Prof. Lubos Pastor: Equilibrium Models vs. Intuition (EP.124)
Nov 12, 2020
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Professor Lubos Pastor, renowned for his finance research, discusses the impact of political cycles on stock returns, the relationship between green assets and expected returns, and challenges conventional wisdom on stock volatility. He also addresses the effectiveness of quantitative easing in boosting the economy and the influence of market-wide liquidity on stock prices.
One of the main highlights of the podcast episode was the host's connection with Professor Lubos Pastor, a significant figure in the finance world. The host came across the professor's extensive body of research, particularly appreciating his work published in renowned finance journals like the Journal of Finance. By reaching out to him to appear on the podcast, the host exemplified the excitement and importance of networking with influential guests to provide engaging content for the audience.
Exploring Quantitative Easing (QE)
The discussion delved into the concept and implications of quantitative easing (QE). QE is depicted as a monetary policy tool aimed at boosting the economy during challenging times when traditional measures have been exhausted. By reducing borrowing costs for various entities like firms and governments, QE aims to stimulate investments and spending, thereby supporting economic growth. Additionally, the podcast highlighted the complex relationship between QE, inflation, asset prices, and the potential risks of creating bubbles.
Rethinking Stock Volatility in Long-Term Investments
A critical exploration of stock volatility in long-term investments provided valuable insights challenging the conventional perception. Contrary to the common belief that stocks become less volatile over extended periods, the discussion emphasized a forward-looking perspective for investors. It revealed that the uncertainty associated with long-term stock investments, especially regarding mean returns, increases with the investment horizon, leading to a reevaluation of stock allocation strategies for long-term asset management.
Implications for Young Investors and Stock Allocations
Young investors should consider their human capital argument when determining their stock allocations. Not all young people have safe jobs resembling a bond-like human capital. This study suggests that young investors should be cautious with leverage and stock exposure, tailoring their investments based on their unique human capital situation.
Active vs. Passive Funds and Investment Management Skill
There is a significant shift from active to passive funds in the investment landscape. Evidence shows that active managers demonstrate skill, but performance is not solely reliant on skill. Industry-level decreasing returns to scale impact an active manager's ability to outperform. As more money moves from active to passive funds, it may become easier for active managers to outperform, indicating a potential shift in the investment equilibrium.
Professor Lubos Pastor’s brilliant and varied research has been consistently referenced on this podcast. From how politics impacts stock returns to measuring the skill of active fund managers, Lubos joins us today as we explore some of the ‘greatest hits’ of his research. With Lubos’s position on the board of the Slovakian Central bank, we ask him about how quantitative easing can be used to strengthen the economy. His answers highlight how easing can prop up asset prices and raise inflation — and why inflation is the “least bad” option to deal with post-pandemic debt. We then discuss Lubos’s research on how political cycles affect stock returns and why stock returns are higher when a Democrat is in the White House. After diving into how stock prices respond to political uncertainty, we look at why green assets tend to generate higher stock prices but low expected returns. While talking about his research on measuring volatility, Lubos argues against the conventional wisdom that stocks are stable, in the long run. We touch on how this can affect your retirement asset allocation before chatting about whether young people should use leverage. With so many people moving from active to passive and index fund investing, we analyze the relationship between the scale of active funds and the skill of active managers. Near the end of the episode, we talk about the effect that market-wide liquidity has on stock prices and why you cannot diversify away from liquidity risk. Our conversation with Lubos is filled with insights, each of which could inspire hours worth of discussion. Tune in to hear more from our discussion with Professor Lubos Pastor.
Key Points From This Episode:
Introducing Professor of Finance and today’s guest, Lubos Pastor. [0:0:15]
The role of central banks and the goal of quantitative easing. [0:05:06]
Whether quantitative easing props up asset prices. [0:07:58]
Exploring different findings on quantitative easing by central banks and academics. [0:08:51]
Why inflation may be the “least bad” option to deal with post-pandemic debt. [0:10:27]
How increased inflation helps shift the burden of debt from those who are most impacted by lockdowns. [0:11:17]
Lubos explains the relationship between political cycles and stock returns. [0:13:39]
Hear how political uncertainty affects stock returns. [0:18:46]
Why green assets tend to generate higher stock prices and low expected returns. [0:20:38]
What factors would cause green assets to perform well, and how long this might last. [0:25:22]
The link between sustainable investing and firms pushing to turn green. [0:27:48]
Dispersions among ESG rating organizations and issues related to ESG scoring. [0:29:45]
Why green assets will, most likely, never outperform in the long-term. [0:32:37]
Exploding the conventional wisdom that stocks are less volatile in the long run. [0:34:26]
How long-term stock volatility affects your retirement fund asset allocation. [0:38:30]
How human capital and mean reversion should factor into a young person’s decision to use leverage. [0:39:54]
Analyzing the skill and scale of active fund management. [0:42:49]
Why consumers moving towards passive investing will increase active fund performance. [0:46:37]
Answering the question: Did active funds do well over the pandemic? [0:52:39]
Ways of selecting a good active fund manager. [00:54:28]
Buffett’s alpha strategies of replicating the decisions of top fund performers. [00:56:55]
How market-wide liquidity impacts stock prices. [01:10:42]
Whether current liquidity betas can predict future liquidity betas. [01:02:32]
Lubos shares how he defines success in his life. [01:05:18]
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