Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer.

Mostly Mary [0:18]

And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:36]

Thank you, Mary, and welcome to Risk Parity Radio. If you are new here and wonder what we are talking about, you may wish to go back and listen to some of the foundational episodes for this program. And those are episodes 1-3-5-7-8. and nine. One of our listeners, Karen, has also reviewed the entire catalog and has additional recommendations as foundational episodes. Ain't nothing wrong with that. And Karen's recommendations are episodes 12, 14, 16, 19, 21, 56, and 82, in addition to the first five that I mentioned. Now, I realize women named Karen get a bad rap these days, but I assure you that all of our listeners are intelligent, thoughtful, and savvy. Yes! And don't forget that the host of this program is named after a hot dog.

Mostly Mary [1:39]

That's not an improvement.

Mostly Voices [1:42]

Lighten up, Francis.

Mostly Uncle Frank [1:46]

But now onward to episode 189. Today on Risk Parity Radio, we'll do what we do best here. Here I go once again with the email.

Mostly Voices [1:57]

And we will continue to plow through our stack

Mostly Uncle Frank [2:01]

from June. There were a lot of them towards the end of the month. But without further ado, first off. First off, we have an email from my contact info.

Mostly Voices [2:14]

Oh, I didn't know you were doing one. Oh, sure.

Mostly Uncle Frank [2:17]

And the ever-engaged My Contact Info rights. Frank, hope you are well.

Mostly Mary [2:25]

Once again, thank you for replying to my emails. I think I've improved on your methods a bit, too. In episode 183, you explore GDP as a weighting mechanism. Maybe worth exploring the relationship between economic growth and equity returns. Conceptually, it's hard to internalize and believe, but my understanding of the literature is that there is historically little evidence of a link between economic growth and equity returns. Below is one paper, among many, that discusses this subject. Despite the evidence, it is amazing to me how much the press and financial community discuss economic growth when it is not correlated with equity returns. Thank you.

Mostly Uncle Frank [3:08]

Well, I took a look at the paper you linked to and I will put a link to it in the show notes. Let me just read the abstract from it for discussion purposes so people know what we're talking about here. This is a paper entitled Economic Growth and Equity Returns from November 1, 2004 by J.R. Ritter, the Cordell Professor of Finance at the University of Florida.

Mostly Voices [3:36]

Now you can call me Ray, or you can call me Jay, or you can call me RJ Jay, or you can call me RJ Jay Jr.

Mostly Uncle Frank [3:48]

And the abstract says, It is widely believed that economic growth is good for stockholders. However, the cross-country correlation of real stock returns and per capita GDP growth over 1900 through 2002 is negative. Economic growth occurs from high personal savings rates and increased labor force participation and from technological change. If increases in capital and labor inputs go into new corporations, these do not boost the present value of dividends on existing corporations. Technological change does not increase profits until firms have lasting monopolies, a condition that rarely occurs. Countries with high profit growth potential do not offer good equity investment opportunities unless valuations are low. Now, I did not go through this paper with a fine tooth comb, but I am in general agreement that there is only a tenuous relationship between GDP itself on a given day, month, or year and What's going on in the stock market at that particular time?

Mostly Voices [4:56]

Inconceivable.

Mostly Uncle Frank [4:59]

But first, I think we need to understand the history of the concept of GDP itself, because that was not used as a metric for determining the health of a nation's economy until the 1930s. Let me just read you a little piece of the Wikipedia entry about that so you can understand where it comes from. The modern concept of GDP was first developed by Simon Kuznets for a 1934 US Congress report where he warned against its use as a measure of welfare. After the Bretton Woods Conference in 1944, GDP became the main tool for measuring a country's economy.

Mostly Voices [5:42]

We have become lovers of pleasure rather than lovers of the economy. There are those who will say that the economy has forsaken us. Nay, you have forsaken the economy.

Mostly Uncle Frank [5:54]

At the time, the Gross National Product, or GNP, was the preferred estimate, which differed from the GDP in that it measured production by a country's citizens at home and abroad, rather than by its resident institutional units. You can't handle the economy. the switch from GNP to GDP in the US was in 1991, trailing behind most other nations. The role that measurements of GDP played in World War II was crucial to the subsequent political acceptance of GDP values as indicators of national development and progress. And I can link to the rest of that article in the show notes, so you can check that out if you're interested. But GDP has not been around that long, and academics have long debated what it is, how it should be measured, what it should be used for, and many other things.

Mostly Voices [6:50]

It was never really intended as a metric for evaluating the stock market in a particular country. Well, here we are, my friends. You have brought the economy's vengeance upon yourselves.

Mostly Uncle Frank [7:01]

What people have found is more useful is looking at the first derivative of GDP, as a measurement for changes in growth because you're interested in not what the absolute number is, but in which direction it is going. So is the economy growing at that particular time or shrinking at a particular time? And that metric has been of some use because it also reflects when an economy is going into a recession or not. And so Ray Dalio and many others have observed that Stocks tend to do well in economies that are showing growth at the particular time, and not so well when the economy is shrinking at a particular time. Treasury bonds seem to do the opposite most of the time. But it's a fuzzy relationship, and so you can't look at a particular growth or contraction of GDP and make some kind of prediction or use it as a decision making tool to make stock trades on particular days or anything like that. I think one of the real problems with it is you're always measuring the GDP of the past, whereas the stock market itself tends to be forward looking and encapsulating all of the collective beliefs of the participants in the stock market as to what's going to happen next as opposed to what just happened. But that is probably enough of a frolicking detour for one episode on that topic.

Mostly Voices [8:33]

Shut it up, you. Shut it up, me.

Mostly Uncle Frank [8:37]

And so I will now leave it be. But thank you for that email. Second off. Second off, we have an email from Rob, and Rob writes.

Mostly Mary [8:52]

After listening to Ray Dalio talk about changing world order and how China may replace the US with the world reserve currency, I know, Crystal Ball. Really big one here, which is huge. I am trying to research and think ahead in case this does occur. What are your thoughts in terms of good investment opportunities if this occurs? Do you think dim sum bonds are a good option? Thanks for all you do.

Mostly Uncle Frank [9:20]

Well, Rob, interesting question. I hope you read his book there because I'll couch this answer in the context of the book. We're some pretty existing paradigms.

Mostly Voices [9:32]

And I have to say, I don't necessarily agree with his conclusions

Mostly Uncle Frank [9:36]

that he draws in the book based on his own data and analysis. Looking at that data and analysis, I would draw different conclusions than China's currency is about to overtake and replace the US dollar. And the reason I say that is because if you read the book, he talks about a series of changes in a nation that shows its ascent and decline. And some of the first changes that occur are improvements in education, and then later on you get to military domination or becoming the most dominant economy in the world. And then the last thing that actually happens is getting the reserve currency. And so correspondingly, the last event that should occur in this sequence of ascendencies, if you will, is losing the reserve currency. So I didn't find that the conclusion he drew in that book was supported by the analysis that he had actually done. And in particular, according to the data and what he developed over those periods of hundreds of years, you would want to see or have to see the essentially Chinese military exceed the US military in terms of world domination before you would see a change in the reserve currency, similar to what you saw during World War II or in the aftermath of World War II. And I just don't see that happening anytime soon. And in fact, it may never happen at all. That would be great. Because if you look at the history, again, from his own book, of how and how long it takes to change from one reserve currency to another in the world, it's not something that happens quickly. It tends to take decades for that to happen. Because firstly, alternative currency has to rise in usage around the world. Both of the currencies have to be freely exchanged, and then over time, one ascends over the other. We're nowhere near that with respect to the Chinese currency, because it's not freely traded. It's pegged to the dollar. It's controlled. So there's no incentive for people around the world to use it for the most part, unless you're dealing specifically with China. In the meantime, the US dollar is still used for over 80% of international transactions. Yeah, baby, yeah! So the process that you would see historically is first you'd have to float the Chinese currency, then everybody would have to start be using it, and then eventually it would displace the use of the US dollar around the world. And we're just nowhere near that event. or those events, they haven't occurred yet. And so what are the reasons this may never occur? There are a couple, one which is a big hole in Ray Dalio's analysis in that he fails to discuss the demographic issue. Other people who study geopolitics are all over this. Peter Zeihan is one of the most prominent ones these days. I think he's got a new book out, but basically what these people are looking at is saying, Because of the one-child policy, the population of China is going to be shrinking and shrinking really fast, in fact faster than any other population has ever shrunk in history. And so the argument there is that they've essentially already reached their apex and now they're going to go into decline due to this demographic issue. Now, I'm not sure I necessarily believe that thesis either. But one of the holes in Dalio's analysis is he fails to discuss it at all. And so without accounting for that obvious large factor, which is different than what has happened historically in countries that grow in ascendance, which they tend to increase in population, not decrease in population, you would have to wonder if China will overtake the United States in any meaningful way if its population and its economy are both in decline. And now you know the economy's wrath. So what we might be seeing is what happened in the late 19th century, which was when Germany first became organized as a nation and experienced rapid growth in all sectors from education to science to technology to foreign affairs. But in terms of the world's reserve currency, they never overtook the pound sterling. And so Britain's dominance with the pound sterling lasted all the way from the late 18th century to essentially World War II when it was transferred to the United States in a transition that really lasted from the end of World War I to the beginning of World War II. But I believe I've pontificated on that enough now. The upshot of it is I would not make any investing decisions based on this theory that the Chinese currency is going to overtake the US dollar in any meaningful time frame that's worth us considering. But if I thought it was, I would wait to see how much of world commerce involves the use of the Chinese currency and how that compares to the US currency, because that gives you a metric or idea of how much you should switch into those kinds of bonds if you believe that that currency is in ascendance, because that's where really comes down to is, which are going to be the safe asset haven for the world. Right now, that's US Treasury bonds that everybody runs into when you have a world crisis like the pandemic. I don't see any indication that people are going to start hoarding Chinese bonds during world economic crises. In fact, what they're still doing today, even today, is running to the dollar. and dollar-denominated bonds. So if you're going to buy dim sum bonds, which are simply Chinese bonds traded outside of China, for those who don't know what that is, there are some ETFs that invest in such things. I think one of them is called CBOE, C-B-O-N. I have no reason to invest in something like that. It would be a pure speculation if you did. Fortune favors the brave. I think Chinese stocks are a lot more interesting because they can represent a diversification play. So if you look in one of our more complicated sample portfolios, the Risk Parity Ultimate, there is a fund in there called KBA, which invests in what are called Chinese A-shares, which are the domestic companies doing business in China. And the reason that kind of fund or those kind of stocks are interesting is because they are extremely well diversified from US stocks. The correlation number is somewhere down around 0.2 or 0.3, and over time they have shown reasonable returns. The problem with them is there's a lot of country risk there, particularly for somebody outside of China who is holding Chinese shares. You don't know what the government there is going to do. And they have a history of interfering with the companies in China when it suits them. So that needs to be accounted for. I think it largely is accounted for in many ways, just in the relative share price of those companies, because it's much lower than corresponding companies in other countries. But again, this is more of a speculation or diversification play than It is a core holding for your portfolio. And you would compare investing in something like that to investing in, say, AVES, which is the Avantis International Small Cap Fund, because both of those would tend to occupy the same position in your portfolio. So those are my thoughts and thank you for that email.

Mostly Voices [17:52]

You're gonna end up eating a steady diet of government cheese and living in a van down by the river.

Mostly Uncle Frank [18:04]

Last off, we have an email from Justin and

Mostly Mary [18:07]

Justin writes, Hey Frank, just FYI, I emailed with Julie about her question from episode 182. We left you out of the email chain. Anyway, the result was a new rebalancing spreadsheet, version 1.1, with the added functionality of tracking cash for withdrawals. Here's the write-up if you're interested, Justin.

Mostly Uncle Frank [18:31]

Well, this is absolutely fabulous. The best, Jerry, the best. And I will link to it in the show notes. For those of you who do not know who Justin is, Justin runs a website called Risk Parity Chronicles, which he put together in the past year to be almost a companion for this Podcast, because as we all know, I'm too lazy to put together things like blogs to go with my podcast.

Mostly Voices [19:02]

I don't think I'd like another job.

Mostly Uncle Frank [19:07]

But that's because I'm retired and only wish to do things that I find enjoyable and not too much work. I have people skills.

Mostly Voices [19:14]

I am good at dealing with people. Can't you understand that?

Mostly Uncle Frank [19:18]

If you go back and listen to episode 182, What we were talking about there with Julie was how to coordinate rebalancing with withdrawals of cash from a portfolio. And so what Justin's done is created a rebalancing Google sheet that you can check out and use. And he's also added some withdrawal functions to it in version 1.1. He's also got a screencast tutOrial there with the worksheet or the spreadsheet I should say and that should help guide you through it. So if you're interested, please check that out.

Mostly Voices [19:59]

Yes!

Mostly Uncle Frank [20:03]

And check out the rest of the blog over there because he's got some really excellent materials.

Mostly Voices [20:07]

Real wrath of God type stuff.

Mostly Uncle Frank [20:11]

I'm very grateful for all the work you do on this topic, Justin, and thank you for Your email and your link.

Mostly Voices [20:18]

Young America, yes sir.

Mostly Uncle Frank [20:22]

But now I see our signal is beginning to fade. And I'm hungry, so it's time for lunch.

Mostly Voices [20:30]

You can't handle the bananas.

Mostly Uncle Frank [20:33]

If you have comments or questions for me, please send them to frank@riskparityradio.com that email is frank@riskparityradio.com Or you can go to the website www.riskparityradio.com and fill out the contact form there and I'll get it that way. We'll pick up again this weekend with our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com on the portfolios page. If you haven't had a chance to do it, please go to your favorite podcast provider and like subscribe, give me some stars, a review. That would be great. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [21:23]

We must all wear sheets instead of buying clothes that need detergent. Instead of cars that take gasoline, we can get around on llamas from Drake's farm. Instead of video games that take batteries and software, our kids will play with squirrels. We must let the economy know that we are capable of respecting it. No more needless spending. The economy is our shepherd. We shall not want.

Mostly Mary [21:54]

The Risk Parity Radio Show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial, investment, tax, or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here, making sure to take into account your own personal circumstances.