In our view it is better to hold cash and deal with the limited real erosion of capital caused by inflation, rather than hold overvalued assets and run the risk of the permanent impairment of capital.
He went on to note that the current lack of attractively priced stocks is a reason to have a lot of cash now.
The inflation comment is very thought provoking. A building block that offers perspective is that at a 3% annual inflation rate, expenses would be 50% higher in 15 years. This is complicated by the fact the health care expenses have gone up at a much higher average rate and I doubt there is any chance of that changing anytime soon.
Over the last couple of years or so reported inflation has not been that bad compared to the impairment of capital that some have endured up to this point. The notion of permanent impairment is a little fuzzy to me. The SPX is down 15% from its 2007 highwater mark. It is also down 12% from the March 2000 high. I have no doubt that the SPX will take back both those levels, the variable of course is when. If it takes back those levels in 2015 that would certainly be a long time but not permanent.
If he means individual holdings it is still not clear to me. Take a crazy example of the investor who five years ago put 50% into Fannie Mae and 50% into Apple (AAPL). The Fannie Mae position is permanently impaired but the AAPL position has quintupled. $10,000 into each is now worth about $57,000 despite a total wipeout in Fannie.
As a more realistic example, by virtue of luck and having avoided a few things an investor could be up a fair bit from the SPX’ 2007 high water mark. This could sill be the case had an investor been unlucky enough to have had Fannie Mae or Freddie Mac at a 3-4% weighting and who then rode it all the way to (almost) zero. I obviously believe in looking that the bottom line of the portfolio as being more important than the individual holdings but someone who believes otherwise would view these examples as permanent.
The interesting part of the comment is preferring to take a chance with inflation than stock market declines (permanent impairment or not) when valuations look poor. I wrote the other day that it is ok to hold cash when market circumstances dictate. One way to take the comment is that Montier is granting permission to consider a radically different asset allocation.
Some people are permanently afraid of stocks now and would consider holding a lot more cash or cash like investments (Soros is currently 75% cash?). There has been a proliferation of merger arbitrage products, inflation linked products, funds like COLLX, currency funds, hedge fund trackers, managed futures and so on which I have referred to in the past as diversifiers.
My opinion remains the same which is that stocks still can work but you may have to look to other countries but some people can no longer tolerate equity market volatility and for these people it may make more sense to have more in products like the ones above that, if they function properly, give a chance to keep cash a little ahead of inflation and then have a much smaller than “normal” allocation to stocks. For people who save a lot this can work but there is no reason someone pursuing this can’t still have a properly diversified equity portfolio.
I would also note that the person who makes this change on a reactionary basis is very likely to regret in the face of a large market rally.