Who’da thunk it? 51 years ago (June 18, 1973) my co-founding partner, Sheldon “Shep” Goldberg (deceased) and I received a letter from the Securities and Exchange Commission informing us that Cumberland Advisors was legally registered as an investment advisory firm. And we’re still around. And now headquartered in Sarasota, Florida.
Cumberland Advisors Ribbon Cutting Early 1980's
During the span of a half century, I’ve witnessed a Dow Jones average as low as 600 and as high as 40,000. I’ve seen a 30-year US Treasury bond new issue yielding 1.25% – and I’ve seen double-digit US Treasury rates on bills, notes, and bonds. I’ve seen the price of a barrel of oil as low as $3 and over $100. I’ve seen multiple wars. And I’ve seen federal budget surpluses and deficits. I’ve seen that Presidents, Senators, Members of Congress have come and gone, and many have died. With certainty, the rest will, too, even if some of them refuse to admit it.
About the most important takeaway for me is how little we know and how poorly we perform at forecasting anything. I recall the famous quip by the late Nobel Laureate Paul Samuelson which still applies: “The stock market has forecast 9 of the last 5 recessions.” I welcome any effort to update those numbers. Anyway, we’re still going!
To all my Cumberland colleagues I wish each of you a happy anniversary. To those readers and clients who have been here from the beginning, I wish you longevity and good health. (I started writing market and economic commentaries over 40 years ago.) Thank you for sticking around. To newer folks, a warm welcome. And to our clients and referring consultants, you have been the most important cohort throughout the firm’s history. You are the reason we are here, and we thank you for all the support over the many years.
Here’s a podcast I recently did with a longtime friend and journalist. There is also an edited transcript. Please enjoy.
“Kotok Celebrates Half Century of Navigating Fed, Inflation and Markets,” Kathleen Hays Presents: Central Bank Central Podcast
https://kathleenhays.substack.com/p/kotok-celebrates-half-century-of
APRIL 2, 2024
KATHLEEN HAYS
Welcome to Central Bank Central. I'm Kathleen Hays. Well, today we're celebrating with a very special guest. 50 years plus, more than half a century of money management, financial markets, central banks, inflation, and more. And in fact, more than a quarter century doing interviews with me. I'm talking about David Kotok. Uh, he was the CIO, Chief Investment Officer, one of the founders of Cumberland Advisors, joining us today from Sarasota, Florida. David, welcome and congratulations!
0:37
DAVID KOTOK
Well, Kathleen, thank you so much. It's so nice to do this again with you. And you haven't changed a bit in 25 years. Look at that. I'm still 39. Just ask Jack Benny.
0:51
KATHLEEN HAYS
Oh, there you go. Well, I have a friend who used to say, once you get to 39, you start counting the other way. So, we'll see. We're somewhere, aren't we? But David, it is something. When I saw you put it out on an announcement, it was on LinkedIn, I'm like, oh my God, 51 years! That's, you know, that’s half a century. So, take us back. Because, you know, we have a lot of new people in financial markets and we think they're new, right? Oh, they've never been through big inflation. They've never been through this. They've never been through that. What a tough time to start. But what a tough time it was when you started in the business.
1:23
DAVID KOTOK
Well, in retrospect, today I can look back and I can say that was a gift. 1973 is when my partner, Shep Goldberg who is no longer with us, and I founded Cumberland Advisors. June of ‘73 is when, it is the date that the Securities and Exchange Commission mailed us, snail mail, the official document. We didn't have email, you know, it was 50 years ago. And what happened? Bam! A few days later, Egypt closes the Straits of Tehran under President Nasser, subsequently, war breaks out in the Middle East, we had the Yom Kippur War that went into 1974, the Dow Jones went from over 1,000 - Dow Jones over 1,000 - it's 40,000 now - to under 600. Interest rates explode to the highest levels since the Civil War, Fed Chairman Arthur Burns had to fight a recession and inflation, and the energy price, the price of oil, went from $3 a barrel - I remember $3 a barrel - to $12 a barrel, and we had a shock. There were gas lines, couldn't buy gasoline. If you filled your tank, you had to do it on a Tuesday and a Thursday, not a Monday and a Wednesday, no airplanes flying, no jet fuel, General Motors wasn't making cars because nobody could buy them. That was the first two years of Cumberland being in business, trying to manage money. Nobody wanted you to do anything. Panic, fear, the world was coming to an end. It was a hell of a time to launch an investment advisory firm that was an independent fee-for-service firm. By the way, we still are, it hasn't changed. And in retrospect, going into this business under fire, in the pit, is the best thing that can ever happen.
KATHLEEN HAYS
Why is that?
DAVID KOTOK
Because you learn, well you learn to fight the wars. You learn that number one, trends, and trajectories have lifespans. You learn how to deal with adverse circumstance. And adverse circumstances, and we have some today, we can talk about it. Adverse circumstances are the types of things that season the money manager, the analyst, the mature economist who admits they don't know everything. That's what it takes. Adverse circumstances. Anybody who thinks they're smart in a roaring bull market when everything's going up is caught in a trend. Adverse circumstances. You learn the Malcolm Gladwell story. You want to get better at what you do? You do it with a struggle. It makes you better.
4:34
KATHLEEN HAYS
All right. Well, give us a little more context. Uh, you know, who was in the White House, where the bond yields were, uh, you know, so we can, because yields go up again. But that's another thing. I mean, you've always been big in fixed income and particularly municipal bonds when you first started out. But what was, give us a brief nutshell of that.
4:53
DAVID KOTOK
Well, you were in the ‘70s so, so you had war in the Middle East and then you went into the Carter administration, towards the end. The oil price was rising. I mean, four times increase in the price of oil at the time when everything was dependent on oil. There were no fuel substitutions to speak of. That was a huge shock, triggered on inflation that went several times.
In 1979, Paul Volcker came into the position of Fed Chair. And I would say he was the go-to candidate because, at the time, inflation was double digits, interest rates had been rising, we had been through a whale of a recession, and while there was some recovery, it was not a lot. And Volcker stopped the inflation by taking interest rates at double-digit levels and, and people believed him. And as soon as it became credible, the system started to do better. Ronald Reagan followed Jimmy Carter; Paul Volcker was still Fed Chair. Interest rates peaked in 1981. The bond market sold off to its lowest level in 1981. If you bought bonds in 1981, you bought into the beginning of a 40-year bull market in bonds as rates came down since. And the stock..
6:23
KATHLEEN HAYS
Do you remember exactly what that lowest level was, David?
6:26
DAVID KOTOK
Oh, my God. Well, it was in the teens. It was in that. I remember the first bond we bought in Cumberland because I did the block trade for the company. And it was a AAA-rated Pacific Telephone and Telegraph 30-year corporate bond. And the interest rate coupon was 12.15%. 1% a month to loan your money to a subsidiary of AT&T that had a credit rating of three capital As. You were paid 1% a month. I turned to my partner at that time. We hadn't bought bonds for several years because we were in this rising interest rate trend. I turned to my partner. I said, “Shep, you're going to be paid 1% a month from the telephone company, 1% a month. We need to buy this bond.” We bought that bond, Kathleen. Little did we think that within two years at the worst, when there was raw panic in everything, I would see that bond trade at 70 cents on the dollar. I bought it then, too. Bought more. And 10 years later, that bond was called away. And during the 10 years, the clients got paid 1% a month for the telephone company. Not a bad trade.
7:45
KATHLEEN HAYS
Not a bad trade at all. So, let's uh, let's look then. So, you, you came in uh, you were still a kid when it came to investing, you made some good trades right out of the gate. Uh, what was it like uh, in financial markets in the sense of, for example right now people are concerned about, oh maybe the Fed shouldn't be too aggressive, you know, and a lot of people hearken back to Paul Volcker which, when you, when you mentioned Jimmy Carter it made me think, he made a brave move because Jimmy Carter was not helped as President by Paul Volcker's aggressive rate hikes, you know. At the beginning it wasn't popular at all, so we must remember Jimmy Carter and give him respect for that. But I'm thinking in terms of investors and the mood, what it was like and, you know, how you navigated that.
8:35
DAVID KOTOK
Well, you had the ‘69-‘70 bear market. There was some recovery in ‘71-‘72. And then you had ’73-‘74. And that was a whale of a bear market. Stock prices by any broad index, I again refer to the Dow, 45% from peak to trough in 18 months, so investors were shocked. They had had double shocks. And along comes Volcker and the final shocks were the rising interest rates, rising inflation rates. Miller was the Chair before Volcker and Burns before Miller. And the Fed was trying to deal with two problems at once. An economy struggling, trying to overcome an energy price shock about which the Fed can't do anything. They don't have a drill for oil.
KATHLEEN HAYS
<laughs>
DAVID KOTOK
And the inflation rate and the tools they had at the time had not been refined. So, we had crisis following crisis following crisis. Paul Volcker probably created credibility for the Federal Reserve because he said what he was going to do. I remember sitting in his testimony, listening, I sat two seats behind him thanks to a friend in the Congress at the time who got a seat for me. And I remember there was Volcker. There was no discussion. People said, I believe this man because he means it. And his history, prior to being Fed Chair, convinced everybody he meant it. You know, I had the occasion a few times to meet with Paul Volcker or do a conference or two with him. He was credible. You believed him. And when market agents can have confidence and belief, they know what to do.
10:43
KATHLEEN HAYS
So, David, in terms of inflation, what uh, what were the lessons learned in terms of the era you just described and looking back over your 50 years? What's the takeaway that as people celebrate your half century that you want to share with them?
11:04
DAVID KOTOK
Well today, if you look at the Federal Reserve today under Powell and the leadership in the Fed and the commentary coming from the Fed, and you put it all together and you say, look, these folks know that they cannot lower interest rates and must turn around very quickly and raise them if inflation starts to flare.
So, they don't want to do that. And if there's financial stability, key words “financial stability”. If there's financial stability, they are going to go slow and be patient. And they have raised rates enough so that the interest rates, the policy rates, are above the inflation rate.
Now, how much and how to measure and how to estimate is always a debate. But if we look at the PCE, for example, and we look at the policy rates, we see maybe the real rate is 2%, 2.5%, something like that.
The Fed knows that if they can keep the real rate positive by two or three points, over time, the inflation pressures will be brought down. That requires patience. Market agents, who are a little younger than I am, don't remember these earlier times. They don't remember longer trajectories. They want instant gratification. We saw that in the last few months. Seven cuts. No, five cuts. No, it'll be seven cuts. For what? Opinions. Punditry on a TV show? The history says trends are longer and they take a while. And it's easy to get inflation to go from 6 to 5%. It's harder to go from 5% to 4%. It's harder still to go from 4 to 3. You and I have discussed this for 25 years in various interviews. Try to get from 3 to 2! And do it, what, we had news today. There's 8 and three-quarter million unfilled job openings in the United States. And whether the unemployment rate is going to be 3.7% or 3.8% doesn't make a difference. With that kind of gap, you can't suppress inflation quickly. It requires patience. That's what the Fed's been saying, Kathleen. Slow down, market. Cool..
KATHLEEN HAYS
Yes.
DAVID KOTOK
Cool it.
13:40
KATHLEEN HAYS
Well, and of course, we had the National Association, well excuse me, we had the ISM, Institute for Supply Management, uh, PMI, Purchasing Managers’ Index, the oldest one, what is it. It's, it's hey, that's been around since you started investing, right? I mean it's got a long track record.
DAVID KOTOK
Shhhh. We don't, we don't, we don't talk about the old factor here.
KATHLEEN HAYS
<Laughs>
Anyway, but there's several things that are coming in saying either the economy, you could at least say it's solider than you thought and other things might say gee it's maybe it's even a little hotter. So, besides patience, if you, let's say you were coming back in or you were going to set down all these people who have only been in the market and following the bond market, et cetera, for a shorter period, what's your number one piece of advice? Is it what you just said, be patient? Is there another sort of investment angle here they should be thinking about?
14:28
DAVID KOTOK
Well, our view, now I can talk about what we're doing in Cumberland, there are tax-free bond sectors, which are very appealing right now. And the real interest rate is a positive number. Now, we can debate whether it's 2%, 2.5%, or 3%. It doesn't make a difference. If you can have a tax-free cash flow from a AAA municipal bond, and it is above the real interest rate on the entirety of the Treasury curve, for an investor who is a very conservative, income-driven investor, that's a good thing. You want some of that.
The stock market's a different issue. We've concentrated the magnificent seven or six or five or four. Who knows? Look at Tesla. They're not in the club anymore. But if you look at the stock market and say, well, I don't know what to do about 40, 50, 60 price earnings ratios. That's a valid question. I don't know what to do. I faced that question for the last 50 years, and it's still an enigma. What about the mainstream equal weight S&P 500?
We use an ETF called RSP. Equal weight S&P 500 index. What are you doing? You're taking the top 500 companies in the United States. You're saying I'm going to ignore the variations in market cap. I'm going to use the Standard & Poor's screen. That's how they get in there. And I'm going to look at their earnings collectively, not worry about four stocks being 30% of the capital weight. What do you see? You see earnings in the teens. You say, gee, if the earnings rate is in the teens and the U.S. economy is growing and the Fed is maintaining a real interest rate, then diversified portfolio in stocks of the United States has a place in my portfolio. And by the way, it does, and one of the ETFs we use is RSP.
16:44
KATHLEEN HAYS
All right. So, you touched on financial stability. That's another aspect, I mean, that I want you to look at. Because when again, when you came into the industry, sort of the mid ‘70s, I think there'd already been some prominent uh bank failures, right? But they used to be like one at a time. And they didn't happen every few years, which is kind of how it's gotten to now, it seems, in our financial system. So, talk to us about that. What kinds of things, how you've navigated that, to start with, and then what have you learned?
17:31
DAVID KOTOK
Well, my observation is the Federal Reserve has learned. So, we've had sequential crisis. Savings and loan crisis, remember that one? Okay. And then, and then as time progressed, we had a dot-com bubble burst and there were financial institutions tied to it, and we had a currency crisis that was already under Greenspan's role where he had to get a few banks in New York and say, listen, we don't want to have contagion because the Thai baht fell apart and a hedge fund failed.
KATHLEEN HAYS
<Inaudible>
DAVID KOTOK
Yes. So, you look at the progression of history, and what do you find? Every time the Fed permits financial instability, contagion, the multiplier effect of the bad times, who suffers? The general economy suffers. Businesses fail, and people lose jobs. So, do you want to impose such a harsh discipline as to have that as the outcome, or can there be a policy that is more gradual without throwing millions of people out of work or bankrupting businesses? Well, we, we learn that each time differently, but we learn it each time in the great financial crisis. It was learned the hard way. That was 2007, 8, and 9. What's been learned since? Well, look what happened a year ago. Silicon Valley Bank, $200 billion in size. Two more banks right behind them. Total $600 billion in size. If you total the three, that's larger than Washington Mutual's failure, which was the largest single institution in history. And that was the great financial crisis. What did the Fed do? It intervened quickly. It said, we're not going to allow a contagion. We're not going to permit the meltdown and the subsequent depression. We're not going to allow the banking system to be under such duress that 500 companies will lose their deposits and must go out of business. Hooray for the Federal Reserve! They did the right thing.
19:56
KATHLEEN HAYS
Well, I'm curious because uh, not everybody agrees with you, I mean,
DAVID KOTOK
<Nods>
Oh, I could..
KATHLEEN HAYS
That they’ve done, you know, did they have their eye on the ball? There's this question about the Basel III bank regulation requirements and what's going to happen there. And I think for a lot, I would assume for a lot of people who are money managers, portfolio, whatever, like you. How much of a concern is this? Is it a concern like, well, let's keep our eye on them. If nothing bad happens, we're fine and we don't have to look at this too much. We must look at other things much more, like the Fed and inflation, for example. Or is it something that as an investor of, you know, half a century now, that you see as a potential, I don't know, a potential minus, a potential plus, depending on how it goes?
20:50
DAVID KOTOK
Well, that's the trade-off between how much hardball and discipline do you impose on market agents? And at what point do you tolerate a level? And is it necessary to have the harshest punishment or is there a way you can spank a few people and the others will observe the spanking and then you change the rules to tighten capital requirements on banks, you regulate harder, and they don't like it, so they squawk about it, which they always do, and at the same time, you don't get a multiplier effect or contagion. So, in the Silicon Valley Bank subsequent case, we didn't get the contagion and multiplier. Look at where we are. We're at an unemployment rate under 4% persistently, we've got eight and three quarter million job openings today, we have an inflation rate that's coming down. Is it two? No, but it's not five anymore. And it seems to be headed south. And we have a thriving economy that is the model for the world. We have a stock market at new highs. And we have everybody who wants it to go to 6,000 in the S&P tomorrow. It'll have to wait a few weeks.
22:11
KATHLEEN HAYS
So, David, uh, in terms of uh, the Fed and inflation, you said earlier in this conversation that patience, patience is what they need. And what's striking me right now uh is that a lot of people are saying, oh, 2% inflation. That's something that the Reserve Bank, no, it was the Philippines and the Reserve Bank at New Zealand years ago, 1991. Let's do 2%. At least that's how they perceive it. I suspect they put a little more thought into it than that, right? But then people say, well, why? Just stop at three. I mean, why?
Why make people lose a few jobs? I mean, why? You know, so what's your answer to that? Because there's, there's two very, two strong sides developing right now.
22:52
DAVID KOTOK
I've had that conversation for a lot of years. 2% inflation, rule of 72. You double the entire price level. Level. That means 80,000 prices. Some go up more, some go up less. But when you average them all out, you double the price level in 36 years. At 2% inflation. 36 years is greater than a generation in time. So, my grandchildren grow up in a world of 2% inflation. They don't have any expectation of higher inflation, and it's low enough not to change a lot of behavior. That's Greenspan's old argument. We want to have a little inflation but suppress it, so it doesn't alter behavior. Take the inflation rate to three. 24 years. Take it to four, 18 years. So, the gradations are not linear. The expectations accelerate as the rate goes up. So, 2% doesn't have to be a hard, fast 2%. Can it be one and three quarters? Can it be two and a quarter? Sure. But it's currently above that range and therefore the expectations of inflation with prices changing at 4 and 5% a year becomes embedded. And embedded inflation expectations, as we know from history, are very difficult to extract. That's why - The Fed knows this. All the academic studies know this. The Fed will persist because it wants to get that trend solidly in the 2% camp. Does it have to hit 2.0? Can it be 2.1? Sure. There’s a margin of a couple ticks in either direction just on trying to estimate what the rate of inflation happens to be. We don’t know. We must guess at it.
24:56
KATHLEEN HAYS
Well, so, as you look back over your half a century, doing all the things you've done, and of course, you've always made it a big part of your life and your work with the Global Interdependence Center and more to go around the world, speaking to central bankers and taking other people with you. What, um, you know, what do you, if you're advising, let's say somebody else who's in the industry, maybe they're going through tough times. Should they stay? Some person is thinking, well, I don't know. It's very competitive. And what would you, what would you, what would you advise them or what would you have them think about to make such an important decision? And, and if it would, or would you say, “Hey, jump in, dive in. It's a great place to be”?
25:44
DAVID KOTOK
Well, it certainly is a volatile place to be in the financial services industry. And the financial services industry from the United States has been a gift to the world. We have a tremendous financial services industry with great skills, capital, applications, and the rest of the world tries to use them and adapt to them. And we export it as well as do it for ourselves. So, marvelous. Why do we have that? Because over time, we understand or work at the credit multiplier. We don't just open-endedly inflate. We don't like the rate of inflation, or we don't think we have enough, and we debate it, but we don't have a Weimar Republic in the United States. We don't have a Zimbabwe in the United States and we're not going to get one if we have an independent central bank. Second thing is we have a rule of law. And that is under attack from some circles these days. But the rule of law allows us to have understandable and enforceable contractual arrangements for business and commerce. You and I get into a contract, we shake hands, afterwards we must resolve a dispute. We don't go out in the street like we did in Dodge City 150 years ago and have pistols shooting at each other. Some people are doing that now, which is interfering with the rule of law. But we operate with a set of rules. It's a wonderful system. So, when you couple rule of law, court system, a way to resolve disputes with credit, finance, and commerce, and the expansion of business, you have this great thing called the United States of America. And it's a wonderful thing. That's my opinion, but it's derived after doing this for a few years. And I stick to it.
I would say to the younger serious student of finance and economics the same words that Winston Churchill said to students before he left us and after he was the prime minister when he was asked what to do. And he said, “Study history, study history, study history, and when your eyes are tired and you're exhausted, wake up and study more history.” Study history. It's a great guide. It's not completely repeated, but as Mark Twain is reputed to have said, it rhymes. And that would be my advice. Study history.
28:36
KATHLEEN HAYS
I don't want to say too much except I think David, in the not-too-distant future, is going to be coming back to share some work he's done on history, financial history, and that will be very soon, we hope.
28:50
DAVID KOTOK
Well, we're hoping soon. New book. We're a month or two away, I hope. We've been at it for four years. What happens with pandemics, epidemics, COVID, and other shocks, what are the economic outcomes, industry outcomes, inflation rate outcomes, wages, markets, asset prices.
Four years my colleagues and I have worked on this and we're very excited about it and I hope to be back and discuss it with you before this summer is over.
29:22
KATHLEEN HAYS
Holding you to that, sir. David Kotok, thank you so very much for joining us. Um, great conversation, great uh, putting, connecting a lot of dots for us. I really appreciate it and David of course, one of the founders of Cumberland Advisors. Um, anyway David, thanks so much uh. and we'll see you again soon.
DAVID KOTOK
I hope so. Thank you, Kathleen.
KATHLEEN HAYS
Okay. And thank you for joining me here on Central Bank Central. I'm Kathleen Hays.
David R. Kotok
Co-Founder & Chief Investment Officer
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