FA Magazine March 2023 | Page 23

freezing to death was seen as a real possibility , he recalls . But while Europe ’ s economy is hardly paradise ( which everyone has known for decades ), so far it has managed to sidestep a recession .
Despite a strong rebound in value stocks and the EAFE and emerging market indexes since last fall , Arnott notes that value stocks in many markets remain in their cheapest historical quintile . In his view , a broadly diversified portfolio that underweights U . S . growth equities presents a plethora of interesting opportunities .
Despite renewed interest in the bond market after a disastrous 2022 , he observes many sectors of the U . S . bond universe still sport negative real yields . Most emerging market debt offers higher yield than U . S . junk bonds . “ A basket of non-U . S . liquid alternatives is likely to have a stupendous decade ,” he predicts .
Value investors like to find glaring gaps between mainstream perception and reality . Arnott is proud of Research Affiliates ’ call almost two years ago that U . K . stocks could be “ the buy of the decade ,” reasoning that economies and equity markets are not nearly as correlated as many investors believe .
Since then , Brexit has exacted a terrible toll on England ’ s economy , particularly the supply side , at precisely the same time the post-pandemic reopening disrupted global supply chains everywhere . Yet in 2022 when the U . K . had three prime ministers in as many months , its stocks beat their U . S ., European , Japanese and Chinese counterparts .
People forget that when 19th century financier Nathan Rothschild said “ buy when there is blood in the streets ,” he qualified the remark with “ even when the blood is your own ,” Arnott explains .
But when it comes to the world ’ s most recent calamity , Covid-19 , the world is managing to move on . “ Covid hasn ’ t left us , but we ’ ve left Covid ,” Arnott says .
His advocacy of broad diversification in uncertain times coincides with Michael Cuggino ’ s philosophy . Cuggino , the president and portfolio manager of the Permanent Portfolio Family of Funds , says , “ Unless you were long energy and short everything else , you were probably negative last year .”
But Cuggino also thinks 2022 ’ s gloom may be overdone . Early this year , a lot of economic data points prompted “ people to question the recession call .” Unemployment may be a lagging indicator , but he notes it ’ s difficult “ to have a deep recession when this many people are working .”
However , people still don ’ t know what the impact will be from QT ( quantitative tightening ) or central bank interest hikes , which can take as long as 18 months to influence economic decisions .
Besides the market ’ s swing from growth to value , Cuggino sees changes undermining several decades of developing conventional wisdom . “ The Fed has been a backstop [ for stocks ] for 35 years , and investors have a bias to believing that ’ s what ’ s going to happen when push comes to shove ,” he says .
He notes that the concept of “ TINA ” ( there is no alternative to stocks ) is now under question — and that there have been significant outflows from U . S . equities into foreign vehicles in recent months . But if the Fed is forced to maintain higher interest rates for longer than many market participants expect , investors could continue to move into bonds . Moreover , the macro backdrop with the
“ Last fall , the fear factor was getting pretty intense . We never got to peak fear in the U . S ., but Europe and emerging markets did .”
— Robert Arnott
reopening of China favors commodities and materials .
If there is any consensus , it ’ s that this decade will look very different from the last . Exactly how isn ’ t clear , but some signals are appearing .
Tangible Assets Are Ascendant
Every cycle experiences its own misallocation of capital . In the 2009-2020 era , intangible assets like patents got elevated to extreme levels , observes Rob Almeida , global investment strategist at MFS Investment Management . With a very low cost of capital , businesses could invest “ in IT moon shots .” Today , Alphabet shareholders are wondering whatever happened to its driverless vehicle , Waymo , and demanding accountability for so-called “ science projects .”
The U . S . economy also experienced a massive expansion of profit margins coupled with very weak GDP growth in the last decade . “ Profits grew 250 % to 275 %, stocks were up two to three times , and GDP grew 2 %,” Almeida says . “ Too much capital went into non-physical assets . You can do that in a low interest-rate world . Now we have a physical world we ’ ve outgrown .”
Forty years ago , about 80 % of U . S . capital expenditures were devoted to physical infrastructure , Almeida says .
Continued on page 62