Meb Faber: Get Ready for a Bull Market in Diversification

US stock investors are paying the price for years of high valuations, along with what podcaster and investment manager Meb Faber once dubbed a bear market in diversification. Faber, who is also the cofounder and chief investment officer of Cambria Investment Management, says the market collapse of recent days, triggered by tariff announcements, could persist for a while. Cambria’s ETFs pay close attention to market trends like momentum.

In a conversation with Morningstar on the afternoon of April 4, Faber detailed US stocks’ reversal from being “expensive and in an uptrend” to “expensive and in a downtrend,” meaning returns are unpromising. Meanwhile, he says the bull market trend in diversification in assets like gold, bonds, and foreign stocks may persevere.

Condensed, edited excerpts of our conversation follow.

Leslie Norton: This market decline is that extreme, rare tail event that everybody has been waiting for. What’s next?

Meb Faber: We went through a ton of uncertainty like this during the covid-19 period: extreme volatility, big down-and-up days. We do a lot of historical research and try to model things out so when times like this happen, you can see what helped before and what didn’t. History helps as a guide and gives you an anchor or framework to work with. Most investors don’t have a plan, certainly not a written plan. But a 5% down day is normal. It’s happened before, and it happens roughly 1% of the time in the past 100 years. And we’ve had worse. We had a 20%-plus down day in 1987.

More Market Declines May Lie Ahead

Norton: Do you expect more down days?

Faber: I wrote a paper in 2011 that says most of the down days happen after the market’s already declining, if it’s below something like a 200-day moving average. But also most of the best days occur then too, simply because volatility is expanding. So 70% of the best and worst days occur under the long-term trend. I tweeted out a good Paul Tudor Jones quote today: “Nothing good happens under the 200-day moving average.” That’s true on average downtrends.

For a long time, the market has been an expensive market on an uptrend. That’s okay. But the worst is an expensive downtrend, which is where we were now.

Norton: True, much of this decline was driven by expensive US stock valuations. But there’s also the trigger of tariffs.

Faber: My favorite chart in all of investing is the 120-year-plus chart of the US stock market overlaid with the crisis of the year: Pearl Harbor, Spanish Flu, Vietnam, etc. Despite all these terrible things happening all the time, the stock market relentlessly compounds at 10% a year. That doesn’t mean it doesn’t go down. My favorite piece I’ve written is called The Bear Market in Diversification. It said that from 2009 until recently was arguably the best period in history for US stocks versus a diversified allocation, no matter what that allocation was. The S&P 500 outperformed the diversified allocation 13 out of 15 years.

When stocks get expensive, they get frailer, subject to big fat drawdowns. What’s the catalyst going to be? Who knows? The P/E ratio on US stocks got close to 40 in 2024. In 1999, it was almost 45. With the certainty of hindsight, you can say, this is what happened. Could we have a scenario where countries come to resolutions [over tariffs] and the market rips back higher? It’s only evident with the fullness of time.

Norton: The pandemic’s ripples played out over many years. Are we in a situation where the usual rules don’t apply?

Faber: I don’t think so. The US stock market peaked in February and had already been declining prior to this week, right? We have an ETF called Cambria Value and Momentum ETF VAMO which will hedge up to 100% of the portfolio if the stock market’s expensive and trending down. Right now, that portfolio is 100% hedged. The signals were there. There’s a fun Peter Bernstein quote: “I view diversification not only as a survival strategy, but as an aggressive strategy, because the next windfall might come from a surprising place.”

Norton: Such as?

Faber: US stocks have outperformed for so long that other areas have been forgotten, particularly foreign stocks. We have a fund, Cambria Global Value ETF GVAL, that was up almost 20% in Q1. It buys the cheapest quartile of country stock markets. Foreign stocks underperformed the S&P 500 by an enormous amount, and suddenly something changed very quietly, and they outperformed. With the exception of tailrisk and bonds, everything yesterday and today is getting pummeled.

A lot of things that people think diversify their portfolio often don’t when it hits the fans.

Why US Stocks Still Look Frail

Norton: Does the US market still look fragile? Valuations have come down.

Faber: That’s the thing about expensive markets. The US Cape ratio [cyclically adjusted price-to-earnings ratio] was 38 at the end of 2024. Now the average P/E is down half from there. But that’s happened before. In 1999, the Cape 10-year ratio was 44. In 2009, it got down to 12. Stocks were atrocious for almost an entire decade. They did terribly, and in that period everything else did better: gold, bonds, REITs, value hedge funds.

This could play out over decades. In the 1980s, Japan got to almost a 100 CAPE ratio and didn’t go anywhere for three decades. These regimes can last much longer than people expect. You just had one, except it was one of US stocks’ excellence and outperformance.

We did a study looking at countries when the hit a CAPE ratio of 40. We didn’t get all the way there in 2024. But after they hit 40, five- and 10-year real returns for any country were negative. So historically it hasn’t made sense to pay up. In 2007, we saw China and India trading at P/E ratios of 50. They went nowhere for darn near 15 years.

The Cheapest Markets

Norton: What looks cheap?

Faber: The good news is the rest of the world is reasonably priced to downright very cheap. It’s a lot cheaper after yesterday and today. We look at valuations like CAPE, dividends, cash flow, book, and try to come up with an average. The cheapest country on average [at the end of Q1] is Poland, followed by Colombia, Brazil, Thailand, and Hong Kong. The US looks most expensive.

On the CAPE ratio, the US ended the year at 38, and is down to 33. But it still ended the first quarter as the most expensive country in the world.

Norton: What do you recommend?

Faber: You’ve got to come up with a plan. We examined a dozen different famous asset allocations—endowment, risk parity, Buffett, and so on—and they all return 7%-9% a year. During this period, all performed great, just not 15% a year like the S&P 500.

The thing almost every investor in the US does wrong is they put almost everything in US stocks and bonds, and of that they put almost all their money in US stocks, and that’s horribly undiversified. Yes, you remove single-stock risk.

So: One, move from US stocks and bonds to global stocks and bonds because global P/E ratios are much cheaper. The Achille’s heel of market-cap weighting is you put most of your money in the most expensive market when it’s at its peak.

Two, tilt toward things like value. Our flagship strategy is shareholder yield. That won’t diversify in one day, but it will over time.

Three, you have to have real assets: gold, TIPS, commodities, REITs. We like global REITs. Most US investors don’t have any. And before everything, be mindful of taxes and fees.

Norton: You did a study that talked about the effect of outliers on market performance, which said market timing is possible and can be beneficial to the investor. Would you say that today?

Faber: Historically, the big market outliers have a huge impact on returns. We wrote about this topic of power laws in a paper titled “Where the Black Swans Hide.” If you miss the 10 best days in the market, your return gets crushed. What if you miss the 10 worst days? Your return is amazing, it’s like 20% a year.

People stop there and conclude you can’t time the market. But the reality is that 70%-80% of those outlier days occur after the market’s already declining, because the market is more volatile. We call that volatility clustering. The good and bad days tend to happen near the same time, like this week, when investors were fearful and volatility expanded.

The interesting takeaway was that if you miss both the best and worst days, your return is better than buy and hold. I wrote a paper in 2006 called A Quantitative Approach to Tactical Asset Allocation which demonstrated a very simple trend following approach of when it made sense to be a little mindful of risks and step aside when markets are declining. It’s trying to keep you out of the 20%-plus decline in markets, and historically has done a great job.

Trend following can be hard, because often you look different than your neighbor. For most investors, actively trading their own account with trend following lands in the “too hard” bucket. Often trend following systems have a low batting average with lots of losers and whipsaws, and often emotional investors introduce subjective overrides to their system. A more straightforward approach is to allocate to a fund that utilizes trend following, or what many refer to as managed futures.

How to Make an Investment Plan

Norton: Let’s talk about the investment plan people should have.

Faber: The late Jack Bogle said that when crises come along, the best rule to follow isn’t “Don’t just stand there, do something,” but “Don’t do something, stand there.” It’s so good. The point being that most of these asset allocation strategies, if you backtest them over 50-100 years, incorporate scary events of history already. So put it together ahead of time. Get a diversified portfolio. What do you do if things hit the fan, if you want to fiddle? There’s rebalancing, so if you have a 60/40 portfolio where stocks get smoked and it’s now 40/60, you could rebalance back to 60/40. It’s a natural mean reversion strategy. Second, you look at things that are absolutely murdered. Sometimes it’s closed-end funds trading 40% below net asset value. And three, stick to your strategic asset allocation.