In our view it is better to hold cash and deal with the limited real erosion of capital caused by inflation, rather than hold overvalued assets and run the risk of the permanent impairment of capital.
He went on to note that the current lack of attractively priced stocks is a reason to have a lot of cash now.
The inflation comment is very thought provoking. A building block that offers perspective is that at a 3% annual inflation rate, expenses would be 50% higher in 15 years. This is complicated by the fact the health care expenses have gone up at a much higher average rate and I doubt there is any chance of that changing anytime soon.
Over the last couple of years or so reported inflation has not been that bad compared to the impairment of capital that some have endured up to this point. The notion of permanent impairment is a little fuzzy to me. The SPX is down 15% from its 2007 highwater mark. It is also down 12% from the March 2000 high. I have no doubt that the SPX will take back both those levels, the variable of course is when. If it takes back those levels in 2015 that would certainly be a long time but not permanent.
If he means individual holdings it is still not clear to me. Take a crazy example of the investor who five years ago put 50% into Fannie Mae and 50% into Apple (AAPL). The Fannie Mae position is permanently impaired but the AAPL position has quintupled. $10,000 into each is now worth about $57,000 despite a total wipeout in Fannie.
As a more realistic example, by virtue of luck and having avoided a few things an investor could be up a fair bit from the SPX' 2007 high water mark. This could sill be the case had an investor been unlucky enough to have had Fannie Mae or Freddie Mac at a 3-4% weighting and who then rode it all the way to (almost) zero. I obviously believe in looking that the bottom line of the portfolio as being more important than the individual holdings but someone who believes otherwise would view these examples as permanent.
The interesting part of the comment is preferring to take a chance with inflation than stock market declines (permanent impairment or not) when valuations look poor. I wrote the other day that it is ok to hold cash when market circumstances dictate. One way to take the comment is that Montier is granting permission to consider a radically different asset allocation.
Some people are permanently afraid of stocks now and would consider holding a lot more cash or cash like investments (Soros is currently 75% cash?). There has been a proliferation of merger arbitrage products, inflation linked products, funds like COLLX, currency funds, hedge fund trackers, managed futures and so on which I have referred to in the past as diversifiers.
My opinion remains the same which is that stocks still can work but you may have to look to other countries but some people can no longer tolerate equity market volatility and for these people it may make more sense to have more in products like the ones above that, if they function properly, give a chance to keep cash a little ahead of inflation and then have a much smaller than "normal" allocation to stocks. For people who save a lot this can work but there is no reason someone pursuing this can't still have a properly diversified equity portfolio.
I would also note that the person who makes this change on a reactionary basis is very likely to regret in the face of a large market rally.
6 comments:
Loved your last line: no doubt anyone who did go all cash would be wild during the next big rally. Equities are more volatile, no doubt about that. But all cash??? Amazing.
Fidelity has an article on immediate annuities. Interesting concept but again, I think fear of loss drives people to over-react. I don't see such a product in my future, just my opinion.
Good morning. Inflation has been under 2% for three years and was briefly negative in 4Q 2008 1Q 2009 so holding cash -- short-term T-bills more likely -- won't erode net worth too badly. However, if transactions costs are added to the mix however the cost of reallocating a portfolio in pursuit of too much safety could be higher than anticipated. Opportunity costs may play into that as well of course.
Still, interest rates are so low, that the current yield on US Treasury bills and notes is negative nearly up to 5 years maturity so a lot of people are clearly willing to pay up for assets they consider safe and it is safety and/or reliable collateral they clearly desire now above all.
But safety can take other forms and, from my POV, there are several longitudinal trends coming to a head that are worthy of attention (most were established several decades ago):
1. Large, non-discretionary household expenses -- housing, insurance, health, education and transportation -- have been growing faster than other household expenses and, worse, have been growing faster than wages. With the notable exception of housing, which took a lot of people's wealth with it, that is still the case so maintaining standard of living is much more difficult never mind more limited ability to withstand financial shock.
2. Inflation is most strongly correlated with wages in developed nations and has been falling YoY for nearly two decades. As noted above, most measures of inflation have been below 2% for over two years with some periods of negative growth (average wage growth in the US is negative in real terms).
3. The US dollar has been in decline as a store of value even though a cheaper dollar is good for US balance of trade (current account). The $USD's role as the primary global reserve currency distorts US policy and puts US wages under additional pressure. Regardless, the $USD invariably rallies strongly when there is a crisis.
4. Movement conservatism and the notion that liberal government and the taxes to run it is the primary cause of society's woes has reached its logical, intellectually landlocked conclusion and there appears to be no possibility of constructive intervention as long as the movement remains dominant.
5. the Federal Reserve's dual mandate -- maintaining an inflation target and and an unemployment target -- has mainly been honored in the breach with more policy oriented to asset prices than mandated targets.
Current inflation target is set at 2% (it ought to be 3% to encourage capital deployment and discourage cash hording) and the unemployment target around 5%. The official inflation rate is now around 1.5% and the official unemployment rate is 9+% so the Fed is either ignoring both its mandates or is incapable of moving the metrics.
Either way and with paralyzed government in the mix it's easy to understand why an investor focused on the macroeconomic picture would want a bit more safety here. I've certainly had no reason to regret maintaining my bond positions or $USD hedges and don't expect to for the foreseeable future. FWIW
I do not like the market, but except for the early stages of this bull I have not ever been happy with this (or most) markets.
But why on earth would I sell this market? Its volatile. It keeps correcting. It keeps staying above the 200 dma. It is just trying to frustrate us and it is succeeding. But I have no objective reasons to sell right now. (I do not count that it is overvalued as it can stay overvalued for long periods)
Inflation is a government static and something we have to deal with individually; I personally pay for insurance (auto, health, home), college tuition, transportation expenses, home expenses, entertainment expenses, food, etc. (essentially the stuff most people pay for). My personal inflation rate is something I do not spend a lot of time calculating; however, it feels as if it is more than the official government number. Interesting site here:
http://www.shadowstats.com/alternate_data/inflation-charts
According to the site, the current inflation rate is about 12% as measured in 1980 (end of the Carter era) and about 4% as measured in 1990 (Bush I era).
I would think that at some point there is a natural limit to health care inflation.
If we assume that currently medical expenses (including insurance premiums) are 20% of a household budget inflating at 10% per year and the other 80% of the budget is inflating at 3% per year, then a quick back of the envelope calculation shows that healthcare would become 50% of a household budget in a little over 21 years.
Assuming household budgets reflect a proportionate share of GDP, it seems hard to believe that health care will become 50% of the economy in 21 years. I think something will give before then.
Yea the government will confiscate income as the first thing to give
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