Link to: Interview with James Montier
James, are you able to find anything in today’s financial markets that still has an attractive valuation?
Nothing at all. When we look at the world today, what we see is a hideous opportunity set. And that’s a reflection of the central bank policies around the world. They drive the returns on all assets down to zero, pushing everybody out on the risk curve. So today, nothing is cheap anymore in absolute terms. There are pockets of relative attractiveness, but nothing is cheap or even at fair value. Everything is expensive. As an investor, you have to stick with the best of a bad bunch.
Do you see outright bubbles anywhere?
By some measures, you can say we are in a bubble, for example in U.S. equities. But it doesn’t feel like a mania yet. Today we experience something like a near-rational bubble, based on overconfidence and myopia by investors. It’s a policy-driven, cynical kind of bubble. Not a mania.
You coined the term foie gras rally, where the Fed just shoves liquidity down investor’s throats. How will it all end?
Probably not well. The exit from these policies is going to be extraordinarily difficult to handle. Today’s situation shows parallels with 1994. Then, the Fed had thought that they had done a great job in communicating their policy going forward. But it turned out the markets were not prepared at all, given the fact that it resulted in the Tequila crisis in Mexico. Couple that with expensive markets, and you have a good reason to want to own a reasonable amount of dry powder. You don’t want to be fully invested in this world.
Since the tapering started in December 2013, markets take it rather calmly.
Yes, the ones that suffered were the emerging markets. The S&P-500 just keeps drifting upwards. But I think emerging markets are the canary in the coalmine, the first signal. They had been the beneficiaries of these incredible capital inflows. So the fact that they are the first ones to suffer makes sense. It’s not a huge surprise that stock markets in the U.S. have not reacted, because the bond market has not reacted. The bond market seems to think the tapering will turn out fine. Maybe they’re right. But there is no margin of safety in asset pricing these days. That’s no comfortable position to begin a tightening cycle.
What if there won’t be any exit?
That’s a possibility. The Fed might decide that growth is still too weak and that inflation is not an issue. Then they could keep their policy in place for longer. The history of financial repression shows that it lasts a very long time. The average length of periods of financial repression in history is 22 years. We’ve only had five years so far. That creates a huge dilemma for asset allocators today: How do you build a portfolio with such a binary situation? Either they exit QE, or they don’t. And the assets you want to own in these two scenarios are pretty much inverse. So you either bet on either one of these scenarios, with is kind of uncomfortable for a value-based investor, or you say because we don’t know, the best we can do is build a robust portfolio. A portfolio that is able to survive in all kinds of scenarios.
And what does such a portfolio look like?
If you have continued financial repression, you want a much higher share of equities, because they are the highest performing asset, compared to bonds and cash. If you think financial repression will go on for another 20 years, you need to have equities. For the scenario that the central banks will exit their policies, you will want to own cash, because that’s the only asset that does not get impaired when interest rates rise. So you have two extreme portfolios: One almost fully in equities, the other almost fully in cash. So that’s what we do: We have about 50% in equities, and 50% in dry powder-like assets. That means some cash, some TIPS, and some long/short equity spread trades. But as said, we are reducing the equity part over the course of the year, to build up dry powder.