What’s your current market assessment? How have you positioned your portfolio?
We see that most asset classes around the world are expensive relative to their own history. They make more sense relative to each other. Take the obvious example of US cash and bond rates, which are very low versus their long-term history. But bond rates kind of make sense when compared with cash rates. To us, the most striking overvaluation is that of the US stock market. Other equity markets, emerging markets (EMs) in particular, look better. So, we really don’t own any material amount of US stocks anymore. EM equities constitute a quarter of the overall portfolio, and non-US developed markets make 15% of our portfolio. The other striking factor is we own a lot of liquid alternative strategies. We are living through a period where most long-duration assets have been big beneficiaries of falling discount rates. But the biggest risk to portfolios over the next decade would be if those rates start going back up. So, if you can find some short-duration assets that are offering decent returns, it’s a nice way to make money while having less medium-to-long-term risk.
What could make those discount rates go up?
The most obvious trigger would be if inflation started rising again. The biggest economic mystery over the past, say 17 years, is why the developed world has been so resistant to inflation. The market is saying, well, there has been this permanent change. It could be true. It could also be true that this trend is driven by temporary factors. One is — the rise of China as a manufacturing center. Once they joined the WTO, their share of global exports exploded. But their ability to absorb evermore share of manufactured goods may be ending. There really aren’t underemployed people in their rural economy anymore, so they’ve run out of extra people. Another obvious factor is in terms of the ‘Phillips Curve’. The relationship between unemployment and wage growth has been much weaker than it used to be. It could be because of globalisation of labour markets. Again, there are quite a number of jobs that aren’t as portable. I look at market valuations today, and the market seems to be utterly convinced that we’re nowhere near the end; because the markets are priced as if the potential of inflation is non-existent. And that&rs