Christine Benz: Hi, I'm Christine Benz for Morningstar.com here at the Morningstar Ibbotson Conference and today I have the opportunity to sit down with John Hussman. He runs very wide ranging portfolios and we got his opinions on a broad swath of different asset classes.
If you are thinking 3.5% return on equities over the next decade. With 10-year treasury yields about in that neighborhood, wouldn't bonds appear to offer a compelling alternative to stocks?
John Hussman: No. Well, let's put it this way. Bonds have less volatility than stocks. So, if you are expecting a similar long-term return with less volatility, in some sense that's true.
The problem with bonds is that they typically have returns that are themselves significantly higher than they are now. So, while bonds are in some sense less bad in terms of a 10-year return, you can also get negative returns if we get inflation pressures or if some of this extraordinary monetary easing comes off the table.
So, I think really what quantitative easing has done is it has created a pool of zero interest bearing assets that somebody has to hold. And since people also have to hold all the other assets that are out there, all of the competing returns have been pressed lower.
I think on a relative basis you're really talking about, it's kind of like when people talk about the dollar versus the euro. You're talking about the worst of two worlds. I don't think that any of these asset classes are particularly well priced right now in terms of offering opportunities to be aggressive.
That said, I do think that the risk on trade that's been provoked by all this sort of speculative activity, this belief that the Fed has investors back, we really saw an enormous divergence between very high risk sectors and very stable sectors. Very stable sectors; valuation, cash flow, stability, margin stability all those were essentially the laggards. Because if somebody tells you go out and take risk and investors believe them, then those are the beneficiaries.
So, some of these stocks have been left behind are actually reasonable valued. They are not attractive, they are not exciting, but over a 10-year period I think they'll prove to be better investments.
Benz: So you mentioned inflation, I'd like to get your thoughts on TIPS currently, which do have that hedge against deflation built in.
Hussman: TIPS are interesting, because if you look at some of the shorter term TIPS, you see exactly the same property that we're seeing in commodities and everything else. The real yield on TIPS right now is negative, for shorter maturities. So, you're going to get your inflation compensation, but you're going to give back some of that in losses. So, really what the TIPS market is reflecting is the same thing the commodities market or anything else is reflecting, which is that we've got negative real interest rates.
It's more attractive, of course, to load up on TIPS when you've got a very high real interest rates available on those securities. We got that, for instance, in some of the Panic of 2008, where real interest rates soared. There were deflationary fears and nominal interest rates didn't decline as much as inflation.
Benz: No one wanted that inflation protection at that point.
Hussman: Nobody wanted it and so the yields, the real yields on TIPS shot up to about 4% and we picked up a lot of those for strategic total return at that point. That was also a point where, if you remember commodities just got crushed because, again, commodities sort of try and move ahead of the goods market, the CPI in general, and so commodities got crushed. That was a good time to accumulate commodities as well.
Right now, we've got very thin or negative real interest rates. It's not terrible. I mean they could get worse. And if real interest rates get worse, what will happen oddly enough is that TIPS will advance as will commodities. Why? Because in order to get the yield down on any fixed income security, you've got to raise the price.
So if you expect that TIPS don't accurately reflect the probable inflation rate or you expect the real interest rate to get significantly worse, this would be a reasonable time to buy TIPS. My view is that that's probably not a compelling case. It's probably a neutral case, so we do have some TIPS in strategic total return as a diversification, but it's not a core position for us.
I think when you get either a spike in real rates and so you need to watch those real rates on TIPS or you start seeing actual movement in inflation, where TIPS would actually be a true inflation hedge. I think that can work well. And I think in a persistent inflation, TIPS will generally be likely to perform better than commodities as a hedge.