Refinitiv Newscasts - Breakout: Investing to survive
01/04/2022 10:40
Click the following link to watch video: https://share.newscasts.refinitiv.com/link?entryId=1_opr26chs&referenceId=1_opr26chs&pageId=RefinitivNewscasts Source: Thomson Reuters Description: Despite recent wobbles, U.S. stocks still trade at sky-high levels, while the return of inflation means more volatility. Passive investment strategies won’t work in this new environment, says Edward Chancellor. A more nimble approach is required. Short Link: https://refini.tv/3iUemRC Video Transcript: Actually, the game is about to change. It's about to get a lot nastier. And given that the US market is creating a bubble levels that there are the capacity for huge capital losses. Welcome back to Breakout with Breakingviews, brought to you buy PGIM. I'm Peter Thal Larsen, the Acting Global Editor of Breakingviews. And I'm speaking to Edward Chancellor, who is joining us as usually from the British countryside. Eddie, welcome back. It's good to see you. Quite a lot has happened since we last had you on the show. Inflation has come roaring back, central banks are raising interest rates around the world, and most recently of course Russia has invaded Ukraine. You've been thinking about what all of this means for investors, and in particular what you call the "battle for investment survival". What do you mean by that phrase? Well, as you say, quite a few things have happened in the first quarter. And I would say, from an investment perspective, that we are seeing the underpinnings of the great US bull market, one of the great bull markets of al times, have been taken away in this last quarter. Now, the market- the S&P 500 is only down sort of around 4%, so that might seem like a small setback. But if you think about it, what created the great bull market? It was the decline in inflation, falling interest rates, the advance of globalization, and the advocacy or companies' embrace of the shareholder value management philosophy. Now, if you look at the last few months, all of those trends appear to be in reversal. So, I mean, you're well-known as a financial historian. You're obviously taking us back into- delving back into the past for sort of signposts and guides of how we might sort of navigate this period. And I think you've ended up in the mid-1930s. What can we learn from that period that would be useful today? Well, in 1935, an American stockbroker called "Gerald Loeb" wrote a book called "The Battle for Investment Survival". And this book is considered an investment classic. And Gerald Loeb was the contemporary of Ben Graham, much better know the mentor of Warren Buffett. And Ben Graham, as you many know, advocated a "buy and hold" mentality. Now, the trouble is that Ben Graham actually lost 60% of his portfolio in the October 29 crash, whereas Loeb by his own boasting claims to be out of the market beforehand. And what Loeb is saying is that investment is a hopelessly difficult task, that markets are dangerous, and the best strategy for an early investor is to move in and out of the markets quite quickly rather than advocate- rather than adopting a passive approach to investment in which you're fully invested. Now, if you think about it, over the last few years, those who have done best are those who have just bought the S&P 500 index and gone to sleep. And last year, that returned 29% including dividend. So, that really is sort of investment genius. But I'm arguing that actually the game is about to change, it's about to get a lot nastier. And given that the US market is creating a bubble levels that there are the capacity for huge capital losses. Now, think about the problem of inflation, and here I cite a piece by Henry Maxey, who's the Chief Investment Officer of the London-based firm Ruffer. And Maxey, he's written an interesting essay recently in which he argues that when inflation comes into the system, it doesn't go in- it doesn't come in a straight line, it comes in this sort of waves. And he says there's no point investing for the end-game, the inflation end-game. You have to be- and here he's a bit like Gerald Loeb, you have to be a lot more nimble. You have to- on the up side of the inflation wave, which we've said been going through for the last few months, you want to be preparing for the inflation. So, if remember last year, I was advocating sort of buying things like energy stocks. But now, those have been on a tremendous run. Now, the next phase, with the Fed tightening and- obviously, a very tiny 25 basis points from zero is not the- that's not the end of the tightening. So, the next phase, as Maxey describes it, is the inflation down wave. So, if you're going to invest in that way, if you're going to sort of take that onboard, then you actually need to be a lot more nimble. And there I said, and this is something that is considered complete heresy in the investment world, there I said, you need to engage in a bit of market timing, when the moving in and out. So, the central thesis is that passive investment has gone tremendously well, and bully for those S&P index investors. But now, actually, is the time to get active. I mean, this probably is contrary to all of the sort of investment advice that you read in magazines and newspapers, and things people say, "Don't try and time the market. You'll only get it wrong. You'll get out when the market is low and you go back in when it's high. Don't try to pick stocks and just keep your cost as low as possible, buy an index fund and just sit on it." And that's the best thing you could do because anything else you might do will be worse. Market timing is a perilous activity. However, and I used to work for this investment firm GMO, where in the asset allocation we did try and forecast markets at times better- sometimes better than others. But the essential point then, and these forecasts were developed in the late-1990s, was to say that some markets are cheaper than others and you don't want to be in a bubble market. Now, Jeremy Grantham, my old boss, has put out a note earlier this year pointing out the US stock market is a three-sigma bubble. That's three sigma's away from its long-term trend. Now, if capitalism has any sort of meaning, it's that what goes up, come down, that there is a reversion to the mean. So, I think that, yes, market timing is difficult but in bubble moments- and extreme bubbles you see at the moment, then that's a different matter. The other thing I would say is that in inflationary periods, as I've mentioned earlier, markets get whipsawed. Now, if you go back- I didn't actually mention this in my piece but, as you know, in the 1970s, the US stock market actually lost value. And I think in real terms, a balanced portfolio - 60% equities and 40% bonds - declined something more than 50% in real term. So, clearly, in an inflation time, if you're buying stocks in a highly-valued market, are not going to protect you from the return of inflation. So, I'm afraid that if you want to protect your capital from now on, you're going to have to get out of bed or at least have someone else to get out of bed and do the job for you. Well, there you go, so it's- there's a bull market coming in active investment managers, which it's been a long time coming potentially. But it's interesting to your point because it sounds almost like the adage the people who thinks- people used to say during the 2008 crisis, it's about- it's now become about return of capital rather than return on capital. Yeah. Or, Pete, another way of saying it is it's the preservation of purchasing power overtime. That is- as far as I'm concerned, that should be the prime aim of investment. And if you can get any supplemental return, well, good for you. But first of all, preserve your capital and that may require being a tiny bit more nimble than you've been in the past. Eddie, thought-provoking as always, I'm sure that many of themes we will be returning to you in the coming weeks and months. But for now, Eddie Chancellor, thank you very much. Thanks