Where Will Stocks Go Under Trump? Watch Passive Capital Flows | Mike Green
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Well, the election is over and we have a clear victor.
What kind of economy is President-elect Trump inheriting? And what impact on it are his policies likely to have?
And what does this mean for investors? Where do the opportunities, as well as the risks, lie?
To discuss, we're fortunate to be joined again by Michael Green, portfolio manager & chief strategist at Simplify Asset Management.
Mike has strong opinions on the above questions, though his convictions are strongest that passive capital flows (aka, the “giant mindless robot”) will play a HUGE role in determining the future of financial assets over the coming years.
#capitalflows #bullmarket #trumpeconomy
00:00 Mike's Macro Outlook 8:44 What Kind Of Economy Is Trump Inheriting? 16:20 Will Trump's Disruptive Policies Create Pain? 31:35 Why Passive Capital Flows Are So Critical 54:00 Mike's Investing Ideas _____________________________________________ Thoughtful Money LLC is a Registered Investment Advisor Promoter.
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Green argues that passive investing flows have decoupled equity valuations from economic fundamentals, creating unsustainable price inflation that will eventually require a severe correction, and that Trump's policies could either trigger necessary realignment or exacerbate the crash depending on implementation.
- Passive flows create price-insensitive buying that pushes valuations to 170% of historical norms independent of fair value estimates
- The bifurcated economy benefits asset holders while disadvantaging young workers and borrowers, creating political instability
- A recession combined with negative passive flows could create cascading losses as the active investor ecosystem shrinks
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Dollar-cost averaging works well during accumulation because buying at various prices and more shares when prices are low reduces average cost and provides volatility benefits, but the strategy reverses once retirement distribution begins—if prices fall during retirement, forced selling captures losses rather than benefits from volatility.
“if I dogmatically invest in the stock market every two weeks that tends to reward me because I'm dollar cost averaging in I myself am taking advantage of the volatility in the stock market so that I'm buying more when prices are low and that same amount of dollars buys less when prices are high therefore I actually am benefiting over time from doing that but the flip side of that equation is those same Rules start to work in Reverse once you begin to retire and take distributions right so a strategy that works really really well in terms of dollar cost averaging in and pursuing volatile assets through dollar cost averaging in needs to migrate to less volatile assets with much more consistent payouts”
Dollar-cost averaging into volatile equity markets works very well during accumulation phase (buying more shares when prices are low) but reverses during retirement distribution phase (forced selling more shares when prices are low).
“a strategy that works really really well in terms of dollar cost averaging in and pursuing volatile assets through dollar cost averaging in needs to migrate to less volatile assets with much more consistent payouts Etc as you begin to take distributions right the unfortunate reality is that same thing works in Reverse prices fall if I need a set quantity of money to cover my bills I'm going to be selling more when markets are down and less when markets are richly Priced”
The 2006 Pension Protection Act changed 401(k)s from opt-in programs where employees chose to participate and selected their investments to opt-out programs where employees are automatically enrolled into qualified default investment alternatives (QDIA), which are typically passive index funds.
“you mentioned the idea of I tell my employer I want to invest in this right that actually describes the world pre2 2006 and the pension protection act which changed 401 case from something you had to choose to participate in right those of those of you who are listening who are you know roughly our age distinctly remember getting your jobs having to fill out your I9 application Etc and then having the HR manager saying do you want to take advantage of the 401K or the company's stock purchase you know plan right um and you'd say well what does that mean they say well we'll hold you know whatever percent you tell us out of your your uh income and on a pre-tax basis that'll go invest into the stock market or or into various funs that you have to choose right so you want to be in growth funds you want to be in bonds Etc the default for a lot of people is like wait you're going to take 5% of my paycheck away no I don't I don't want to t you know that's mine I I promise I'll do it afterwards right even though it was a terrible mistake in 2006 that system changed to become an opt out framework”
Passive investing has created a separation between equity market valuations and underlying economic fundamentals, such that global equity markets reflect the mechanical buying pressure from passive flows rather than the actual health of the global economy which shows signs of lacking aggregate demand.
“I think that the two are increasingly separated right so if I look around the world at Global Equity markets in particular I think that they largely reflect the um impact of something you've heard me talk about over and over again which is passive investing which raises valuations”
The Pension Protection Act of 2006 changed 401(k) plans from opt-in to opt-out structures, meaning unless employees explicitly opt out, they are automatically enrolled in the Qualified Default Investment Alternative (QDIA), which is inevitably a series of passive investments, creating the mechanical monthly buying pressure observed in markets.
“in 2006 that system changed to become an opt out framework so unless you now specify at the vast majority of companies that you don't want to do withholdings from 4 a 401k then you will be opted in and instead of you making a selection you will be opted into What's called the qdia the qualified default investment alternative which as Adam was describing is inevitably a series of passive Investments okay but it ends up in this again monthly right programmatic buying”
Forgetting money in the stock market is a feature of traditional investing that improves returns because inattention prevents frictional behaviors like rebalancing and trading that incur transaction costs and tax consequences; dead clients have the best track records.
“in attention by the way is a feature of traditional investing a lot of times people will just forget money is there and ironically I'm sure you've seen the studies that say people that forget their money in the stock market do the best outperform those that actively manage their portfolios yeah dead dead clients have the best track records”
Making significant policy changes like Trump's requires being prepared for unforeseen outcomes because you cannot model every aspect of how radical changes will affect a complex system, particularly when initial conditions are uncertain.
“anytime you make significant changes to policy and the magnitude that is being discussed in the Trump uh uh platform you can't really know right you don't know what the initial conditions were to allow the chaotic system to become predictable right your initial conditions could be radically different than my initial conditions could be radically different than a 22-year-old's initial conditions I would certainly hope they would be um and as a result we we can't possibly model every aspect of how this is going to affect us so when you make those radical changes you have to be prepared for unforeseen outcomes”
Reagan's 1980s amnesty for illegal immigrants in the US is a historical model for potential Trump-era immigration policy, showing how regularization can improve economic outcomes if implemented thoughtfully.
“we have a model for that in Reagan who did a similar um uh amnesty for illegal immigrants in the United States in the early 1980s right”
The inflow and outflow dynamics in individual accounts create frictional behavior and transaction costs that harm returns, so accounts that remain untouched with regular contributions and no rebalancing decisions tend to outperform those where people actively trade.
“the inflow and outflow that you make from those accounts actually causes frictional Behavior it forces you to actually make changes that incur transaction costs that incur tax consequences all sorts of things that if you just ignore all those components you actually tend to outperform over time”
Passive investing creates a feedback loop where active value investors form expectations about fair value and act accordingly, but passive investors have no expectations about fair value and their buying is determined purely by price movement—creating a self-fulfilling prophecy where high-priced stocks get weighted higher in indices and therefore receive more passive flows.
“as a as a active value investor I form expectations about fair value right and so I say well I think apple is worth X and then I compare how apple is trading versus X if apple is way above X then I will try to either short apple or I will neglect to put it into my portfolio but my trading Behavior reflects my expectations about value when you introduce passive players they actually have no expectations about the asset or the concept of fair value presuming somebody else has done that for them but within the index once I decide I'm going to buy the S&P 500 I've actually implicitly loaded my decision process in the opposite direction right so how does something get heavy weights from an index investor well it goes up a lot in price what about fair value it actually doesn't matter”
Markets are designed to help price the marginal cost of capital and allocate capital efficiently, but by turning them into 'high income savings accounts' through passive flows, we have corrupted the system and separated utility from outcome.
“we have a market that's actually designed for something markets are designed to help price that marginal cost of capital to provide that price information to economic actors right and for the allocation of capital we've corrupted the system by trying to turn it into effectively a high income savings account right we talk about what I need from the market as compared to what am I contributing to the market”
The choice to make public equities the primary retirement vehicle for Americans (rather than pensions or national pension systems) has structural implications that cannot be ignored—designers must own those consequences.
“we chose to choose the stock we chose to make the stock market the tool for American retirements public equities became the primary tool for American retirements as compared to pension systems which are liabilities of corporations that employ you or as opposed to a national pension system you know which is the same thing just happening on a national level beyond the scale of a social security when you make those choices you have to understand there will be implications associated with it”
By designing systems where people respond to price incentives but then muddying price discovery through passive flows, policymakers also must own responsibility for the repercussions that follow.
“well and if you design a system where people are supposed to respond to price incentives and then you muddy price Discovery you also have to own that that's going to have repercussions right”
Global equity markets are increasingly separated from underlying economic reality because they reflect the impact of passive investing flows rather than economic fundamentals, with passive flows raising valuations that are then misinterpreted as economic sentiment indicators.
“the two are increasingly separated right so if I look around the world at Global Equity markets in particular I think that they largely reflect the um impact of something you've heard me talk about over and over again which is passive investing which raises valuations and unfortunately that's treated as a sentiment component for the economy”
China is trapped as producer to the world, which is a tenuous position because the rest of the world can charge China for access to their customers, demonstrating how trade deficits from other countries actually represent a form of control or leverage that can be weaponized through tariffs and trade policy.
“they are now somewhat trapped in the position of producer to the world right now that sounds awesome you want to be producer to the world right we're supposed to make things not consume things but the simple reality is that puts you into a very tenuous place where the rest of the world can begin to charge you for access to their customers”
The US economy under the Biden Administration has deeply bifurcated into two groups: those who must sell their labor daily to meet financial objectives, and those who can capitalize on outsourcing labor globally, with higher interest rates particularly disadvantaging the labor-selling group while benefiting asset owners.
“the economy under the Biden Administration and this has been something that's been going on for a long time has very deeply bifurcated into those that are needing to sell their labor and produce on a daily basis in order to meet their their uh Financial objectives and those who effectively are able to capitalize right the traditional capitalist on the ability to Outsource that Labor All Over The Globe right”
Most investors lack the capacity to ask whether they need incremental returns and instead engage in performance comparison racing (pursuing 25% returns because neighbors made 25%), leading to excessive risk-taking and poor portfolio construction.
“recognize that the majority of investors that you're now facing don't actually have the capacity to ask the question do I need this next dollar right do I need this incremental return um and I see a lot of people that are basically trapped right now in a model of you know well my neighbor made 25% therefore I want to make 25%”
Higher interest rates have removed selling pressure from Boomers by allowing them to take distributions as income from money market funds and bond holdings rather than selling equity positions, which has actually extended the passive bid by reducing a major headwind.
“now that we've hiked interest rates to 4 and a half% by way of 5 and a half% or 5 and a quarter percent Baby Boomers who had saved for their retirement and need to take distributions from their 401ks can increasingly just take it in the form of income distributions without ever having to sell having to sell yeah exactly yeah right”
If Trump successfully implements tariffs and companies do not increase domestic sourcing but instead source from other countries like Malaysia, the outcome would be negative for the U.S. consumer because prices would rise, leaving less money for discretionary purchases and savings, with no corresponding increase in U.S. worker incomes.
“the simple math is prices go up in the United States that means that on things that people need they would have to spend more money on those that leaves less money available for discretionary purchases and savings that in turn trickles through the economy with a dramatic slowdown”
If Trump's tariff policy is implemented without reciprocal trade increases, prices rise for US consumers while aggregate demand falls because corporations source from other lower-cost countries and American workers see no income increase, resulting in net loss of purchasing power.
“there's a point at which you know a crazy venol person on the other side of the negotiating table is actually an asset for you right like every once in a while you want to just release the Mad Dog right um He's a Bully but he's our bully that very well said um and so like you know again it boils down to what others respond right so Trump has articulated what he would do if we were to put 20% tariffs on all us Imports and 60% tariffs on All Imports associated with China and we were to receive no net benefit in terms of increased ports to those countries in exchange for it then you have a very bad outcome right I mean the simple math is prices go up in the United States that means that on things that people need they would have to spend more money on those that leaves less money available for discretionary purchases and savings”
Passive investing is a 'relentless bid' with 'monthly programmatic buying' where workers' 401k contributions are automatically invested in market-cap weighted indices regardless of price, creating a price-insensitive buyer that pushes valuations higher each month independent of economic fundamentals.
“monthly right programmatic buying and so it is as Barry uh Barry ridols has described the Relentless bid for stocks is sourcing itself from from those flows right and and you have famous ly coin this the giant mindless robot right which is just out there in the world buying buying buying”
Young people and those trying to get their start in life are disadvantaged by higher interest rates because they need to borrow for capital acquisition (apartment, car, suit, career costs), and higher rates increase the cost of these essential borrowings while not affecting consumption choices.
“I think he's inheriting a bifurcated economy that can effectively be split between those who are rich in financial assets and therefore don't need to borrow and instead benefit from higher interest rates through increased income and those that are trying to get their start in life you know who need to borrow to effectively obtain Capital to use in their productive career right um you graduate from college you need a suit you need a car you need an apartment you need you need you need right and all of those things...by hiking interest rates we've actually disadvantaged that segment of the economy”
When passive share reaches very high levels and an investor tries to sell at market prices no longer supported by valuation, the universe of potential buyers is destroyed because active investors won't buy at inflated valuations, resulting in a crash below fair value that can take 30-40 years to recover from like 1929 or Japan 1989.
“it's when you go to sell under those conditions you've actually destroyed the universe of potential investors who would have any interest in buying it anywhere close to that and so what you actually experience then is a crash that takes you below Fair values and you really never recover from it right and that's the fear right that's a 1929 it takes us 30 or 40 years to recover that that's Japan in 1989 type phenomenon”
Current market dynamics represent a 'collective societal mania' driven by how society chose to structure investment systems (passive default in 401ks) rather than a signal that the economy is booming or that investors will be 'left behind' by not participating in equities.
“it's a bit of a collective societal Mania that is caused by the for with which we've chosen to invest in these markets”
Price signals are the mechanism of information exchange in a market economy, but when government offers student loans without risk to borrowers, it removes price signals and leads to cost inflation and administrative burden expansion in higher education.
“part of the reason we do that is because we steal from Adam Smith right price is the mechanism of information Exchange in a market economy we look at prices to Divine information both in terms of their utility and their value to us right so we look at the S&P we're like oh that must mean something right well really it just means where trades cross right um the same thing has happened in education as we've talked about over and over again right when you introduce student loans that are offered without risk to people to pursue any degree what you end up with is a bunch of degrees that are less valuable than you would get if you had a system that was built around price signals”
A lot of the historical equity return premium (expected 8-13% annually) is actually a byproduct of valuation expansion and price appreciation rather than fundamental earnings, and those returns are unlikely to repeat if valuations don't continue expanding.
“so much of what's being offered in financial markets and fixed income is being ignored because people are trained to think that that assets kind of have embedded returns right that equities are supposed to return 8% a year or 10% a year or 13% a year depending on the study that you look at and you can convince yourself of this all you want part of my message is a lot of those returns are actually a byproduct of that price appreciation that valuation increase that I was sharing with you and those are likely to reverse going forward”
Capitalism's strength is that individuals don't need to solve all problems themselves; they just need to pay people who have solutions, allowing system-wide problem-solving without centralized coordination.
“I'm actually super sympathetic to that that's one of the things I love about capitalism is true capitalism is simply a system in which I don't have to come up with the answer I just have to pay the person who does right”
Young people under age 25 have seen marked deterioration in employment opportunities partly because many states ban those under 25 from driving for Uber or renting cars at airports due to insurance purposes, eliminating gig economy alternatives that older generations used when losing jobs.
“we see this particularly in the unemployment area where many of the tools that have allowed other Americans to avoid filing for unemployment when they lost their job things like uber Etc are less available to the younger generation many states actually ban those under the age of 25 for driving for Uber because of insurance purposes same reason they can't rent a car airport for example”
Schiller PE ratio is currently at 38, which has only been matched twice in history (peak heading into 2022 and slightly exceeded at dot-com peak), indicating extreme valuation levels matched only in the most speculative bubbles.
“the Schiller PE is at a level right now that's only been matched twice one was heading right into 2022 and we saw the big Market correction that year it was slightly exceeded by thec Peak but those are the only other times in history we've been this high”
A positive outcome for tariffs would resemble Japan's response in the late 1980s and early 1990s, where Japan acknowledged it needed to actually consume more rather than running trade surpluses, and invested in manufacturing in the United States (Tennessee, South Carolina, Indiana, Georgia) to build products for American consumption.
“if on the flip side the super positive aspect of it is similar to what transpired for Japan in the late 1980s early 1990s in which the Japanese acknowledge okay we have to actually consume more we can't continue to run these these trade surpluses in this manner we're going to have to invest in Tennessee we're going to have to invest in South Carolina and Georgia and various other places to be Indiana to build cars in the United States to sell to American citizens you know then you could actually see a very positive impulse associated with it”
China is unlikely to respond to tariffs by investing domestically in the U.S. because China's population is declining, urbanization has slowed, and aggregate demand shortage means there is no internal incentive to consume more.
“unfortunately my hunch is there's going to be a lot of resistance to that primarily again because China suffers from a shortage of aggregate demand a population that is now declining urbanization has slowed to a crawl those all create conditions under which the need to consume additional amounts really is not there right”
China is unlikely to voluntarily consume more or invest internationally in response to tariff pressure because China suffers from shortage of aggregate demand, declining population, and slowed urbanization, creating no internal incentive to increase consumption.
“unfortunately my hunch is there's going to be a lot of resistance to that primarily again because China suffers from a shortage of aggregate demand a population that is now declining urbanization has slowed to a crawl those all create conditions under which the need to consume additional amounts really is not there”
The Federal Reserve's rate hiking created an environment where monetary tightening became stimulative to equity markets by increasing the income available to retirees without forcing them to sell, which is economically bizarre.
“where tightening becomes stimulative to to a certain become stimulative correct yeah all right Mike what what I'm taking from you and correct me if I shouldn't take this but is is I think your answer is yes we we are sort of on a collision course with this Destiny”
Dead clients have the best track records (attributed to Charlie Munger quote about inattention being a feature)—forgetting money in the stock market causes investors to avoid transaction costs and tax consequences that actively managed accounts trigger.
“dead dead clients have the best track records They say dead clients have the best track records and that's actually a really critical point because the inflow and outflow that you make from those accounts actually causes frictional Behavior it forces you to actually make changes that incur transaction costs that incur tax consequences”
When interest rates rise in an environment where substantial money has been printed and wealth has been created in nominal terms, the U.S. government benefits because the rapid increase in interest rates means a sizable fraction of the economy benefits from higher rates through increased income on their assets.
“that rapid increase in interest rates in an environment in which lots of money has been printed and lots of wealth has been created you know quote unquote wealth in terms of paper terms has been created actually means that when the US government raises interest rates right it actually benefits a sizable fraction of the economy”
When passive flows increase, active managers respond by becoming more aggressive in trying to short overvalued stocks, but this strategic response only offsets about two-thirds of the passive buying impulse, creating a persistent imbalance where each dollar of passive inflows forces harder pressure against remaining active investors.
“the response function from active managers in general is to become more aggressive right this is what's called a strategic response in the academic Community but the empirical data we have shows that that strategic response is only able to offset about 2third of any one impulse right and so if you just mechanically think about what that means it means each dollar into mive starts pushing harder and harder against the remaining pool of active investors”
A recession occurring simultaneously with falling interest rates could create feedback loops where deteriorating corporate profitability combines with lower rates that can no longer support valuations, transforming what might be a minor recession into a severe one much more quickly.
“a recession that feels like a minor recession actually could become a relatively severe recession very quickly and and the same Dynamic I was talking about interest rate hikes becoming stimulative ironically if you start lowering interest rates at exactly the same time that a recession is occurring so that you have deteriorating corporate profitability which means that the interest rate is really not the determine of your credit worthiness or your ability to meet your payments it means that the corporate activity have suddenly now become a potential Albatross you can create feedback loops that go in the opposite direction right”
Without interim recess appointments allowing Trump to bypass Senate confirmation, policy changes could be significantly delayed or blocked, meaning two years from now we still might be debating whether Trump has begun implementing his agenda.
“Trump has asked for interim recess appointments if he gets those we could hit the ground running and see change kick in immediately to the point that many politicians have raised if we don't see those appointments if we don't see that capability then we could very well find ourselves two years from now still debating what the impact of trump getting started on his political agenda is”
The global economy is suffering from a lack of aggregate demand, evidenced by weak oil prices that contradict expectations of strength, which indicates China is far weaker than people expect despite having pushed its trade surplus to approximately one trillion dollars annually.
“everything we're seeing is consistent with an an economy that is suffering from a lack of aggregate demand um the most notable component of this would be things like oil prices being quite weak versus expectations that they would be very strong that in turn suggests that China is far weaker than people expect um despite the fact that it has you know managed to push its Trade Surplus to about a trillion dollars”
Unemployment rates for those under 25 have deteriorated markedly relative to other age groups because many tools that allowed older Americans to avoid unemployment when losing jobs (like Uber) are unavailable to younger generations, with many states banning those under 25 from driving for Uber due to insurance purposes, the same reason they can't rent a car at airports.
“we see this particularly in the unemployment area where many of the tools that have allowed other Americans to avoid filing for unemployment when they lost their job things like uber Etc are less available to the younger generation many states actually ban those under the age of 25 for driving for Uber because of insurance purposes same reason they can't rent a car airport for example right um and we actually see this in the data so there is a very marked deterioration in the unemployment rate for those under the age of 25 relative to all other age groups”
Trump's tariff proposals should be understood primarily as negotiating tools and signals to American corporations to source from the United States rather than from China, with the real mechanism being a tax on corporations that choose to source abroad, fundamentally different from a direct tariff on consumers.
“what we're really actually talking about is taxing corporations that choose to Source from China or other countries abroad as compared to sourcing in the United States and that's going to be the real question does that action actually result in a dimunition aggregate demand because it simply shows up as higher prices”
Trump's proposed deportation policy could be conducted productively by announcing a registration period for illegal immigrants with jobs, expediting green card processing for those without crimes, and establishing penalties for those who don't register, creating a legal framework for currently undocumented workers.
“deportation of illegal immigrants you know that can be conducted in a manner that's actually fantastically valuable right you're in a trump could make an announcement you're in a legal immigrant in the United States you have 30 days to register with the ins if you have not committed any crimes if you have not done XYZ and you have a job we're going to expedite you through the process of getting a green card”
If a mild recession occurs while passive flows remain positive and employment stays robust, people won't be forced to sell stocks and will continue 401(k) contributions, which could actually intensify the passive flow multiplier effect rather than break it.
“a very mild recession like we may have very well had in 22 and 23 could be actually a factor that contributes to this type of behavior right people largely kept their jobs employment has remained relatively robust their for flows have been more robust than we would have anticipated and with Baby Boomers not selling because they're now receiving their income in the form of of interest payments there hasn't been a huge incentive to sell right that correction will come at some point it's just a question from how high does it come”
China's trillion-dollar trade surplus actually indicates weakness rather than strength because it demonstrates that China's internal demand is not capable of rising to meet its productive capability, trapping China in the role of producer to the world rather than consumer, which puts it in a tenuous geopolitical and economic position.
“China is far weaker than people expect um despite the fact that it has you know managed to push its Trade Surplus to about a trillion dollars which appears to be an incredible amount of strength the flip side of that is just remembering that that's really telling you that their internal demand is actually not capable of rising to meet the productive capability that they have they are now somewhat trapped in the position of producer to the world”
Higher interest rates paradoxically benefit a sizable fraction of the economy by increasing income to savers and asset owners, which is why the economy has been able to sustain 5%+ rates despite predictions it could not exceed 3%.
“that rapid increase in interest rates in an environment in which lots of money has been printed and lots of wealth has been created you know quote unquote wealth in terms of paper terms has been created actually means that when the US government raises interest rates right it actually benefits a sizable fraction of the economy”
Short interest as a share of outstanding shares has declined as shorts lose money on high-flying passive-driven stocks like Tesla and MicroStrategy, damaging the community of informed investors who normally counterbalance passive flow effects.
“although you're seeing less and less of that over time as people basically give up shorting right so short interest is a share a share fraction of shares outstanding has started to fall the headlines are regularly filled with you know shorts have lost x billion shorting Tesla or micro strategy or anything else and so we're actually really starting to uh damage that Community which is unfortunately very consistent with my findings”
PE ratios (including Shiller CAPE) calculated on GAAP earnings haven't shifted, but AI and related companies are using liberal accounting policies to report earnings that don't qualify under GAAP, creating the appearance of broad market earnings growth while it's actually concentrated in non-GAAP accounting.
“the traditional earnings valuation the PE ratios that you see for Schiller pees etc those are all calculated off of Gap earnings right generally accepted accounting practices those actually haven't shifted at all what we've really seen is an increase in an isolated set of companies the AI Affiliated companies and those that are selling the equipment to build this component are seeing an increase in earnings associated with it but the liberal accounting policies that are being used to accommodate that don't qualify those earnings under a gap basis”
Vanguard's own investors have dramatically raised return expectations from 6% at start of 2024 to nearly 8% by September, despite Vanguard strategists projecting much lower forward returns, creating a mismatch where investors believe valuation warnings are wrong.
“Vanguard does a survey of their investors and asks them what their expectations are for the next decade and mysterious right quote unquote mysteriously those expectations have begun to rise dramatically they started 2024 at like 6% which is roughly consistent with history and by the end of uh by uh I think it was September they were up to almost 8% right and these are for long-term returns so people are basically saying well yeah you told me returns were going to be low before because you know PE multiples were high clearly you don't know what the hell you're talking about”
The academic community resists acknowledging passive investing as a market problem because it advances 'one funeral at a time'—older thinkers trained in efficient market theory die before new paradigms can take hold, slowing institutional response.
“you can find any number of academics from the 1960s and even more recently who were trained by those individuals who will say ah it's not that big of a deal we should wait and see you know the market will come up with a solution Etc and by the way I'm actually super sympathetic to that that's one of the things I love about capitalism is true capitalism is simply a system in which I don't have to come up with the answer I just have to pay the person who does right but we we need to recognize that what we're actually seeing in financial markets are markets that are that behave because they were designed a certain way right and the participants and the rules by which they engage influen that”
The 2024 U.S. election was fundamentally a vote for reprioritization of what matters to average American households, with negative voting against Kamala Harris driven by economic concerns rather than identity characteristics, as people felt the Democratic Party had lost focus on what was important to them and voted with their wallets.
“there was much more negative voting against Kala Harris not because of her skin color or because of her sex but because simply it felt people felt that she had lost the Democratic party had lost focus in terms of what was actually important to the average American household and they were voting with their wallets and their their checkbooks right which are worth less relative to what they need to buy every single day”
The U.S. economy under the Biden Administration has bifurcated into two groups: those who must sell their labor daily to meet financial objectives, and traditional capitalists who benefit from the ability to outsource labor globally, with the first group significantly disadvantaged.
“the economy under the Biden Administration and this has been something that's been going on for a long time has very deeply bifurcated into those that are needing to sell their labor and produce on a daily basis in order to meet their their uh Financial objectives and those who effectively are able to capitalize right the traditional capitalist on the ability to Outsource that Labor All Over The Globe”
Strong borders represent a physical barrier around access to customer markets that citizens of a country have the right to control through democratic representation, making them economically important for consumer market power.
“that sounds awesome you want to be producer to the world right we're supposed to make things not consume things but the simple reality is that puts you into a very tenuous place where the rest of the world can begin to charge you for access to their customers that's really kind of the right way way to think about a US citizen somebody inhabiting us soil it's one of the reasons why things like strong borders are so important is because they ultimately you know represent the physical barrier around access to those customers”
We are on a mathematical trajectory toward the collapse Green describes unless we take proactive action to slow passive share growth, and without such action, continued demographic aging and passive expansion create an inevitable collision course.
“I think your answer is yes we we are sort of on a collision course with this Destiny unless we do something unless we we exhibit a intelligent proactivity that we haven't been exhibiting uh in the system so far yeah unfortunately I think that's right”
Reagan successfully reversed early 1980s recession before coming out of it, allowing him to demonstrate economic improvement during his re-election, whereas the Trump first administration juiced the economy at the start and then had to deal with deteriorating conditions.
“Reagan reversed that process you had recession early in as you made some of the structural changes associated with it and then as you came out things were clearly getting better and you could see the direction associated with it”
Reagan handled policy transitions better than Trump's first administration by accepting early pain (recession) to make structural changes, then showing clear improvement in the back half, whereas Trump's first term juiced the economy early and faced disaster in the second half.
“Reagan reversed that process you had recession early in as you made some of the structural changes associated with it and then as you came out things were clearly getting better and you could see the direction associated with it right so you know I can't know what they're going to do the Temptation is always to pump and stimulate upon arrival so people can basically say hey look at the new guy look what he did right”
Current US budget deficits are largely in line with 2003 projections made after the global financial crisis, meaning deficit spending reflects the natural consequence of promised Social Security and Medicare benefits to retirees rather than new unsustainable spending.
“in some ways the deficits that we're incurring right now are just the Natural Evolution of something we already knew was going to happen right we we we actually if you look at the deficits that we currently are experiencing they're almost exactly in line with 2003 projections right and that's after the global financial crisis it's after you know a couple of recessions Etc it's after covid right and we're almost exactly where we were quote unquote supposed to be”
Older Baby Boomers invested through traditional pensions and active stock selection, so they didn't rely on passive flows; the passive flow phenomenon primarily affects younger cohorts and the tail risk of negative flows depends on when younger passive investors need to retire and sell.
“the older Boomers simply because they did not invest passively right so you've heard me talk about this before that they had pensions or whatever right they had pensions and they selected their own stocks they built their 401ks prior to the pension protection act of 2006 and relative inattention in many situations meant that they continued to invest in traditional forms right”
Successful tariff implementation poses risks to world peace because China could be expected to fight back against tariff-induced loss of market access in 'a variety of ways'.
“is that net negative for a lot of Commodities is that net negative for um potential World Peace because China would be expected to fight back against that outcome in a variety of ways yes those I think become key risks”
Much of the embedded return expectations for equities (8%, 10%, or 13% annually depending on study) are actually byproducts of valuation appreciation rather than earnings growth, and are likely to reverse as valuations normalize, making investors overestimate future returns.
“so much of what's being offered in financial markets and fixed income is being ignored because people are trained to think that that assets kind of have embedded returns right that equities are supposed to return 8% a year or 10% a year or 13% a year depending on the study that you look at and you can convince yourself of this all you want part of my message is a lot of those returns are actually a byproduct of that price appreciation that valuation increase that I was sharing with you and those are likely to reverse going forward”
In the dot-com cycle, small-cap value stocks were extremely cheap even while the broad index appeared extremely expensive because valuations were heavily skewed toward unprofitable tech companies, and today most stocks (including small caps) are more richly valued than in 1999-2000.
“on a forward PE basis you know we're looking at an S&P that is now actually more richly priced than during the dotc cycle the PE ratios and the do com cycle were a reflection that you had so many unprofitable companies and you were basically putting multiples on their Capital which then looked like the index as a whole was priced extremely richly but you actually had a ton of companies that were very very cheap as a small cap value investor 1999 2000 felt like just the most unbelievable opport opportunity set in history a lot of people draw attention to the spread between you know the most richly valued companies and the the less richly valued companies but they're not actually highlighting the fact that those less richly valued companies are much more richly valued than they were 20 years ago 25 years ago”
Current market price appreciation is driven by a collective societal mania caused by the structural framework of passive investing, not economic 'gang busters' performance, so fear of being left behind is misplaced.
“it's a bit of a collective societal Mania that is caused by the for with which we've chosen to invest in these markets”
A severe recession coinciding with negative passive flows and falling corporate profitability could create feedback loops where interest rates can't help the economy because credit stress is about corporate viability, not borrowing rates, leading to worse outcomes than anticipated.
“a recession that feels like a minor recession actually could become a relatively severe recession very quickly and and the same Dynamic I was talking about interest rate hikes becoming stimulative ironically if you start lowering interest rates at exactly the same time that a recession is occurring so that you have deteriorating corporate profitability which means that the interest rate is really not the determine of your credit worthiness or your ability to meet your payments it means that the corporate activity have suddenly now become a potential Albatross you can create feedback loops that go in the opposite direction right”
The stock market was chosen as the primary vehicle for American retirement savings rather than pension systems or national social insurance, which means implications of that structural choice (like passive flow dynamics) cannot be separated from market behavior.
“we chose to make the stock market the tool for American retirements public equities became the primary tool for American retirements as compared to pension systems which are liabilities of corporations that employ you or as opposed to a national pension system you know which is the same thing just happening on a national level beyond the scale of a social security which at least was supposed to be a social insurance function when you make those choices you have to understand there will be implications associated with it”
AI-affiliated companies and those selling equipment to build AI are seeing earnings increases, but these companies use liberal accounting policies that do not qualify those earnings under GAAP (Generally Accepted Accounting Practices), creating the same dynamic seen with Webvan and Cisco in 1999 where profits appear more substantial than they actually are.
“the traditional earnings valuation the PE ratios that you see for Schiller pees etc those are all calculated off of Gap earnings right generally accepted accounting practices those actually haven't shifted at all what we've really seen is an increase in an isolated set of companies the AI Affiliated companies and those that are selling the equipment to build this component are seeing an increase in earnings associated with it but the liberal accounting policies that are being used to accommodate that don't qualify those earnings under a gap basis”
Government-backed student loans without risk assessment for the borrower have created a massive expansion in college costs and administrative burden, with institutions incentivized to never tell students they're wrong or deny them because institutions fear losing enrollment, leading to degrees of questionable value and student debt burdens.
“when you introduce student loans that are offered without risk to people to pursue any degree what you end up with is a bunch of degrees that are less valuable than you would get if you had a system that was built around price signals right I mean right and if you have a sensitive lender I meaning the government coming over and basically taking over The Lending part yeah you know you get exactly what you would expect you have a massive expansion in costs and services right the administrative burden on colleges has exploded”
Barry Ritholtz describes the relentless bid for stocks as coming from passive flows, which has created a 'giant mindless robot' buying continuously without regard to valuation, and at some point if this robot starts shrinking or reducing purchases, it could severely upend the markets.
“you have famous ly coin this the giant mindless robot right which is just out there in the world buying buying buying so that has um created this this price um in appreciation some would say some would say price inflation um I don't think you see this changing anytime soon in terms of the structure of it I know you've warned that hey at some point if this giant mindless robot actually starts um shrinking you know it's reducing its purchasing that could really upend the card in the markets here”
Those with financial assets benefit from rate increases through higher incomes, making them resistant to policy changes that would disadvantage them, which explains why despite identity politics failures, the Democratic Party lost because it overplayed identity concerns rather than addressing economic bifurcation and the need for more fair governance.
“we have an environment in which those who already have are benefiting it is very hard to incent them to change in a way that is adverse to their interests and so when you enter into things like identity politics and again I think the Democrats significantly overplayed their hands on this”
Baby Boomers have not yet significantly sold financial assets because they largely did not invest passively (they had pensions or built their 401ks before the 2006 Pension Protection Act), and now that interest rates are higher (4.5-5.5%), they can take distributions as income rather than selling, reducing selling pressure on markets.
“it's been less of an issue with the older Boomers simply because they did not invest passively right so you've heard me talk about this before that they had pensions or whatever right they had pensions and they selected their own stocks they built their 401ks prior to the pension protection act of 2006”
Peter Thiel's expression about Trump—'take him literally but not seriously'—frames his tariff threats as negotiating theater rather than literal policy outcomes, a useful interpretive framework for understanding Trump's stated positions.
“my old Peter teal had a fantastic expression about Trump which people take him literally but not seriously”
Corporations source from illegal immigrant labor at below-market rates in ways that create billionaire and millionaire founders renting facilities to illegal immigrants, a system that Trump's deportation policy would disrupt.
“we've all seen the tick talk videos of the billionaires and millionaires that have been created by leasing out facilities to illegal immigrants paid for by various states and cities I'm going to guess those businesses are going to suffer right”
Tariffs should be understood as a negotiating tool rather than a policy to be literally implemented; Trump's stated tariff rates are designed to signal to corporations that they need to reshore production from China, while actual tariff implementation would depend on whether trading partners agree to import more from the US in exchange.
“what Trump has made very clear is is that tariffs are a negotiating tool and I think that's actually a brilliant articulation y he hopes to never use them right right exactly so my old Peter teal had a fantastic expression about Trump which people take him literally but not seriously and so when he says you know we're going to Institute 20% tariffs and we're going to put 60% tariffs on China what he's actually saying is to the American corporations get your sourcing out of China”
S&P 500 valuations are now more richly priced on a forward P/E basis than during the dot-com cycle, with the key difference being that in 1999-2000 unprofitable companies skewed the aggregate but many small-cap value companies were very cheap, whereas today even less richly valued companies are much more richly valued than 20-25 years ago.
“on a forward PE basis you know we're looking at an S&P that is now actually more richly priced than during the dotc cycle the PE ratios and the do com cycle were a reflection that you had so many unprofitable companies and you were basically putting multiples on their Capital which then looked like the index as a whole was priced extremely richly but you actually had a ton of companies that were very very cheap as a small cap value investor 1999 2000 felt like just the most unbelievable opport opportunity set in history”
The Shiller PE ratio is currently at 38, which has only been matched twice in history—heading into 2022 (before the market correction) and slightly exceeded during the dot-com peak, representing the only other periods of comparable extreme valuation.
“the Schiller PE is at a level right now that's only been matched twice one was heading right into 2022 and we saw the big Market correction that year it was slightly exceeded by thec Peak but those are the only other times in history we've been this high”
Investors approaching retirement should shift focus from asset accumulation to alternative investments that create family and community value, such as helping children buy homes at lower rates than market mortgages or other direct family investments, rather than pursuing returns through public equities.
“for most of your listeners who are going to be a little bit older and going to be closer to retirement really I would encourage you to start thinking about what are alternate things that I can invest in that will add significant value to me or to my family right I think we're seeing a lot of evidence of this this is families helping their children buy homes if they have the resources Etc replacing a mortgage that the child would have to take out at 7 and a qu% right now”
Current passive investor share of the market is approximately 50% and has generated valuations around 170% of historical norms; if passive grows to 70%, valuations could rise to 450% of normal and Shiller PE could reach 150 (three times current levels), but this creates fragility because when passive flows stop, active investors will reappear and values will crash below fair value.
“here's the good news it can grow to the sky if we were to go to around 70% passive we would see valuations climb from my estimate we're about 170% of normal valuations right now um if we got to 70% my model will say we'd be at 450% so good news your Nvidia is going to the Moon right um if we stop s up this would be like I mean what we would have average pees of like 50 or 60 yeah which is by the way where the top stocks are right now”
The U.S. current account deficits are largely explained by natural demographic outcomes (Social Security and Medicare benefits for retirees) rather than policy mistakes, and the deficits today align almost exactly with 2003 projections made before the financial crisis, recessions, and COVID.
“the deficits that we currently are experiencing they're almost exactly in line with 2003 projections right and that's after the global financial crisis it's after you know a couple of recessions Etc it's after covid right and we're almost exactly where we were quote unquote supposed to be right and the reason why is because we decided to build something called Social Security and Medicare and offer benefits and services to those who hit retirement in the United States and that makes up the majority of the spending”
Trump's interim recess appointments request, if granted, could allow ground-running and rapid policy implementation, but without them the administration could spend two years debating policy without implementing it.
“Trump has asked for interim recess appointments if he gets those we could hit the ground running and see change kick in immediately to the point that many politicians have raised if we don't see those appointments if we don't see that capability then we could very well find ourselves two years from now still debating what the impact of trump getting started on his political agenda is”
Short interest as a share of shares outstanding has fallen, with headlines regularly reporting losses from shorts on companies like Tesla and MicroStrategy, and this community damage reduces the natural corrective mechanism against overvaluation.
“short interest is a share a share fraction of shares outstanding has started to fall the headlines are regularly filled with you know shorts have lost x billion shorting Tesla or micro strategy or anything else and so we're actually really starting to uh damage that Community”
The Trump Administration's economic policies risk triggering the type of market crash scenario described because aggressive changes (tariffs, deportations) could require short-term economic pain that breaks the passive flow story if job losses or portfolio declines reduce retirement contributions and trigger Baby Boomer selling.
“this is the fear right that it's you know there's there's uh the Kurt vaget story you know how does the world end or what are the last words spoken by the human species right I wonder what this button does yeah um anytime you make significant changes to policy and the magnitude that is being discussed in the Trump uh uh platform you can't really know right”
The positive scenario for tariffs would follow Japan's late 1980s and early 1990s model where Japan recognized it had to consume more and invested manufacturing capacity in the United States (Tennessee, South Carolina, Georgia, Indiana) to build cars for American consumers rather than running trade surpluses.
“if on the flip side the super positive aspect of it is similar to what transpired for Japan in the late 1980s early 1990s in which the Japanese acknowledge okay we have to actually consume more we can't continue to run these these trade surpluses in this manner we're going to have to invest in Tennessee we're going to have to invest in South Carolina and Georgia and various other places to be Indiana to build cars in the United States to sell to American citizens”
When making radical policy changes like Trump's tariffs and deportations, unforeseen consequences are inevitable because initial conditions cannot be fully modeled, requiring preparedness for unexpected outcomes rather than confidence in prediction.
“anytime you make significant changes to policy and the magnitude that is being discussed in the Trump uh uh platform you can't really know right you don't know what the initial conditions were to allow the chaotic system to become predictable right your initial conditions could be radically different than my initial conditions could be radically different than a 22-year-old's initial conditions”
Society has lost focus and effectively decided that the only way to invest is in multinational companies in the S&P 500, which is incredibly false because there are many opportunities to change children's lives and community lives through alternative investments.
“as a society we've lost focus and we've effectively said the only way to invest is in multinational companies in the S&P 500 and I think that's incredibly false there's opportunities for you to change your children's lives to change your life and your community's lives for the better by thinking about different ways that you could actually invest both time and money”
If Trump successfully negotiates reciprocal trade agreements and forces supply chain reorientation without destroying aggregate demand through price increases, only China will be the net loser and the US could experience positive economic impulse.
“there's really only one loser China right now is that net negative for a lot of Commodities is that net negative for um potential World Peace because China would be expected to fight back against that outcome in a variety of ways yes those I think become key risks”
Strong borders economically represent the physical barrier around access to customer markets that US-based representatives are supposed to protect within a representative democracy.
“that's really kind of the right way way to think about a US citizen somebody inhabiting us soil it's one of the reasons why things like strong borders are so important is because they ultimately you know represent the physical barrier around access to those customers to those clients that you are supposed to represent through a Dem you know a um uh Republican system right a a representative democracy”
The academic community and CFA Institute move very slowly to address market structural issues like passive investing dominance, with resistance from academics trained in older paradigms ('science advances one funeral at a time').
“I've tried to raise awareness of this I've pointed out errors in the academic models I've highlighted the behavior that suggests that this is the case and you know just the sobering message like I've talked to the CFA Institute right which is supposed to be the The Institute of knowledge for trained Financial analysts um and the reality is is that things just move so slowly that once you start down a path like this it's very hard to pull back from you know the Lemmings headed towards the cliff right um it's like everything I mean science they say it advances one funeral at a time right you have to wait for the old thinkers to die out basically”
Muddy price discovery creates repercussions: if the system is designed for participants to respond to price incentives but prices are distorted by passive flows, those distortions must be owned as consequences of the system design.
“and if you design a system where people are supposed to respond to price incentives and then you muddy price Discovery you also have to own that that's going to have repercussions right”
For investors closer to retirement, rather than chasing S&P returns, they should consider alternative investments in their own children (helping with down payments), families, and communities that provide concrete life value and eliminate expensive debt like mortgages.
“I think we're seeing a lot of evidence of this this is families helping their children buy homes if they have the resources Etc replacing a mortgage that the child would have to take out at 7 and a qu% right now with okay you know what I'll just give you the money from my money market fund or I will borrow money or you know I will lend you a down payment to allow you to get a better rate those sorts of components and charge them interest right”
Those with advantages (wealth, education, family support) have responsibility to acknowledge those advantages and support better governance, fairer tax codes, and investment in younger generations rather than simply enjoying their position.
“to not acknowledge that and therefore not recognize that somehow or another I have to actually take on responsibility associated with that as well to say we need better governance to say we need a more fair tax code to say we have we have to actually invest particularly in that younger generation to ease the burdens on young families and encourage household formation Etc”
Trump administration should consider messaging about national sacrifice, akin to WWII rhetoric, to prepare the public for short-term pain before experiencing the benefits of policy restructuring.
“you know kind of should should the Trump Administration be delivering a message of like National sacrifice you know it's not quite the same but like World War II hey we're we got a big goal we're going to do the right thing but we all got to basically you know kind of bear the collective burden”
Trump and his team should avoid releasing 'the Mad Dog' through chaotic first-term behavior and instead focus on coherent execution of policy, which is what they're attempting to address in the second administration.
“if we dither about it and we basically show uncertainty and Chaos or chaotic Behavior which car candidly characterize a lot of the Trump first Administration it's one of the things they're trying to address in the second Administration you know then we could very well experience pain and get no benefit right”
If passive investing grows to approximately 70% of market participation, valuations would rise from current estimated levels of 170% of normal to approximately 450% of normal, with the Schiller P/E ratio potentially reaching levels around 150 compared to its current 38, despite this being mathematically possible within the model.
“here's the good news it can grow to the sky if we were to go to around 70% passive we would see valuations climb from my estimate we're about 170% of normal valuations right now um if we got to 70% my model will say we'd be at 450% so good news your Nvidia is going to the Moon right um if we stop s up this would be like I mean what we would have average pees of like 50 or 60 yeah which is by the way where the top stocks are right now and um you know to take it to its logical extreme at about 70% passive I would have the Schiller PE right which is currently running about 38 and way out of any historical Norm it would be somewhere around three times that level right so a Schiller PE of like 150”
The 2024 election was fundamentally not a vote for Trump but a vote for reprioritization by voters who felt the Democratic party had lost focus on what was important to average American households, particularly working-class and middle-class households whose real purchasing power has declined relative to their needs.
“there was much more negative voting against Cala Harris not because of her skin color or because of her sex but because simply it felt people felt that she had lost the Democratic party had lost focus in terms of what was actually important to the average American household and they were voting with their wallets and their their checkbooks right which are worth less relative to what they need to buy every single day”
Scott Bessent and other thoughtful individuals potentially entering the Trump administration give reason for hope that fiscal policy will move away from 'academic prescriptions' like Janet Yellen's approach toward more sound economic thinking.
“like I'm friends with some people who are going into who look like they are going into the administration individuals like Scott bessent etc those are just really smart actually committed individuals who I am very very hopeful will send us down a different path than we have gone when we've simply followed you know the academic prescriptions of somebody like Janet Yellen right”
Price is the mechanism of information exchange in a market economy, and when you look at market prices like the S&P 500, you're really just looking at where trades cross, not necessarily meaningful information about utility or value.
“part of the reason we do that is because we steal from Adam Smith right price is the mechanism of information Exchange in a market economy we look at prices to Divine information both in terms of their utility and their value to us right so we look at the S&P we're like oh that must mean something right well really it just means where trades cross”
Reagan addressed economic challenges in the early 1980s by implementing amnesty for illegal immigrants, which created a model for how policy changes can have positive economic integration outcomes if implemented thoughtfully.
“we have a model for that in Reagan who did a similar um uh amnesty for illegal immigrants in the United States in the early 1980s right”
The temptation for new administrations is always to pump and stimulate upon arrival so people can attribute good outcomes to the new leadership, which is a mistake if it sets up inflationary conditions that create problems later.
“the Temptation is always to pump and stimulate upon arrival so people can basically say hey look at the new guy look what he did right”
There will definitely be businesses hurt by deportation policy (those leasing facilities to illegal immigrants paid for by states and cities), similar to the billionaire/millionaire businesses created by this arrangement shown in TikTok videos.
“we've all seen the tick talk videos of the billionaires and millionaires that have been created by leasing out facilities to illegal immigrants paid for by various states and cities I'm going to guess those businesses are going to suffer right”
Adam Tager is the founder and host of Thoughtful Money and has recruited financial advisers for his channel who understand both macro issues and professional financial planning.
“welcome to thoughtful money I'm its founder and your host Adam tager”
Scott Bessent and others entering the Trump administration are 'really smart actually committed individuals,' suggesting hope that the second Trump administration will follow a more thoughtful economic path than the first.
“I'm friends with some people who are going into who look like they are going into the administration individuals like Scott bessent etc those are just really smart actually committed individuals who I am very very hopeful will send us down a different path”
Host Adam Tager and Michael Green are friends and associates who have appeared together on Zero Hedge for debate, indicating active ongoing professional relationship.
“um this is like twice in a week I get to see you we we did a debate a little while ago for Zero Hedge um so it's like Christmas coming twice”