Carl Icahn on the myth of corporate democracy
Tony Jackson’s piece in the FT suggests there is no practical hedge against inflation
CPI +3% (say over 5 years) is often mentioned in the same breath as so called balanced funds (another myth but more about that later). Personally I suspect the balanced or 70/30 (equity/bond) fund originated from the the typical active/pensioner split for defined benefit funds a couple of decades ago. This was probably more like 60/40 but then the equity culture took hold and ‘balanced’ became 70/30. Then, on the basis of experience, the CPI +3% objective was retro-fitted in an environment where it was easily achievable by holding bonds and equities i.e. the prolonged disinflation of the eighties and nineties.
The following graph demonstrates that this is maybe a dangerous assumption to hold in a post-disinflationary environment, especially with relatively high valuations and low but rising inflation as a starting point.
Note that this is based on total returns from US equities (latterly the S&P 500) and US 10 year treasuries. Not a very diversified portfolio perhaps but, given that returns are additive, it is relevant unless one believes that an Australia centric global portfolio will perform better in the future than the US has over the last 100 or so years (the US having been the most successful economy in the world during that period). Risk, of course is another matter although arguably 1) the free global diversification lunch has already been arbitraged away and 2) a smoother path to ruin may be of little solace.
In general therefore:
- Consistent absolute returns (e.g. CPI+3% over 5 years) from a passive allocation to equities and bonds is a transitory phenomenon that can only occur in a highly specific context – a disinflationary environment combined with abnormally high starting yields.
- Low and rising inflation (or deflation for that matter) combined with low valuations (PE dots on bottom of graph) has very, very different implications from high and rising inflation combined with high valuations
- There will be some turmoil and reorganisation as that slowly becomes apparent
From a manager/allocator/investor perspective
- A pure mean-reversionist would contend that prolonged period of weak performance (the US stock market in particular has risen byless than inflation over the last 10 years) is more likely than not to be followed by strong returns. This is, however, only true if poor performance has normalised valuations. Unfortunately valuations remain stretched while earnings are nowhere near mean-reverted levels (Apologies for the counter-counterpoint).
- Greater fool theory (which works wonderfully in an upwardly trending market and rewards wholesale distributors of risk – banks/ private equity etc) will apply over shorter and shorter periods when applied to smaller and smaller pools of assets. The financial behemoths (banks, mutual funds, pensions funds, hedge/private equity funds etc) will struggle the most.
The counterpoint
- One will have to try harder to generate anything over CPI (do something different and contrary to popular perception) – bearing risk does not automatically entitle you to a commensurate return.
- Investing in anything adopted on a mass-scale will be volatile and ultimately unproductive (balanced funds, popular market indices and FoF’s all come under that banner)
- It has been and will be different for the Australian investor. Australianised analysis to follow……..
