Inquiring minds are reading a Guru Focus Interview with
Investor Arnold Van Den Berg, a
value investor.
Guru Focus: You seem to believe that there will be
high inflation risk in
the coming years. What is the best strategy in this inflationary environment?
Van Den Berg: It is important to define what we
mean by inflation. Inflation rates in the low single digits (1% to 3.5%) generally
meet the definition of low and stable inflation. Inflation rates greater than 4% or lower than 0% have a high risk of destabilizing the economy. The primary risk of inflation stems
from the potential for monetary policy errors. Monetary policy makers do well when the underlying environment is relatively stable. But when conditions change suddenly,
there is a possibility for error. Thus, monetary policy errors can be either
deflationary or inflationary.
The risk is especially high in unstable monetary environments, like we are experiencing today.
Both inflation and deflation
compress valuations. In
the 1970s, stocks sank to single digit P/E ratios. We all know what happened to markets in the early 1930s. Generally, economic instability is bad for valuations.
We believe that we could
go through a period of above-average inflation (on the order
of 5%), but nothing like we saw in the 1970s. This period will be
very poor for stocks. Since it is
difficult to predict the
timing of such episodes, we adjust for inflation (and deflation as well) by adjusting our valuations for lower price multiples. When we find bargains,
we will buy them; when
we cannot find bargains, we will hold
cash. We expect that conditions in the economy
and in the market will run counter to our investment philosophy for short periods of
time, but we know that
over the long run value investing
outperforms.
Guru Focus: There was a piece
in OID approximately eight
years ago where you discussed
the post-bubble periods.
It was transformative for me but I wonder where you think we
are at present. It seems the risks are greater than ever as our government
tries to solve an over-consumption
problem by issuing
massive amounts of debt.
Van Den Berg: A major characteristic of bear markets is that things
that would normally cause the market to explode — like low interest rates — have
either minimal or temporary
effects. In bear markets, earnings could continue to grow, but
multiples become compressed.
This causes stock valuations to trade
up one to two years, but then revert back to low levels and start the cycle over. Over the duration of the bear market, the prices of stocks may not significantly appreciate.
Stocks that may look
cheap on a multiple basis may often
get even cheaper. This is exactly what we have been seeing since 2000.
At the end of the bear market, multiples have compressed
to very low levels. This sets the stage for the next
bull market.
How much longer will we be
in this bear market? Bear markets typically last about sixteen years, so I would say
that we have about five
more years to go. This coincides
with our earlier comments on how long we think it
will take for the real estate, unemployment, and
fiscal problems to be reconciled. The way to invest in this kind of environment is to stay focused
on the valuations of individual
companies. You can still make money in this environment by buying stocks when they are cheap and selling when they are near fair value (remember that multiples are compressing, so stocks won’t go as high as one would expect in a normal environment). When bargains can’t be found, hold
cash.
The
Guru Focus interview is well
worth a read in entirety.
Are Stocks Cheap?
Stocks look cheap now but they
aren't because of three factors.
1.
PE
Compression
2.
Earnings
are mean-reverting
3.
Record
government stimulus globally
Van Den Berg discussed point number
one in detail.
I covered points one and two
in Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think.
For a follow-up on those
points, please see Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?
Earnings High From
Record Global Stimulus
Point number three should be obvious,
but obviously it's not given pervasive bullish sentiment nearly everywhere, including smack in
the middle of article with bearish
sounding titles. For example, please consider a few excerpts from Dow Has Its
Longest Weekly Slump Since 2004
·
Michael
Shaoul, whose Marketfield Fund Ltd. beat 81
percent of competitors last year,
said that while the payrolls report was disappointing, it may also
be a signal the slowdown
in the economic data is near its peak.
He noted that weaker nonfarm payrolls reports in February
and July 2004 failed to derail
the last bull market, which
peaked in October 2007.
·
The
biggest decline in the
S&P 500 since August is
creating a buying opportunity for investors, according to Blackstone Group LP’s
Byron Wien. The price-to-earnings
ratio for the S&P 500 has fallen close to its lowest level
in 2011, according to
Bloomberg data. The index currently trades at 14.8 times earnings, near this year’s low of 14.7 when it fell in March after Japan’s earthquake.
·
“The
economy is not as bad as it looks right now. Corporate profits will be good, very good. People are asking
me, ‘Do you still think the market can get to 1,500 by the end of
the year?’ I do.”
In contrast, I think it is crystal
clear much of the recovery is a mirage based on unsustainable government stimulus, that
stimulus is fading, there
is little chance right now for more stimulus, and that
corporate profits have peaked
this cycle in conjunction
with a slowing global economy.
I discussed the slowing
global economy in a video:
Mish on Yahoo Finance Daily Ticker
on Slowing Global Economy;
U.S. Manufacturing ISM Plunge;
Order Backlog and New Orders Barely Above Contraction
High Inflation Coming?
Van Den Berg clearly has a different
definition of inflation and deflation
than I do. I prefer to view inflation and deflation in
terms of money supply and
credit. He looks at prices. He is calling for "high
inflation" but high means
5%.
Can we see a 5% CPI with falling demand for credit? Sure, why not? And if it plays out that way, there will
be no hiding places at all. Treasuries and stocks both would be
hammered. It is one of
the reasons I do not like
treasuries now.
It is also a good reason why corporate
bond rates at 2.33% for 10 years
constitute a bubble. , Bear in mind that a renewed
credit crunch might send treasury
yields lower but it will not be
good for corporate bonds, especially
junk bonds.
Dissimilar Starting
Points, Many Similar
Conclusions
Van Den Berg does not like
gold. I do. I gave my reasons
in a Yahoo Finance video last week.
Please see Why I Continue to Like Gold
for a discussion. There are other differences as well.
However, we have both arrived at the similar conclusions regarding equity valuations in general even though we
have very different starting points about what
inflation is.
Conclusions
·
The
bear market is not over
·
Valuations
are not cheap
·
When there is little
value, then there is nothing wrong
with cash.
Mish
GlobalEconomicAnalysis.blogspot.com
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Mish's Global Economic Trend Analysis
Thoughts on the great
inflation/deflation/stagflation debate as well as discussions on gold,
silver, currencies, interest rates, and policy decisions that affect the
global markets.
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