‘Indians investing in US mkt should avoid bubbles, fads’

Market rallies around the world are divorced from economic reality, says ROB ARNOTT, partner and chairman of the board of Research Affiliates. A speaker at CFA Society India’s 5th India Wealth Management Conference, Arnott tells Ashley Coutinho in an interview that several US tech stocks are trading at valuations as rich as the peak of the tech bubble, and that nearly $2 trillion of the $3-trillion Fed stimulus may have been wasted. He is bullish on EMS, which are “unloved”. Edited excerpts:

Tech stocks have led the market rally in the US. Do you see a bubble building up?

FANMAG-LIKE (Facebook, Apple, Netflix, Microsoft, Amazon, and Google) stocks are in a clear bubble. Many trade at valuations as rich as the peak of the tech bubble, and require implausible future success to justify current prices. We’re also seeing an enormous surge in retail money chasing the market darlings. Speculation in bubbles could still be profitable. But this only works if you have a ‘sell’ discipline.

The S&P 500 has returned nearly 16 per cent annually for 11 years. What are your expectations of equity returns in the US for the next decade?

In the next decade, we expect US stocks to deliver a nominal return just shy of 2.5 per cent per annum (plus or minus 3 per cent). This return expectation is based on our assessment of the ‘building blocks’ of long-term returns. As of July 31, US stocks had a current dividend yield of 1.9 per cent, capital growth expectation of 3.3 per cent (combining 2 per cent from inflation plus 1.3 per cent from real growth, matching the past 100 years’ average), and an expected valuation change of 2.7 per cent per year, which would still leave us over 30 per cent rich relative to history.

Central banks have resorted to massive stimulus after the pandemic. Is this a step in the right direction?

I wish fiscal and monetary ‘stimulus’ weren’t called as such. It doesn’t stimulate anything; it transfers wealth from future spending into today. If the supply of goods and services is sharply eroded, as it is today, all we’re stimulating are asset bubbles and future inflation. One must also ask how much of the $3-trillion spent has gone towards productive causes. I’ve spoken to US Senators who privately estimate that $2 trillion was simply wasted.

Will excess liquidity fuel bubbles in different asset classes?

Excess liquidity from massive fiscal and monetary stimulus fuels asset bubbles or inflation or both. We favour asset classes that are deeply unloved and trading at attractive levels. Such bargains today include EM stocks and bonds, and US energy stocks.

What are your views on Indian equities, given the sharp rebound from March lows?

All these rallies around the world are divorced from economic reality, unless we consider that stimulus monies must go somewhere; if people don’t want to (or can’t) spend it, it fuels asset bubbles. As of July 31, our nominal return expectation for Indian equities, as represented by the MSCI India Index, is 5.9 per cent per annum in the coming decade. Indian equities are trading at a cyclically adjusted price-toearnings (CAPE) ratio of 20.4x, which is a tad below its historical median level of 21.3x since 1994. The broad EM equity basket, as represented by the MSCI EM Index, is currently trading at a CAPE ratio of 13x, which is within its cheapest historical quartile since 1995.

The number of Indian investors investing in US equities has seen an uptick. What is your advice?

For those investing in US equities as part of their diversification strategy, avoid bubbles and fads. Seek the feared and unloved assets trading at cheap valuations. The easiest words in investing are ‘buy low, sell high’.