On this week's Stansberry Investor Hour, Dan and Corey welcome Eugene Fama to the show. Eugene is a Nobel Prize-winning economist and widely recognized as the "father of modern finance."

Eugene kicks things off by talking a bit about his efficient-market hypothesis, whether he believes it's still relevant in today's economy, and how passive investing plays a role in all this. He also discusses what it's like winning a Nobel Prize, the impact of his five-factor model on investing and the rise of factor-based funds, rationality versus irrationality, and the importance of luck in markets. Comparing investing with gambling, he notes...

Lots of the winners are just lucky. They're not good, they're just lucky... You don't go to Las Vegas in the expectation of making a lot of money. You go in the expectation that you know you're going to lose some amount because the house takes [its cut] and the state takes [its cut], and you get what's left over.

Next, Eugene argues against a New York Times article claiming that a PhD in economics won't bring affluence or prestige anymore, laments the lack of new breakthroughs in financial theory/modeling, and comments on the modern competitive environment in economics that didn't exist 60 years ago. Things then take a more personal turn, and Eugene talks about his how he discovered his love of economics and what he wanted to focus his research on...

I worked for a professor, Harry Ernst, at Tufts during the summer of my junior and senior years. And my job was to come up with ways to beat the market. And I was really good at it... Harry always kept a little data out of the sample that I used to fit the models to. And my models never worked out of sample, so there was a big message in there for me that kind of guided me thereafter in looking at models.

Finally, Eugene shares what it was like in Chicago back when the city was the epicenter of financial research, including his experience working with some other notable economists. After that, he gives his opinion on market bubbles. Speaking about the dot-com era, he says that the total value created from the industry is a big part of international wealth today, so it can't be considered a mistake. And he closes things out with a conversation about uncertainty in making predictions...

I look forward. I see this unexpected value going out. But around it there's just an enormous amount of uncertainty that is unresolvable. You cannot resolve it at this point. And that's what we live with all the time, especially investing in equities. It's that uncertainty.

Click here or on the image below to watch the video interview with Eugene right now. For the full audio, including Dan and Corey's post-interview thoughts, click "Listen" above.

(Additional past episodes are located here.)

This Week's Guest

Eugene Fama won a Nobel Prize in economic sciences in 2013. Widely recognized as the "father of modern finance," his research is well known in both the academic and investment communities – especially his efficient-market hypothesis. Much of his research is focused on the relation between risk and expected return and its implications for portfolio management. On top of everything else, Eugene is among the most cited researchers in economics. A prolific author, he has written two books and published more than 100 articles in academic journals. Also, he was the first elected fellow of the American Finance Association in 2001.

Eugene earned a bachelor's degree from Tufts University in 1960, followed by a Master of Business Administration and PhD from the University of Chicago Graduate School of Business (now the Booth School) in 1964.

Dan Ferris:                 Hello, and welcome to the Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and The Ferris Report, both published by Stansberry Research.

Corey McLaughlin:    And I'm Corey McLaughlin, editor of the Stansberry Daily Digest. Today we're talking with a Nobel Prize-winning economist, Eugene Fama.

Dan Ferris:                 You heard that right. We are talking with the one, the only Eugene Fama, the father of modern finance. Let's not waste another second. Let's do it. Let's talk with Eugene Fama. Let's do it right now.

                                    Welcome to the show. Thanks for being here.

Eugene Fama:            Thank you.

Dan Ferris:                 So, I wanted to just mention the first time I ever heard your name, Gene, and according to The Financial Times and some other folks, you're the most famous economist in the world. So, I should have heard of you –

Eugene Fama:            No, that's [inaudible].

Dan Ferris:                 I knew you would say that. I knew you'd react like that. But this book I read maybe 25, almost 30 years ago called The New Finance: The Case Against Efficient Markets, right on chapter one, page one it mentions a study by Eugene Fama and Ken French – voted the best article published in The Journal of Finance in 1992. Later I learned more about you and found it a bit ironic that the guy whose name is associated so much with the efficient market hypothesis was mentioned as the author of a study where he's saying he's against the efficiency of markets.

Eugene Fama:            Well, you misread it.

Dan Ferris:                 Yeah. I guess the first thing to ask you then is, are markets truly efficient? Are they as efficient as you thought when you first put these ideas together?

Eugene Fama:            Nothing is ever perfectly anything. So, it's not perfectly efficient. The question is: Is it efficient for your purposes? Do you have information that's not in the prices that you can use to, shall we say, beat the prices? For most investors, the answer to that question is no. They don't have special information. And that includes most professional investors as well. So, there are some people out there who do have special information and for them the market is not efficient. That's fine. So, there are people who help to contribute to make the market more efficient by taking advantage of the people who think they're efficient or think they have special knowledge, but really don't.

Dan Ferris:                 Right. And overwhelmingly, the market is efficient for professional managers. I think less than 10% of American managers actually beat the market. And I think the figure was less than 20% of UK and then there were some studies in other countries. But yes, overwhelmingly, in practice, this theory has been very useful to many, many people – and more and more people as so-called passive investing has become much more prevalent – have taken advantage of this. In practice, this has worked out for a lot of people, hasn't it?

Eugene Fama:            I think so. And it's worked out for a lot of big investment managers as well that jumped into the passive-management game.

Dan Ferris:                 Some might say, "So far so good, but…" nowadays. Nowadays there is a fair amount of discussion about how passive has changed market structure and how that might not be the best thing in the long run for many investors. I assume you've thought a bit about this, no?

Eugene Fama:            I don't know what particularly they have in mind. I mean, is it that the pressures are getting less efficient as a consequence? Or what's the problem?

Dan Ferris:                 Well, the market as a mechanism for pricing securities, when so many people are basically buying –

Eugene Fama:            I get your question. So, it depends on who stops doing it. If the people that stop trying to beat the market really had no special information anyway, their dropping out and becoming passive is actually making the market more efficient and making – there's less need for informed investors to come in and offset their actions. So, the market actually gets more efficient when the misinformed people drop out.

Dan Ferris:                 And presumably, I would suppose, on that viewpoint, that there are still more left to drop out with the performance of investment managers not improving any over the long term.

Eugene Fama:            Listen, as long as they get high fees, they won't drop out.

Dan Ferris:                 Right, right. But overall, of course, there is a shift toward the lower-fee, so-called passive funds, so maybe the market is doing its thing and getting rid of them. It's dumping them whether they like it or not. I have to ask you something on a personal note. I hope you don't mind. If you don't want to answer it, that's fine. But of course, in 2013 you won a Nobel Prize for these ideas that you had worked on for decades up to that point. And I just had to wonder – did your life change? I noticed you were talking about Merton Miller in a Financial Times article, and you said, "Well, he changed his life. He won a Nobel Prize in 1990 and he went off and sailed around the world or so, traveled the world, and that's great." How did your life change, if at all, once you got this award?

Eugene Fama:            Everybody treats you differently after you win the Nobel Prize. All of a sudden you become smart. I mean you're anointed, basically, and people take you much more seriously than they did before that. You've got to be leery of what effect that has on the way you behave from then on out. So, I sort of said at the time that I wasn't going to let this change my life all that much. I was just going to keep doing what I did. I don't like to travel anyway, so I'm not going to travel all over the world doing speaking engagements just to capitalize on the prize. So, basically I've just done what I've always done since then.

Dan Ferris:                 All right.

Eugene Fama:            Just do my research and hope it works and hope people like it.

Dan Ferris:                 Another thing I was curious about is the process leading up to that. Do you learn ahead of time that "Hey, you're being considered for a Nobel Prize in economics?" or does it just kind of –

Eugene Fama:            You don't learn anything ahead of time because it's a very secretive process. You know you're probably being considered because the nominating is done by a large group of economists. So, you figure that there are probably people who put your name in because you know your name came up in the past. So, you know your name is in there, but you never know if or when you're going to get it. So, that's always a complete surprise.

Dan Ferris:                 I see. All right. So, in addition to the efficient market hypothesis, your name is also associated with these factor models, the three-factor and the five-factor. And I noticed – if you just sort of Google around and you're looking for, for example, ETFs, there are factor ETFs that you can buy. There are, what, the quality factor and size factor and momentum factor. And then I looked at your five factors and they were a little different. There was something called the investment factor, which I found interesting. I'm wondering in your mind, what's the state of these things? People are selling these things. They've created products out of – just the same way they did out of the AMH, they created passive products.

Eugene Fama:            Right. Right.

Dan Ferris:                 What is your assessment of all the products that are created out of your work?

Eugene Fama:            Well, the problem with creating products out of the work is –  it can kill some of the results. When people start investing in these things, you find out whether they were there by chance or whether they were actually real things because then the prices change in response to trading. The jury's still out on that. I think that the whole area of what we call asset pricing, which is basically models of risk and return and how well they fit the data, that how you measure risk in a multifactor world, that's evolving. That's basically back to scratch, I think, at this point.

Dan Ferris:                 Really?

Eugene Fama:            So, there's a lot more work for people coming along now to really try to fill that in. Basically, there's a lot more work to be done. I don't think anything's settled there. I think the factors that we put in our model are really the best factors going forward – are the most informative ones going forward. And this is always a changing landscape.

                                    Now, if you look at the literature, you can easily come up with 50 factors – 50 different factors. But they all turn out to be kind of minor variants of the same thing. They're somebody's little wrinkle. We were very careful when we did ours to look backward and forward in the data and make sure it looked pretty robust. If you look at markets across the world, it seemed to look pretty robust. But that doesn't mean it will continue to be robust in the future. No matter how careful you are about past data, it doesn't tell you about the future, obviously. And the future can turn out to be different.

Dan Ferris:                 Right. The future can turn out to be different for the factors and also the, how does one say, the real results. The out-of-sample can turn out to be quite different from the theoretical work, can't it?

Eugene Fama:            Sure.

Dan Ferris:                 For whatever reason.

Eugene Fama:            Right.

Dan Ferris:                 Yeah.

Eugene Fama:            Well, trading itself can affect these things. People's decisions to jump on these things or not to jump on these things, to avoid them, can itself cause changes in prices that either wipe the thing out or lead to pricing in a different direction. You don't know that until long into the future. The problem is –  uncertainty about what the true values are is so high, it takes a ton of data before you can even start measuring things.

Dan Ferris:                 Right. So, I knew we'd get to behavior pretty quickly – or eventually. And so, I have to ask you, given who you are, Gene Fama, is homo economicus rational or irrational? Or somewhere in between? Or something else entirely?

Eugene Fama:            Who am I? I don't know. Where would I classify myself? I try to be rational but that doesn't mean I succeed. And unfortunately, I'm not the best judge of that.

Dan Ferris:                 Right. But economic man – homo economicus – people in general, as economic actors, it seems to me it's tough to come down either way. Where – would you have to say as economic actors –

Eugene Fama:            Well, nobody would say that everybody's completely rational about everything. Nobody would say that.

Dan Ferris:                 No, no. Or completely irrational, right? I mean, people use –

Eugene Fama:            Or completely irrational. Hopefully.

Dan Ferris:                 Right, right, right. I mean, there are folks like – I don't know the pronunciation – Gerd Gigerenzer, I think his name is, he talks about people using heuristics. To me, it's almost like a blend of your gut and your rational mind, a heuristic, a rule of thumb, right?

Eugene Fama:            Right. Shortcuts. Right.

Dan Ferris:                 Yeah. It seems like we're somewhere in the middle and we can never quite be sure. That's got to make your job a lot harder. Or somebody's job, some economist's job.

Eugene Fama:            What you would like to know and we don't really know in great detail is how all of that affects price formation in markets. What's the end result of all that? How does it lead, how does it change the way you think about risk and return and whether prices are right? So, those are the big open questions in asset pricing. Those were the big open questions when I started and I'll die and they'll probably still be the big open questions because the world changes all the time.

Dan Ferris:                 Yeah, whether prices are right. I'm glad you brought that up too, because I was wondering, I was thinking about this idea of the efficient market and you can't beat the market because the market prices are basically right, and we've established that for a lot of people that's been a pretty good idea. But in order for you to say, "I can't beat the market," it's not necessary, is it, to say, "Because the prices are right"? Is it?

Eugene Fama:            That's too absolute a statement. The prices are right as far as I'm concerned. So, they may not be right for – somebody else that's more informed, they may not be right for that person.

Dan Ferris:                 Right. I see.

Eugene Fama:            But for everybody who doesn't have special information, the best way to proceed is to think prices are right.

Dan Ferris:                 I see.

Eugene Fama:            Or stay out of the market entirely if you don't like that idea.

Dan Ferris:                 Right. It's simply the best assumption –

Eugene Fama:            Right. Well, I mean, it's the assumption that gets supported by lots of data, including – when I look at all the professional managers and I see there's only a small fraction of them that actually win... then I know, well, for most of those other guys, the market's efficient. And even for the guys that win, you get the second – you get the problem that we look at them after the fact. So, lots of the winners are just lucky. They're not good. They're just lucky.

Dan Ferris:                 I was going to ask –

Eugene Fama:            So, even in there you're – well, but it's true on the other hand too. Lots see the guys who do poorly also just have bad luck. So, there's a lot of luck involved in winning and losing in markets.

Dan Ferris:                 Right. And therefore we can look at indexing or so-called passive as a way to account for that, which I find –

Eugene Fama:            Well, there are clearly tons of investors that don't want to invest that way because we haven't killed active management. It's still alive and kicking. And people pay high fees to get into the game, even though maybe they know, maybe they don't know that on average they're going to lose. But they still do it, so they must be getting something out of it.

Dan Ferris:                 Not necessarily good returns but something.

Eugene Fama:            Something, right. Well, you don't go to Las Vegas in the expectation of making a lot of money. You go in with the expectation that you know you're going to lose some amount because the house takes its take and the state takes its take and you get what's left over.

Dan Ferris:                 And presumably using what we said about those who had no better information becoming passive and that doesn't hurt the market, maybe those who realize their odds in Vegas, I would think they'd have a lot bigger impact if they stopped showing up in Vegas. We're not going to crash the market by everybody going passive but we could crash Vegas if we talk these people into not gambling, certainly.

Eugene Fama:            Well, that's harder because that's just a wheel, you know?

Dan Ferris:                 Yeah, apropos of nothing. Sorry. I was just making a joke.

Corey McLaughlin:    Hey, Gene, you mentioned there's a lot of work to be done still on the factors here. If you were starting over today, what would you be looking at?

Eugene Fama:            I'd be looking at the stuff I'm actually looking at. So, at the moment, it's not primarily finance. I spent my life doing finance half the time and general economics the rest of the time. So, I've done a lot of macro work. I've done a lot of micro work. I've done a lot of work in different areas of economics, even sub areas. So, I don't know what I would do. And that's what makes it fun, is that you really don't know what you're going to do until you start doing it and then that pushes you in different directions. So, when people ask me "What are you going to do?" I always say, "Well, if I knew that, I would have already done it." So, basically looking forward, I hope I'm always surprised by what I do. But I haven't got too much time to do that because I'm 85 years old.

Corey McLaughlin:    Right. Do you have any ideas or thoughts on this current generation of investors, younger, getting into the market, who are maybe treating it like a casino? I mean, what should they be aware of?

Eugene Fama:            I never talk to individual investors except in very large groups where I do give talks. I never advise people one-on-one. They never take your advice anyway, so what's the point?

Dan Ferris:                 That's right.

Corey McLaughlin:    Right,  yeah. Unless they ask, I guess, yeah.

Dan Ferris:                 So, Gene, I'm wondering if you saw an article in The New York Times recently – and here's the headline, OK? It says "The bull market for economists is over. It's an ominous sign for the economy. Earning a Ph.D. in economics has long been a reliable path to affluence and prestige. Not anymore." I think they're talking about you with the affluence and prestige.

Eugene Fama:            I don't know. I'd like to see the data behind that, because among the various areas where people get Ph.D.s, economists are still getting jobs. They're getting jobs in the public sector, they're getting jobs in the private sector, and they're getting teaching jobs. So, I don't know where that comes from. Whereas, if you look at other fields – so, for example, they say we always need more scientists. But if you look at scientists who get Ph.D.s, what you find is they spend many, many years working for the – never going out and getting a job because it's just too difficult to get jobs in the sciences. So, I think economics is still pretty strong as a discipline to get a job in.

Dan Ferris:                 All right. In a Financial Times piece about a year ago, I think it was with Robin Wigglesworth, you did seem to lament the lack of big, big new work being done. You seemed to think that folks were focusing on the details of things that had already been done, things by people like yourself, and they weren't taking on the big new ideas. Do you feel that way?

Eugene Fama:            Well, I'm waiting for what is the big new idea? What areas are we working on? Where is it sitting that we don't know about? It's been a while since we've had something like that. I mean, my generation was lucky. When I came in, basically there was nothing in finance, so – and very little in economics as a whole – so whatever you did, it was pretty new. It was like shooting fish in a barrel. Now it's not true anymore. Now, you have had thousands of economists – all very well-trained – working on problems. And lots of the problems have been dug into by other people, so there's just little scraps available here and there. But of course, every once in a while, you can expect a big jump ahead. If you knew what that was, you would already have done it.

Dan Ferris:                 I see.

Eugene Fama:            So, it's totally unpredictable.

Dan Ferris:                 So, what you're saying – so, then it's not that people aren't doing it. It's just that it's harder now. It's more competitive.

Eugene Fama:            It's harder now. Right.

Dan Ferris:                 Yeah.

Eugene Fama:            Right. We have better backgrounds. We have more available stuff that's already been done. So, it's much more difficult to make absolutely new inroads, especially big ones. It's always been hard to make big ones, but it's even harder now that kind of the cheap big ones are already worked out.

Dan Ferris:                 Right. And that sounds – I feel like I've heard people in hard sciences make a similar complaint. They're all just sort of futzing with the same material and not coming up with anything new and big.

                                    Let's see… So, given that, given how competitive it is, I don't know what The New York Times is seeing, I think they might have a political view. But if we're saying that it's just more competitive, it's still a lot harder, and it becomes harder to get the big ideas, as we say... It makes me wonder what happened – for example – forget this. For example, what I'm thinking is, the official market hypothesis, I knew we were going to interview you, so I sort of just did some Googling. And I was surprised to learn that some people would put the roots of that idea, for example, back in 1900 with a paper by a guy named Louis Bachelier, "The Theory of Speculation."

Eugene Fama:            Right. I do that in my thesis.

Dan Ferris:                 OK.

Eugene Fama:            I don't take credit for the initial idea. He clearly did it.

Dan Ferris:                 Right.

Eugene Fama:            So, it's the testing of it that becomes something new. The idea has been there for a long time.

Dan Ferris:                 So, what I was trying to get to, then, was – has the past, has that call it the ancient – I mean, it's not so ancient, but it's pretty far back now, the year 1900, 125 years ago. Have these old ideas – I mean, have we plumbed this? Should the new crop be trying to find – are there other perhaps 18th, 19^th-century papers that you wish somebody would sort of take another look at? Or are the roots of this next big idea, is it going to be sort of in the modern era? Are they going to be looking at Eugene Fama, for example? That's where they're going to be looking. They're not going to be looking at Louis Bachelier anymore.

Eugene Fama:            Well, they'll be looking at – there's probably only a handful of people that have actually read Bachelier. Benoit Mandelbrot was the person who made the world aware of him because he was another Frenchman. I mean, again, you're asking where are the big new ideas going to come from? If I knew that, I'd already have –

Dan Ferris:                 Right, you'd already have them. That's right.

Eugene Fama:            Oh, no, no, no. When I started, basically Chicago, MIT, and Carnegie Mellon were doing serious research in finance. Now, you've got every university in the country, and some in other countries that have big finance groups and do have people trying to get tenure as professors of finance. So, there's just a lot more going on, a lot more people trying to come up with new stuff than there was 60 years ago when I started. So, the game has changed dramatically. Competition is much more fierce than it was in those days. I mean, I knew everybody in finance in those days and most of the people in economics.

Dan Ferris:                 Wow.

Eugene Fama:            But there's no way to do that now.

Dan Ferris:                 Right, so there's no large historical trove – I guess back to my original question – there's no large historical trove of economic ideas that ought to be looked at. Everybody knows about Adam Smith. Everybody knows about whoever it is. And we just don't know where it'll come from.

                                    All right. Well, I mean, what you described to me as not an unhealthy state of affairs in economics.

Eugene Fama:            No, I don't think so at all. I don't think so at all.

Dan Ferris:                 Right. So, you must have – with what you're doing now, are you still teaching? You still go to work in Chicago every year?

Eugene Fama:            Well, I haven't been back to Chicago – I did my teaching remote the last quarter that I taught, because at this point I don't – I can't do two-hour stand-up classes the way I used to, writing on the blackboard the whole time. So, my teaching is restricted to reacting to Ph.D. students and the theses that they're trying to write, the papers that they're trying to write. So, that's the extent of my teaching. My research, I'm still trying to do new stuff, but I don't have what I would call a big monster paradigm in mind yet. I wish I could have one, but it's not there so far. We'll see if I can get one before I croak. But…

Dan Ferris:                 But you're still at it, man.

Eugene Fama:            Oh, yeah.

Dan Ferris:                 You're 85 and you're still at it.

Eugene Fama:            When people ask "How are you?" my standard response is "Still breathing."

Dan Ferris:                 Still breathing. And still busy, it sounds like.

Eugene Fama:            Oh, yeah.

Dan Ferris:                 Are you still playing golf?

Eugene Fama:            I couldn't take a life where I wasn't busy.

Dan Ferris:                 Right. You still playing golf?

Eugene Fama:            I do. Not more than four times a week though.

Dan Ferris:                 No more than four times a week. Sounds like you're slacking off, Gene.

Corey McLaughlin:    Very good.

Eugene Fama:            Yeah.

Corey McLaughlin:    Yeah. I was looking up your background from your younger days and you were – you played a lot of sports growing up?

Eugene Fama:            I did. I did.

Corey McLaughlin:    In the Boston area.

Eugene Fama:            Right.

Corey McLaughlin:    And you were the Tufts outstanding student athlete of the year when you were there, is that right?

Eugene Fama:            Right. So, senior year.

Corey McLaughlin:    Senior year.

Eugene Fama:            Mhm.

Corey McLaughlin:    And originally, is this true that you wanted to be a teacher and a –

Eugene Fama:            High-school teacher.

Corey McLaughlin:    – high-school teacher and a coach, basically?

Eugene Fama:            Right. Right. In college, my first two years, I was studying languages with the idea of becoming a teacher and a sports coach. In my third year, I took an economics course and I loved it. And I was really good at it. The professors started reading my exams to the class. So, at that point I just dropped all the language stuff and went into economics. And then when I was about ready, getting near graduation I decided I wanted to go on in economics. And so, I asked my professors – they were all Harvard graduates, Harvard Ph.D.s – and they said, "No, if you're going to go to a business school, you'd better go to Chicago because Harvard is not a serious research business school." At that time, it wasn't. It is now. But "Go to Chicago. That's where the serious research gets done." So, I did.

Dan Ferris:                 Well –

Corey McLaughlin:    That was right. Yeah.

Dan Ferris:                 Yeah, good advice, huh?

Corey McLaughlin:    What appealed to you about economics way back then?

Eugene Fama:            Well, I don't know. The ideas were new to me and it looked like there was a lot to be done. I don't know, it just appealed to me. It was just the way of thinking about it. It was a subject that – at that time – didn't require a lot of math. It was basically a verbal science at that point. Now the kids coming out have to know a lot of math. So, that appealed to me as well. I'm pretty good at verbal analysis, so that was still possible in those days. Nowadays, you've got to support it with a few equations. But that just attracted me to it and I've been stuck to it ever since.

Corey McLaughlin:    Yeah, that's interesting. I mean, I wouldn't think of anything but math today if you were getting into it.

Dan Ferris:                 And as I understand it too, Gene, early on you were tasked by one of your professors with sort of working out his stock-picking ideas.

Eugene Fama:            Yes, right.

Dan Ferris:                 And was that the birth of your interest in securities prices? Assets?

Eugene Fama:            Yes, it was actually. So, I worked for Professor Harry Ernst at Tufts in the summer of my junior and senior years, I think. And my job was to come up with ways to beat the market. And I was really good at it. I was coming up with ways to beat the market. Except Harry was a good statistician. He always kept a little data out of the sample that I used to fit the models. And my models never worked on the sample. So, there was a big message in that for me that kind of guided me thereafter in looking at models. If it doesn't work out in a sample, you know there's nothing to it.

Dan Ferris:                 Yeah, looking back it's – it makes a lot of sense. It's all of a piece.

Corey McLaughlin:    So, what was it like in Chicago at that time being there? How would you describe it to people that – at the University of Chicago there? I mean, that's a place that a lot of people just think about that time. What was it like actually being there?

Eugene Fama:            Well, I was in the business school and I took a lot of courses in the economics department, but I was primarily in the business school. And the business school is much smaller than it is now. I think there were maybe a hundred or so MBA students and maybe a dozen Ph.D. students. So, everything has scaled up a lot since then. So, it was very interesting. Especially the Ph.D. students and the better MBA students – were kind of a very intimate group at that point. We were around each other continuously. We ate lunch together, socialized together, everything.

Dan Ferris:                 And we'd probably recognize a name or two among that group today, wouldn't we, besides yours?

Eugene Fama:            Oh, sure.

Dan Ferris:                 Such as…? What was…?

Eugene Fama:            Well, I had a group of students, Myron Scholes, Richard Roll, lots of people in the early days that turned out to be the stars of finance in later years.

Dan Ferris:                 I can only say, Gene, that is so cool. It's really cool. It's like being at Princeton with Einstein or something, all these ideas swirling around and people like Wittgenstein and all the rest of them.

Corey McLaughlin:    Cliff Asness was one of your doctoral students, right?

Eugene Fama:            Yeah, Cliff was one of my doctoral students too. He was the best of his class by far.

Dan Ferris:                 Oh. And now he's kind of on the other side, isn't he?

Eugene Fama:            No, I don't know whether he would classify himself that way. Some of his products look pretty passive. Some of them, the hedge-fund stuff, maybe not so much. But the attraction of high fees is difficult to turn down.

Dan Ferris:                 Yes, it is. Yeah, and he's done OK doing that.

Eugene Fama:            He's done OK. Right. He's done OK by the university.

Dan Ferris:                 Right. I think I just meant that he's not doing research. He's not doing what you're doing. He's sort of –

Eugene Fama:            Well, he writes a lot of papers, actually. He does.

Dan Ferris:                 Oh, yeah? OK.

Eugene Fama:            So...

Dan Ferris:                 I stand corrected. Are there any other – speaking of students, are there any people right now who you feel are doing work that the world is definitely going to hear about in X-number of years?

Eugene Fama:            Oh, that's too hard.

Dan Ferris:                 Too hard. OK.

Eugene Fama:            Yeah. We don't know that –

Dan Ferris:                 Well, make a judgment then, like work that you wish the world knew more about, that they ought to hear more about.

Eugene Fama:            I just don't trust myself on that...

Dan Ferris:                 You don't trust – OK, all right.

Eugene Fama:            I don't think anybody is good at that, predicting that.

Dan Ferris:                 Right. Yeah. Nobody's good at predicting a lot of things, are they? Predicting the future is a mug's game, isn't it? We get to this point with – we interview traders, we interview investors, we interview economists, we interview all kinds of people. And the same, seems no matter what their participation in the market, or if they're pure research, if they're a trader, whatever it is, we always get to these same things that you seem to have known most of your career. It's really hard to beat the market. You can't predict the future. And you mentioned risk when we first started talking. Knowing what risk is is really difficult. And people that we interview who are still in business – they've survived in the market anyway, whether it's luck or not – and they seem to focus all their energy on mitigating risk, however they define it.

Eugene Fama:            Right. Right. Somebody should tell our president about that.

Dan Ferris:                 That's right.

Eugene Fama:            He seems to want to maximize uncertainty.

Dan Ferris:                 Yeah, maximizing risk and uncertainty. Yeah. But a lot of people in the market seem to be – people in institutions seem to want to maximize. They say, "Well, this is good. Let's apply more leverage to it so we can sell more of it."

Eugene Fama:            Live by the sword.

Dan Ferris:                 Right. And brag about a higher return before it all crashes, which those leverage schemes always tend to do, don't they? Now, speaking of things that crash, I wanted to bring up a particular topic because I found some of your comments over the years interesting about this. Let me just ask simply, is there such thing as a bubble, Gene? Is there such thing as a market bubble?

Eugene Fama:            I have a simple definition of a bubble. It's something that has a predictable ending. And I think there are wide swings in the market but they don't have predictable endings, so they don't qualify as bubbles. They're just unpredictable swings in prices. So, there are big swings in prices, if that's your question, for sure. I think basically they're unpredictable.

Dan Ferris:                 So, clearly in retrospect, we can see these things. The dot-com era.

Eugene Fama:            There's a problem with 20/20 hindsight.

Dan Ferris:                 Yeah, I know. We can look back and see a bubble apparently, but we can't tell –

Eugene Fama:            Look at the dot-com. My reaction to that is that if you look – coming out of that, there were some companies that justified enormous valuations. It's just that it was unpredictable at the time who that was going to be. But the total value that was created out of that industry is a big part of international wealth at this point. I mean, so it's not clear that was a mistake. It was a mistake to – it's just not clear it was a mistake. So, a lot of – the vast majority of them failed but the ones that won – won really big. And the whole investment clearly paid off.

Dan Ferris:                 Yeah, bigger than ever. That's right.

Eugene Fama:            Including losers and winners. It's just it was unpredictable who the winners were going to be.

Dan Ferris:                 Yeah, I've begun to think that you just – maybe it's simply that you don't get an Amazon or a Google or the other big winners from that without a thousand other firms like Pets.com and all the other – or Peapod Grocery and all the ones that went to zero, basically. You don't find those lollapalooza effects in a time like that without all those losers, maybe.

Corey McLaughlin:    Yeah, Dan, that's what you said before, or very recently, that people were actually right about the Internet, about the idea itself, but it was the risk-management part of it that you're wrong about – or people were wrong about, I guess. At the time. The timing.

Dan Ferris:                 Right, so maybe valuing Nvidia, speaking of asset prices that seem really high and have gone in big swings upward, maybe Nvidia as the enabler of artificial intelligence is not so unreasonably valued at whatever it is, 100 times sales or some astronomical amount like that.

Eugene Fama:            We'll see.

Dan Ferris:                 We'll find out. I love the fact that I just can't – I can't get you past the fact that you can't predict the future. I can't even get you to say, "Well, maybe it is." Well, you'll say maybe it is or maybe it isn't, but in the end you'll say, "We'll see" and "We don't know."

Eugene Fama:            Right.

Dan Ferris:                 Well, that's a good scientific way to look at the world. Admitting what you don't know seems very important in your profession and in most similar professions.

Eugene Fama:            Right.

Dan Ferris:                 Yeah. And we don't know a lot. It seems to me like a lot of people who invest other people's money even, they use data in a particular way. They say, "This has been the history of whatever it is and every time a certain price has behaved a certain way, what followed was generally on average or mostly more than average, whatever it is, this." So, then they place a bet on this happening based on that. And yet, we're constantly being told past performance does not equal future results. You can't predict the future. And there are people everywhere trying to predict the future. Are they just trying to get fees? Is that what it is? They're responding to an incentive to get fees? They're saying, "Well, maybe we can predict it often enough to make a return."

Eugene Fama:            Yeah. Well, I think the problem is the uncertainty surrounding any prediction. So, in other words, I look forward, I see there's an expected value going out, but around it there's just an enormous amount of uncertainty that is unresolvable. You can't resolve it at this point. And that's what we live with all the time, especially investing in equities, let's say, is that uncertainty.

Dan Ferris:                 Right. We operate under great uncertainty. True. We don't know the future. The term "expected value," what do we mean exactly by that?

Eugene Fama:            It's a mean.

Dan Ferris:                 I see. A mean based on...?

Eugene Fama:            It's a mean based on knowing the true distribution. What is the mean of that distribution?

Dan Ferris:                 OK.

Eugene Fama:            It's another word for mean.

Dan Ferris:                 I see. So, in other words, knowing what we know about, what, a particular series, a particular price series –

Eugene Fama:            Right. Right.

Dan Ferris:                 – you establish this expected –

Eugene Fama:            It's the best prediction of something, but there's a lot of uncertainty surrounding it. There's a lot of uncertainty to what the actual outcome will be.

Dan Ferris:                 It makes me wonder how good those calculations are. How good is that? Not good enough to predict the future, I wouldn't think.

Eugene Fama:            No.

Dan Ferris:                 Right. So, is the expected value – is it sort of like a theoretical plug for economists? Or is there something more concrete about it?

Eugene Fama:            No, I think it's just life. It's reality.

Dan Ferris:                 Oh, so in other words, it's life. It's reality. Generally speaking, on average, things turn out like this. Is that what expected value says?

Eugene Fama:            Right. Well, "This is my best forecast, but the forecast is subject to a ton of uncertainty. The mean is my best forecast, but it's subject to a ton of uncertainty, what the actual outcome will be."

Dan Ferris:                 It reminds me of a story that I recently heard that I think is hilarious of an army meteorologist who was tasked with looking at forecasts and seeing how good they were or weren't. And he sent his report up to the general and he said, "These forecasts, they're always wrong. They don't work." And the message came back, "The general is aware that the forecasts are not good, but he needs them for planning purposes."

Eugene Fama:            That's fine.

Dan Ferris:                 And that strikes me – people don't, they can't predict things, but you have to do something with your money, don't you?

Eugene Fama:            Sure.

Dan Ferris:                 So, you've got to make a decision.

Eugene Fama:            Yeah, I don't think that's – especially in equities, you get paid for bearing risk basically. That's why the expected returns are higher than they are for T-bills.

Dan Ferris:                 Right. And is that also why, for example, factors exist, like a value factor?

Eugene Fama:            No, that's a totally different issue.

Dan Ferris:                 Totally different issue.

Eugene Fama:            Yeah.

Dan Ferris:                 OK, so in other words, you're not paid for bearing risk there.

Eugene Fama:            Well, the uncertainty you're talking about is what's in the residual after you trade or account for the systematic things that affect expected returns. So, the asset-pricing models are those systematic things that affect expected returns. And then there's a residual there that you just can't explain. And it's big. It has a big variance. So – I'm going to have to leave pretty soon, so –

Dan Ferris:                 OK. Well, I tell you, if you have to leave soon, Gene, that's cool. Why don't we ask you our final question? We have the same final question for every guest, and it's just the same no matter what the topic. And if you've already said the answer, feel free to repeat it. OK? But the final question, it's for our listeners benefit, if you could leave them with one thought today –

Eugene Fama:            Whoops.

Dan Ferris:                 – and it can be about anything, absolutely anything –

Eugene Fama:            Something happened.

Dan Ferris:                 – what would it be? Just one final takeaway.

Eugene Fama:            OK, I'll give them my thought on investing. It's a thing that David Booth always says. Diversification is your buddy basically. Investing diversification is your buddy. If you're going to invest in equities, hold a highly diversified portfolio. However you want to tilt it, that's your business, but hold a highly diversified portfolio. And if you don't have special information, avoid active investing basically, I would say.

Dan Ferris:                 All right. Well, thank you for that, Gene. And thanks for joining us. I really appreciate it. It's been a lot of fun to talk with you.

Eugene Fama:            My pleasure. OK, great.

Corey McLaughlin:    Yep. Thanks for joining us.

Dan Ferris:                 Thank you.

                                    Well, I enjoyed that, but I have to admit I think it might be the first time that I felt a little hesitant about asking some questions. I was a little frazzled here and there. I think I was slightly starstruck by our guest today because of who he is. I mean, I hope you couldn't tell too much.

Corey McLaughlin:    Well, I mean, he said himself that people treat you differently once you have the Nobel attached to your name.

Dan Ferris:                 Yeah, guilty.

Corey McLaughlin:    I guess that's not surprising.

Dan Ferris:                 That's right.

Corey McLaughlin:    But I mean, what – the takeaway for me is just – we don't know.

Dan Ferris:                 Yeah.

Corey McLaughlin:    What do we know? He's essentially like "These are all questions but I don't know the answer" is what he's saying. And I guess not a lot of people say that. Certainly consistently. So, I guess that's kind of what – that's an important takeaway, I think. I mean, it's just – you don't hear it a lot and people – when you say "I don't know," people don't like to hear it because they're like "Oh, he doesn't know. He doesn't know what he's talking about." But you're just admitting that you can't predict the future.

Dan Ferris:                 Yeah. And you can't come at him from any way. You can't corner him. He's like "I don't know."

Corey McLaughlin:    You tried.

Dan Ferris:                 He's like "I don't know. I don't know. We don't know. We'll see." Actually to me, that's a sign of a really great intellect. You can get me to talk about what I think is going to happen all day long. I'll say you can't make predictions, you can't tell the future, and I'll tell people that absolutely every time, but you can get me to talk about the future. It's not hard. I'm not Gene Fama. I'm not going to say, "I don't know. I don't know." I think my output would shrink quite a bit if I were to take that stance and say, "Well, I don't know. Therefore, I'm not going to say anything about this."

Corey McLaughlin:    Right. Because people want to hear what you say. Yes.

Dan Ferris:                 That's right.

Corey McLaughlin:    They want to know what you think. That's right.

Dan Ferris:                 Unlike Gene, we are in the business of having some idea of how this is all going to turn out. So, a little different.

Corey McLaughlin:    That is true.

Dan Ferris:                 But also, another thing is that maybe part of the intimidation factor was I felt like his answers were sometimes very, very brief and he knew exactly what he thought and that was it. And I thought "OK, well, I guess that's the last word on that. I'm not going to –" do you challenge Gene Fama on this stuff? I don't know. And he's quick to say, though – one of the things that really struck me is that he was like "Market efficiency is good as far as it goes. And it goes pretty far for a lot of people. But the market isn't efficient from everyone's perspective." He's not saying the market is efficient. Nobody can ever beat it, which is obviously not true. It's just that way for most people. These things are tendencies. They're not like laws of the universe. It's not like the law of gravity, which goes for everybody. It's a tendency. It's different. I didn't get to talking about physics envy in the profession of economics, but it's that type of thing. They just – I think some economists seem to want to establish laws and they set up models and treat the model as though it's a law and then get into a lot of big trouble when things don't work out.

                                    But yeah, very interesting stuff. Gene Fama on the Investor Hour. I have to admit, when the invitation came into my calendar, I didn't even know that we had asked him to be on the show. And it said "Eugene Fama" and I thought "That Eugene Fama? The Nobel Prize-winning guy?" And indeed, that is who it was. Well, I hope you all enjoyed talking with Nobel Laureate Eugene Fama as much as Corey and I did. It was sort of a one-off. I don't know if we're going to wind up with a lot of Nobel laureates on the show and it was pretty amazing just to hear his current thoughts on anything.

                                    So, that's another interview, and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we really, really, truly did. We do provide a transcript for every episode. Just go to www.investorhour.com, click on the episode you want, scroll all the way down, click on the word "transcript" and enjoy. If you liked this episode and know anybody else who might like it, tell them to check it out on their podcast app or at investorhour.com, please. And also do me a favor, subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts. And while you're there, help us grow with a rate and a review. Follow us on Facebook and Instagram; our handle is @InvestorHour. On Twitter, our handle is @Investor_Hour. Have a guest you want us to interview? Drop us a note at feedback@investorhour.com or call our listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my co-host, Corey McLaughlin, until next week, I'm Dan Ferris. Thanks for listening.

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