Happening in ferguson was oppressive and objectionable but worthy of protest. But there was no excuse for violence. Whoever fired those shots should not to tract from the issue they are criminals and they need to be arrested. Olivia last week, a Justice Department report says ferguson had racism and the courts. According to a person familiar with the matter, the fbi is now investigating whether billionaire investor bill ackman and people working for him try to manipulate herbalifes stock. The stock lost half of its value in the last year. We will ask bill ackman at 10 00 a. M. Eastern. In japan, a milestone for the japanese stock index. It is up 172 . The japanese are up more than 10 this year. There is so much oil on the markets there are not enough places to store it. The International Energy agency said that may lead to more price cuts. Storage capacity is already strained. The Senate Intelligence committee has approved a bill that make its easier to fight cybercrime. Companies will be shielded from lawsuits when they share information with each other and federal agencies. That would have happened, but we might have minimized the lost because of the response time. The fears that existed with other health care and other financial companies, they would have also been included by the federal government. Olivia critics are concerned the bill could violate privacy rights. Tom lets look at the data. The markets are always interesting. Futures are flat. Not the drama of 2426 hours ago. That is a huge deal on the japanese index. Brent crude comes in. Sterling showing some rate some weight. The russian bank is coming out with headlines within the hour. Lets look at the confidence in america. I am not a big believer in confidence indexes. Here is the nirvana of the 1990s. This regression down is arbitrary, but there it is. Finally, breaking above it. Olivia it is hard to map this graph along with unemployment. This is not what the comfort index reflects. Im interested in this turnaround. Tom absolutely. Is this the new normal or can we aspire to get back to this nirvana of the 1990s . There is a snapshot on morning in america. Lets have a smart conversation. On a friday, you can do that. A bloomberg Surveillance Data check. Rob has witnessed and written about this strange evolution this morning. He is a cofounder and ceo of research affiliate. I want you to explain the legacy from peter bernstein, Abby Joseph Cohen when, and others when you bring mathematics to investment what does that mean or what are you thinking about for our audience . It is not so much bringing mathematics to investing, as using mathematics as a tool to bring common sense to investing. One of the things that is fascinating about investing is that people think past is prologue. People think the bull markets have a dark side. They set markets up for lower future returns. Bear markets feel miserable, but they have a bright side. They set markets up for Better Future returns. They leave markets cheaper. We are may be at the tail end who knows, of a huge bull market like u. S. Stocks. They feel wonderful, but it leaves markets high, position for low future returns. Tom lets go to investing 101. How important is janet yellen and Mario Draghis great distortion for changing how we invest . We push it aside and ignore economics and the busted macro economics that we have or do you have to amend and adjust . How do you handle that . Rob negative Interest Rates push us into New Territory entirely. They mean that the credit worthy can borrow at the lowest rates imaginable. If you can borrow at the lowest rates imaginable, are you going to invest money in long horizon highrisk projects . Or are you going to take in the low hanging fruit, stock buybacks . Are you going to use the money in ways that capture the easy opportunities . Tom bill ackman is in the news today. Olivia according to people familiar, the fbi is looking at whether bill ackman and people he hired manipulated the stock. Tom kara lack carl icahn bill ackman, are they constructive . Rob absolutely. Anytime you have people who move markets and move assets toward their fair value they are constructive, they are helping markets reprice toward their fair value. Was there overt manipulation . Who knows. Was there an effort to identify stocks that are overvalued and undervalued, absolutely. We are in a regime where you get punished for seeking to identify overpriced or underpriced and get punished after the fact. The rules are determined after the fact and redefined after the fact. Olivia what is your most important metric for valuation . Rob my go to metric is schiller p e ratio price relative to longterm horizon. Olivia critics would say that is too backward looking. Rob it is backward looking, but nothing mean reverts over time more aggressively than earnings. When you have peak earnings like now, the Competitive Pressures in a Global Landscape tend to cause tom i like this, but how do you parse your caution . Rob laszlo tends to focus on cash flows, which are short horizon and drive markets on a shortterm business. The valuation plays out on a long horizon basis. Olivia you do like the schiller ratio, which is retroactive. But you are saying that this sort of jack vogel market cap weighted index, the bull run that has enabled that success, is over. Why are we looking at a valuation metric that inspires past performance . Rob im not saying it is over. Im saying the market is expensive. If you buy stocks today at todays valuation multiples, you are either saying this market is cheap or you are saying i have a selfdiscipline and i know when to get off the train, i know when the bell will chime and i will hear a chime before others do. Tom rob arnott with us. We will speak about all that is going on in passive investing. Olivia coming up, we are going to continue the conversation with rob arnott focusing on emerging markets and why he thinks they are worth the risk. This is bloomberg surveillance. Happy friday. Tom good morning, everyone. Bloomberg surveillance. Im tom keene, with olivia sterns, on a friday. 46. 62. Olivia we begin with the latest from ferguson, missouri. A manhunt is in progress. There were more protests overnight, but they were peaceful. Bill ackman has made a big bet against herbalife. The fbi wants to know if ackman or people working for him try to manipulate herbalifes stock. We will ask bill ackman about all of that later this morning. He will be right here on Bloomberg Television at 10 00. A new biography says steve jobs refused an Organ Donation. They say he refused when cook said he would give him part of his liver. Doctors had told tim cook that the transplant could extend tim jobs steve jobs life. More followed for the fraternity at oklahoma university. Some other Fraternity Chapters new about the racist video. Research done for the fda says slowing teen smoking could be attributed by raising tobacco age to 21. The volcano in costa rica is acting up. A huge plume of smoke and ash in costa rica. Wow. Tom this is close. This is not like, over there. Olivia yes. Tom i flew by mount saint helens. Just stunning. Olivia remember when the airspace in europe was closed because of the iceland volcano . Tom yes. Happy volcanoes. Rob i am hoping i see lots of volcanoes and none of them erupt ring. [laughter] tom lets continue with rob arnott. And the investment racket, they are treated with all. Investors to bring firstorder mathiness. Rob arnott has led the way. What not to do and what to do. Right now, the to do list includes investing abroad. I picked up on this six months ago. All of a sudden, everyone is going, but where abroad . Rob i think the best opportunities are in emerging economies. Emerging markets are cold as ice in the eyes of most investors. People are afraid. Every election in latin america in the last three years has gone socialist. Tom cfa level one. Can you trust the accounting . Rob the accounting in emerging economies is dubious. It is almost as bad as u. S. Accounting. My goodness. When it comes to profits, when it comes to simple p l, they have revenues and expenses. They dont have stock options. They dont have accruals. They dont have preferred shares. It is as can be. I would trust the accounting there as much as i would trust the accounting here. Olivia Political Risk is one thing. There are also economic fundamentals. They say the taper is going to cut the legs off any growth. Rob that is the obvious fear and the fears are legitimate. The fears exist for a good reason. The simple fact is that there are no bargains in the absence of fear. The other simple fact is that valuations there are half the valuations here. The stocks in the emerging economies are trading at singledigit p e ratios. Olivia wordy you invest in the emerging world . Rob i like broadly divested i like broadly invested portfolios. Tom these negative Interest Rates are stunning. The german yield is much higher this morning. Genuine buy siemens, nestle can you buy giant euro blue chips that we trust . Rob i would say yes. I would not necessarily go for the blue chips, but the broad economy, fundamentally weighted. Not in accordance with the popularity of the companies. The Companies Use named our big market companies. Olivia they have also seen a big runup in the dax. Rob if you wait the companies according to their economic footprint, there are a lot of bargains in europe. Rob would you bet on india or china in the next decade . Olivia would you bet on india or china in the next decade . Rob i would bet on china. India has high valuation multiples. I would not bet on china to win in terms of gdp growth relative to india. India has more upside potential and if they get their corruption problems under control there is more room for them to play catchup. Tom we are going to talk about your Investment Strategy in a bit. Within that, there is the banks. In every system you are in you have got to be aware of a financial system. How messed up is our Global Banking system right now . We are out in front of clearing markets. Rob chinas Banking System is problematic. What we need to do is let banks be banks, instead of having them be manipulated arms of government. Let them get in the business of borrowing, putting risk capital at risk tom . Should janet yellen raise rates to normalize so that banks can do business . Rob absolutely. I would recommend that they begin a process of raising rates and get them back to normal levels. Olivia what is normal . Rob 2 3 would make normal and perfect sense. Getting from here to there would be perceived as devastating by the market. Tom ok. Lets come back. Rob arnott. We will talk about this bloomberg Magazine Article about passive investing. In our next hour, Kevin Roberts brings the spirit of marketing and advertising. He is with a small startup firm. We will talk to mr. Roberts about facebook. Tom good morning, everyone. Bloomberg surveillance. It is time for my morning mustread. It is a mysterious mustread on a friday. Rob arnott is with us. We have to do cinderella. Which 1945 film character helped inform kate blanchetts evil stepmother . This is back in the 1940s. Take it julie miller. The moment she comes on the trailer you know she is going to steal the movie. Olivia i feel it is much more of an Mommy Dearest kind of thing. Tom this is very exciting. We are going to talk about this later on. Olivia there is the costar, the belle of the ball. You might recognize her from downton abbey. Tom i might. [laughter] when you look at the risk that disney is taking on this why have they given up risk investment . Olivia i was wondering where you were going with this. Tom if we go down three percent in the markets, we have a coronary. Rob people want returns they dont want risk. That is a given. Of course. They go hand in hand. We are showing Richard Madden in cinderella. There is no difference. The prince talks to cinderella what is your number one advice . You are prince charming to the american 401 k . Rob there are no bargains in the absence of fear. Invest in markets that you are afraid of. Olivia very impressive, the cinderella allegory. Tom good morning. New york city gorgeoisity. Olivia sterns gets ready to see cinderella today. Olivia authorities have yet to make any arrests in the shooting of the two Police Officers wednesday night in ferguson, missouri. Both have been released from the hospital. There was a peaceful protest overnight in ferguson. This is all fallout from last summer. Now, it is activist investor bill ackman who is being investigated. The fbi is investigating whether he tried to manipulate herbalife s stock. He has 1 billion bet against herbalife. Their stock has lost half of its value in the past year. We will ask bill ackman about the investigation later on at 10 00 a. M. , right here on Bloomberg Television. The Prime Minister of greece said his country has started fulfilling its commitments on the economy and it is time for europe to do the same. He said he is optimistic a solution will be found. European leaders have said they will not give any more emergency aid to greece unless it reforms its economy. Benjamin netanyahu is not so sure he will keep his job after next week. He told an israeli tv station he will lose the election. The Zionist Union favors renewing peace talks with the palestinians. In pro football, we have not seen Something Like this in seven decades. Demarco murray has signed a fiveyear, 42 Million Contract with the philadelphia eagles. It is the first time in 68 years that the nfl leading rusher has switched teams. Tom you football junkie, you. Olivia i went to school in philadelphia. Fly, eagles, fly. President obama got a few laughs will talking about life in the white house. It happened when he appeared on jimmy kimmel live. President obama i cannot drive. [laughter] i mean, i am able to drive. Jimmy do you have a birth certificate . [laughter] [applause] president obama in kenya, we drive on the other side of the road [laughter]. Olivia the president also made it clear that he has Hillary Clintons back. Tom very good. Russia out with rates. The ruble moves a little bit. It is not that big of a move. It is the snapshot of a troubled economy. Inflation, 16. 7 . They made it clear that they are on top of this. The weak economy is helping slow inflation. Yeah right area there is the messaging from the russian central bank. It is not news that passive investing is all the rage. But there is a collegial heated debate. The tradition is to replicate an index off of market capitalization. Rob arnott disagrees. He suggests there has to be more and that is conducting at around regulation. Why is your world too complex . Rob it is not at all complex. It is very simple. You Weight Companies by how big they are, not by how much the market is willing to pay for them. Just how big is the business. Tom strategists get a belief in a ratio of price to sales. Which of those Dynamic Ratios is fundamental . Rob they all have fundamental value. If you just weig companies according to their salesht, one of them ties the way to the price. The more expensive the company is, the bigger its weight. Tom are you sort of kind of like passive investment or like active investment . Rob both. Relative to the market. The market is cap waited. Relative to the market, we are active. Relative to the economy, we are passive. Relative to the economy, jack vogel is active. Tom this is a zen approximation, olivia. [laughter] there is a lot going on here. Olivia jack vogel says that your approach is going to shake out just like his in the long run. Rob absolutely not. If you go back over the last 50 years, you find that weighting companies by their economic footprint means that the companies that have been winning in the marketplace by dint of rising and valuation, some of them deserve their high multiples, some of them dont. Tom take us back to december 2008. What was rob arnott doing . You have to get on board in february 2009. Rob rebalance into the deeply outoffavor companies. You rebalance into the outoffavor financial services. Tom how often should our listeners and viewers rebalance . Rob you can do it annually. You can do partial rebalancing quarterly. Move a little bit toward rebalancing quarterly. The rebalancing is where the value is added. At the beginning, people said this is just a warm over reversion of value investing. Value investing has underperformed for 10 years. We have outperformed for 10 years. Olivia does the market the jack vogel built his model for not exist anymore because prices are not there the way they used to be . Rob prices have never been fair. They have always been too high or too low. Jack was and is a genius. He did a wonderful thing for the marketplace. He said, prices of the products manager matter. He said, you can invest in the whole market and you can do it for free. What a wonderful thing to do. Olivia how do you feel about being stacked up to the other people as carrying the torch for jack vogel . Mark weidman, bill mcnabb. Rob these are very smart people. They are terrific leaders. Olivia who gets it most right among those . Rob i would not want to pick that. The notion of who is going to be the next jack vogel is kind of silly. Who is going to be the next tom keene . Tom i want to know where you are right now. People are going into the weekend. Where is rob arnott right now . Rob i would be aggressively trimming the beloved tech names that are trading at lofty multiples and rebalancing into the outoffavor segments of the market. I would be trimming u. S. Equities and rebalancing into emerging markets equities. There are cheap stocks in the world, lots of them. Tom pick a nation. Rob im going to get really controversial here. Russia. Tom you are going to go long to you back right now. Rob if you dont mind supporting a thugocracy. If you dont have ethical qualms. Olivia and you dont . Rob i do. Tom this is not dr. Phil olivia. [laughter] rob if t