Thu, 24 Jan 2013
People have underestimated the risks outside the U.S. and overestimated the risks in the U.S., says Bernstein Advisors CIO Richard Bernstein.
Mike Rawson: I'm Mike Rawson with Morningstar. Joining me today is Rich Bernstein. Rich is the chief investment officer of Richard Bernstein Advisors.
Rich, thanks for joining me.
Rich Bernstein: Sure. Thank you.
Rawson: Rich, over the past several years we've seen consistently strong outflows from U.S. equities. What do you think that means for the outlook for the U.S. stock market?
Bernstein: I actually think that's quite bullish, Mike. We always like to think about where is capital flowing to and where is capital flowing away from? By definition, your longer-term returns are going to be higher in areas that are capital-starved. If there's too much money chasing too few ideas, by definition your rate of returns going to be lower. The fact that we've had these extended outflows for some time from U.S. equities suggest to us that we're still in the very early stages of a bull market.
Rawson: Can you talk a little bit about valuations for the U.S. market?
Bernstein: Sure. Of course it depends on how you choose your valuation, but in our models, we still view the U.S. market as being very undervalued. The fair market interest rate for us right now would be about 4% to 5% on the 10-year note. The 10-year notes is about 1.8%, 1.9% as we speak, and the fair value inflation rate would be in excess of 4% as well, inflation just came out last week at about 1.7%. I think that shows how scared people are, which means that there is very a high risk premium in the marketplace, which means that there are good opportunities.
Rawson: So, you see inflation being less than what people expect going forward?
Bernstein: I think that's right. I think people are much too scared of inflation. When you consider that people kind of have this notion that printing money causes inflation, and that's really not what your textbook says. What your textbook says is, printing money and using it to create credit, causes inflation. Everybody will agree we're in the midst of a credit deflation, credits going to be harder to get. If credit is harder to get, your inflation expectation naturally should be lower.
Rawson: I see. Now on the opposite of the coin, we've see outflows from U.S. equities, but we've seen extremely strong flows into emerging markets.
Rawson: What does that tell you about what people expect for growth in emerging markets versus the United States?
Bernstein: I think people are much too optimistic about the emerging markets. I think what happens is they get caught up in the absolute rates of growth. They say, well look, the emerging markets going to grow at 5%, let's say, and the United States is going to grow at 2%. Therefore, I should invest in the emerging markets. Unfortunately markets don't act on the absolute. It's not good or bad that drives the market, it's better or worse. What those strong flows into emerging market mutual funds kind of suggest to us is that expectations are very high, and if expectations are too high and they are dashed, it argues that things will appear to get worse, and if things get worse, then the markets won't perform very well.
On the profit side, emerging market profits have been very, very weak. I mean last quarter, it was in excess of 55% of emerging-market companies reported negative earnings surprises; it's about 25% in the United States. So it shows you how high expectations are and how hard it is to meet those high expectations.
Rawson: So on the other hand, the expectations are very high in the emerging markets, but in the U.S., expectations have been pretty low. But yet, the economy has actually been performing quite well.
Bernstein: It has been. You have things like jobless claims now at about a five-year low. That's a very critical leading indicator of the economy. People just don't want to believe that the economy is actually improving in the United States, and I think that's the whole story. It's not that the U.S. economy is booming; that's a separate issue, and that's not really an investment issue. That's more of an economic issue. But to say that the U.S. economy has not improved over the last two, three, four years, is just ignoring the data. It is clearly improved from where we were, and that's why the stock market has performed well.
Rawson: Absolutely. So, on your inflation view, you mentioned that you thought the expectation for inflation was too high. How does that lead into your views for the bond market?
Bernstein: Right. Well, we're actually very bullish on Treasuries still, despite the fact that a lot of people can't understand that, because we like U.S. assets, period. I don't care if it's stocks or bonds or whatever, we like U.S. assets, and it's largely because, we think, as I said before, people have underestimated the risks outside the United States, and I would argue overestimated the risks in the United States. As that re-evaluation process occurs over the next several years, that's likely to be very good for U.S. assets, and I would argue very good for the dollar as people around the world begin to buy more U.S. assets.
Rawson: So, it sounds like that's more of a traditional type of asset allocation, focused on U.S. stocks, U.S. Treasuries; less so of the asset allocation which kind of promotes more exotic asset classes, perhaps more expensive asset classes as a way to diversify.
So, you're also the portfolio manager of the Eaton Vance Richard Bernstein All Asset Strategy Fund. Now how do you position that fund? That's an asset allocation fund. How do you position that asset allocation fund in light of your views?
Bernstein: That asset allocation right now has very little in the emerging markets. We can put as much as we want, basically, in the emerging markets, but right now it's very, very little in the emerging markets because of what I've said before.
On the fixed-income side, we prefer to take our risk in equities. So, we have some holdings in things like high-yield bonds or lower-quality munis and things like that, but most of our risk is in equities, and we balance out that equity risk with positions in Treasuries, because Treasuries are really still--and this has been true now for seven years--about the only major asset class that's negatively correlated to all the other asset classes. So, if you're trying to balance out the risk of a fund in a long-only fund, really right now the only way to do it is by holding Treasuries. I mean, you could hold German bunds or Swiss bonds or some like that, but for the sake of discussion, it's basically Treasuries. So, we've been taking our risk in equities, and in some cases in small-cap and very cyclical equities, balancing out that risk with positions in Treasuries.
Rawson: Rich Bernstein, thanks for those insights.
Bernstein: Sure. Thank you.
Rawson: For Morningstar, I'm Mike Rawson.