James, we have slow growth, no inflation, low interest rates and easy monetary policy as far as the eye can see. Are we living in the best of all worlds for investors?
James Montier: How I wish that that were true. The problem with the policy of raising asset prices is that you borrow returns from the future. You can think of it as the front loading of return. So what you’re really doing is pushing down future returns. So it doesn’t really help anybody a great deal in the longer term. Of course, in the short term the effect is positive as you get some sort of balance sheet repair through rising asset prices. At least that’s what central banks hope. But when you look at today’s opportunity set, you’re left with a set of assets where nothing looks attractive from a valuation point of view.
Even if interest rates stay low for a long time?
Montier: Even if we factor in low interest rates for the next twenty years, we’re still not seeing great opportunities. We can find stuff that may be fair value in that scenario, but it’s far from obvious. This is a very difficult time – in contrast to 2007, when risk assets were expensive but cash and bonds were priced to deliver reasonable returns, which is not the case today. It’s much harder to find anywhere to hide. So far from being the best of all possible worlds, this is almost the worst of all possible worlds.
Do your clients still believe in the much-cited low return environment? The further markets move up, the more you might have a credibility issue.
Montier: No doubt. We haven’t yet reached the kind of loathing that was displayed towards us in 1999 where we were just told we were complete idiots and several clients banned us from their buildings. I think there is a broader acceptance of the power of valuation, but the longer the rally goes on, the shorter people’s memory gets. Galbraith used to talk about the extreme brevity of financial memory and I fear that’s kind of what we’re experiencing now. People are looking at last year and say look, it can go up 30%, why on earth are you saying future returns are going to be dismal.
But markets have been expensive for quite some time. How opportunistic should a value investor be?
Montier: There are two possible states of the world: either they keep rates low for a very long period of time or they don’t. Anyone who says they know which one is going to happen is either a liar or a fool or possibly a linear combination with unknown weights. The reality is, nobody knows the future, particularly when it comes to policy rates. By second guessing we’re playing some sort of ridiculous beauty contest. Therefore we should try to build portfolios which are robust and can survive different outcomes.
How do these portfolios look like?
Montier: That’s a challenge because the portfolios you want to hold in those two different worlds are almost diametrically opposed. If financial repression continues, you want to own the least bad thing out there, which is equities. In the other world, the only asset which does not hurt you when rates move to normal, is cash. So you end up with this bizarre portfolio where you own some equities where they are cheap. And you want to own some dry powder assets which protect you against inflation, provide liquidity and real return.
Does cash do the job?
Montier: Cash historically has done all three of those things very well, but in a world where rates are kept very low, cash does not do at least two of those things very well. So in addition to cash, you have to include some long-short strategies, TIPS and bonds which offer at least some yield. The really unsatisfying thing is that no matter what is going to happen in the future, you won’t hold the best portfolio. But at least, this portfolio allows you to survive.
[H/T Zero Hedge]