sort of prediction market aspect of things nowadays? Susquehanna is getting into it.

• 55:26Speaker 06

  I think. No one, again, tells you exactly what they're doing. My sense is they are into it and are good at it. This is incipient for us. We are considering and looking at it. We have a long history. Toby Moskowitz, who's a Yale professor and an AQR partner, great deal, by the way. You get paid for two full-time jobs that are 80% overlap.

• 55:49Tracy Alloway?

  I'll keep that in mind for the future.

• 55:50Speaker 06

  If Toby's listening, just, you know, you're a lucky man. He wrote a book called Scorecasting that was all about sports. But the sports analytics, the Moneyball-type stuff, looks a lot like what we do. It looks a lot like people are not pricing this right. People, I wrote my most downloaded paper ever, which is really a little annoying because it's like the only one I've written outside of my field, was on when to pull the goaltender in a hockey game.

• 56:20Joe Weisenthal?

  Oh, yeah.

• 56:21Speaker 06

  And I wrote it with a colleague and friend, Aaron Brown. We built a model and we came up with, you should be pulling the goalie if you're losing by one with five or six minutes left, not with two minutes left. And I'm pretty sure we're right. We spent a lot of time in that paper saying, why aren't they doing it and making analogies to investing? You know, when people know the right thing to do, but can't do it because the public opprobrium, if they get it wrong, will be much worse.

• 56:44Joe Weisenthal?

  Right. Like, aren't they saying, like, football teams should go for it on fourth down a lot more than they do? That's like one of these things that have.

• 56:50Speaker 06

  And they have started to. There is a feedback where some of these things are slow, some of them are fast. Baseball has largely absorbed a lot of these things. You know, on base percentage was one of the major insights of of Moneyball and nobody, nobody's missing that one anymore. But we still think particularly in the betting markets are not, probably not as rational as Toby's score casting book. So we do think there might be opportunities there, but I don't want to overstate it. Just because I am cynical about online sports betting, I got to tell you two things. I was always a very libertarian guy. I still think I am. But a couple of things have made me less libertarian. Children, the existence of my children will, will make you go.

• 57:32Speaker 06

  Yeah, maybe people shouldn't be able to do anything they want when they turn 21.

• 57:36Joe Weisenthal?

  There should be some rules.

• 57:36Speaker 06

  And sports betting and maybe walking down the New York City streets and getting a contact high. Sports betting, we're already, you know, some of these scandals we're starting to see.

• 57:44Joe Weisenthal?

  Yeah.

• 57:45Speaker 06

  How do you not have them? When, you know, some of these people make a ton of money, but they don't all make a ton of money. And there's a lot of money in sports betting. Anything you do for entertainment is fine if you do it at entertainment size. If you go to Las Vegas and you go, the odds are on the house's side. I'm going to lose $500 over two days. Probably if I win, great, but it's going to be fun.

• 58:07Tracy Alloway?

  It's factored into the cost of a Vegas vacation.

• 58:09Speaker 06

  But like I have a whole bunch of 20 something year old, mostly guys in my extended family. A lot of them are sports betters. And they're not even, it even pisses me off that they're not even rooting for their teams anymore. They're kind of rooting for this player to score on their prop.

• 58:26Tracy Alloway?

  It is a strange dynamic. Yeah.

• 58:28Speaker 06

  So do I think that gamification is highly related? I, I think if you go look at the Robinhood app and FanDuel, I think you will find they are far more similar on their feedback and how they treat things and in how their investors do on average. Particularly sports betting, you know, investors lose on average because the sports betting companies make money.

• 58:52Speaker 06

  It's like saying on average insurance is a bad deal. You know how I know? Because insurance companies are profitable. Doesn't mean it's stupid to do because maybe if it's in a risk you can't tolerate. That could be a fair trade.

• 59:02Tracy Alloway?

  But there's a price you pay for peace of mind, which is something I've come to appreciate over the course of 10 years.

• 59:07Speaker 06

  There is zero chance that the average online sports better is making money.

• 59:12Joe Weisenthal?

  Yeah. I just have one last question. You know, I think if you looked at like some particularly crazy times in markets. Here's something that's changed very much since we started the podcast first 10 years ago. I think if you look at some crazy times in markets, whether it's, you know, 2019, when some of these measures were getting extreme. We're just, you know, the SPAC mania of 2021. One theory that one might have offered is ZERP. And he's like, oh, this is what now we have, you know, we haven't been at ZERP for a long time. And yet some of this sort of speculative mania crazes has not gone away. How surprised are you that the move from 0% to say 5% or whatever?

• 59:51Joe Weisenthal?

  Didn't have more of a sapping effect on some of the behavior and speculative fraud or just sort of animal spirits in these markets?

• 59:59Speaker 06

  I am mildly surprised.

• 1:00:01Joe Weisenthal?

  Okay.

• 1:00:02Speaker 06

  I left this out, but I actually had three possible reasons in my paper. And the third one was super low interest rates for a long time for why things can get crazy. Now, the counter argument is once you break people's brains, they don't necessarily repair themselves instantly. So I think it was probably a contributory factor. Again, very hard to prove. A lot of people in 19 and 20, when the spreads were being cheap and expensive were here, were saying it was the super low interest rate environment. And growth stocks have more cash flows in the future. Low interest rates means they're worth more. We did the math on that. It explained like 2% of the extra value spread. And in 99, 2000, interest rates were quite hot.

• 1:00:43Joe Weisenthal?

  That's right. There was no ZERP in 99.

• 1:00:45Speaker 06

  So it's not a unified field theory explanation.

• 1:00:48Joe Weisenthal?

  Yeah.

• 1:00:48Speaker 06

  Do I think it helped kickstart some? And again, we're in the soft guesswork. But I think these are educated guesses. And I listed it as one of my three. I think it certainly kicked us off on some of these things. Certainly loosen the bounds of rationality. Absolutely free money will do that. I don't think, it's not human nature that they take away Zerp and everything comes back. Would I have thought it was a bigger effect in going back to, you know, at one point we hit about 5% on the 10 year, almost 5%? Would I have thought that would have mattered more? Yeah, only in 2022 did we see one ugly year over that, but it has mattered less than I thought. It doesn't mean it will never matter.

• 1:01:28Tracy Alloway?

  All right, Cliff Asness, thank you so much for coming on All Bots and kicking off our 10 year anniversary celebration.

• 1:01:35Joe Weisenthal?

  Thank you so much, Cliff. That was fantastic.

• 1:01:36Tracy Alloway?

  That was really a pleasure. Thank you.

• 1:01:51Tracy Alloway?

  Joe, that was so much fun.

• 1:01:52Joe Weisenthal?

  That was great.

• 1:01:53Tracy Alloway?

  Literally the perfect guest.

• 1:01:54Joe Weisenthal?

  Literally the perfect guest.

• 1:01:56Tracy Alloway?

  One, well, there are so many things that stuck out from that conversation, but one of the things that stuck out from the conversation is this idea about the thing that flips the wisdom of crowds into the madness of crowds, right? And the idea that maybe the wisdom of crowds theory works as long as everyone is sort of isolated and independent and making their own choice off of the information available to them. But it starts to fall apart when everyone is tied to everyone else and sort of in the same social network. And, you know, if you think about one of the dominant themes in markets in recent years, it has been people herding into the same positions, right?

• 1:02:31Joe Weisenthal?

  I found that to be really fascinating. I think that's a, it makes it a lot of intuitive sense. It probably can explain a lot of things about the world of politics, about the world of markets, et cetera. This idea that we're all just sort of one connected global village, as Marshall McLuhan put it.

• 1:02:48Tracy Alloway?

  We're all just gossiping with each other.

• 1:02:50Joe Weisenthal?

  All the time, just constant talk, talk, talk. No, that's a very interesting idea. I also thought it was interesting, the idea of length of drawdown versus depth of drawdown and the former being more painful. Which strikes me as something I hadn't, I hadn't really heard anyone talk about that before, but especially from the perspective of a manager of other people's money. It's a very highly intuitive, that makes a lot of sense. That, okay, like, yeah, you had a bad quarter, whatever. Eventually, you're like, oh, your ideas are just out of date. It's been three years since you made money. Maybe time to rethink some of your fundamental assumptions.

• 1:03:24Tracy Alloway?

  People are impatient. That's one thing I've learned over the course of 10 years.

• 1:03:28Joe Weisenthal?

  Yeah.

• 1:03:29Tracy Alloway?

  The other thing was the idea of markets not necessarily being an arbitrage mechanism, which I think is very counterintuitive to the way a lot of people will think about markets. And this idea that like, well, sometimes you can't compress the price all the way to where it should be rationally or logically or according to EMH or whatever, because the reward just isn't necessarily there to get to the like final 10%.

• 1:03:53Joe Weisenthal?

  It's interesting, too, to think about the sort of link between patterns and interpretability, why something works. And in our conversation a couple of weeks ago with Ian Dunning of Hudson River Trading, he's like, they do not put a lot of emphasis on interpretability. There's a pattern and they have some reason to establish that the pattern works and makes money. The idea that they then have to also come up with an economic story about why it works is not so important to them. Maybe that's because it has to do with timeframes. Obviously, Cliffs Trading timeframe is going to be very different than a high-frequency trading firm like HRT. But it is interesting. And then it's interesting to think that even in the most established quant patterns,

• 1:04:35Joe Weisenthal?

  like, why do cheap stocks outperform more expensive stocks over the long term? Right? Even there, there's dispute about why this pattern holds, even though it feels a little bit more intuitive. So much interesting stuff here.

• 1:04:46Tracy Alloway?

  It's also, I guess, it sort of warms my old cynical heart that maybe, maybe the edge for humans will be spotting the regime change, right? Which, you know, at least there's something left for us to do if it's not just pure pattern recognition. There's that, that one very difficult thing.

• 1:05:03Joe Weisenthal?

  Good luck to us.

• 1:05:04Tracy Alloway?

  Yeah. All right. Shall we leave it there?

• 1:05:06Joe Weisenthal?

  Let's leave it there.

• 1:05:06Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 1:05:11Joe Weisenthal?

  And I'm Jill Weisenthal. You can follow me at the Stalwart. Follow our guest, Cliff Asness. He's at Clifford Asness. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot and Kell Brooks at Kell Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots with a daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 1:05:36Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we speak to guys like Cliff Asness, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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