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By Michael Rawson, CFA | 01-24-2013 09:00 AM

Bernstein: A Lot to Like in U.S. Assets

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.

Bernstein: Right.

Rawson: What does that tell you about what people expect for growth in emerging markets versus the United States?

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