We chatted with GMO's Ben Inker about where the markets are offering the best rewards and the biggest risks.
It's been a great run for the stock market while bonds took a pratfall amid talk of Fed tapering. This seemed like a good time to talk with Ben Inker of GMO. Inker and his colleagues are some of the most thoughtful researchers on all things macro. Amid the rally, they've pointed to signs of stress in the markets but they aren't beating a big retreat from equities.
His funds aren't very accessible for individual investors, but I think his thoughts are worth the time anyway. While GMO funds are only for institutions, he does run Wells Fargo Advantage Asset Allocation EAAFX and Wells Fargo Advantage Absolute Return WARAX.
Kathryn Spica and I spoke to him just 15 minutes after his latest commentary was published. You can read it here, though it requires free registration. We discussed why GMO likes U.S. high-quality stocks but sees bubbles in China.
Russ Kinnel: I'm intrigued by a line in your latest commentary hot off the presses in which you said, "There is no asset class that you can hold that would be expected to do well if the real discount rate rises from here." So, what does that mean we should do--just hold cash?
Ben Inker: No, it definitely doesn't mean we should only hold cash, because all asset classes are to one degree or another trading higher than their historic averages. You can make a case that maybe European value and emerging-markets equities aren't, but if you adjust for things it's not even clear that they are cheap relative to historic averages. The reason everything looks that way is we have very low current discount rates, very low cash rates, and very low expectations of future cash rates.
So, you are getting paid for taking a risk of owning something other than cash. The trouble is if those cash rates normalize, then everything whose price was pushed up by the very low cash rates would be expected to get hurt. And if that happens, and it's not guaranteed to happen, you get events like we saw in late May and June, where asset classes all around the world that normally seem unrelated to each other get hit simultaneously.
That is a risk that exists today in the markets because of the very, very low discount rate. That makes everything somewhat riskier, but it doesn't mean you want to sit there and hold cash unless you know rates are going to rise soon because sitting in cash you are earning nothing and in the meantime sitting in other assets you're earning something. So the better an idea you have of when cash rates are going to normalize, the easier it is to figure out what portfolio you should have.
Kinnel: So you're saying it makes sense to be cautious, but don't flee the market?