Ben Inker on Value and Asset Allocation (Podcast)

Episode Summary

Executive Summary: Barry Ritholtz interviews Ben Inker, head of asset allocation at GMO, about value investing, market bubbles, and the current state of global markets. Inker argues that value investing has underperformed not because it's broken but because valuation spreads have widened to extreme levels. He discusses GMO's seven-year forecasts, which predict negative real returns for U.S. stocks even under optimistic assumptions, while finding opportunities in Japan and emerging markets. He also addresses the speculative bubble in certain stocks, the challenge of measuring intangible assets, and the pitfalls of traditional price-to-book value metrics.

Main Topics: Market Cycle and Valuation (Priority: 5/5): Discussion of where we are in the current market cycle, with Inker noting froth everywhere but questioning whether ultra-low interest rates justify higher valuations. He distinguishes between the overall market and the speculative bubble in certain names. Value Investing's Underperformance (Priority: 5/5): Inker analyzes why value has underperformed since 2007, attributing it almost entirely to valuation compression (value getting cheaper) rather than fundamental failure. He argues the rebalancing effect still works and value would win if the valuation gap stabilized. GMO's Seven-Year Forecasts (Priority: 4/5): Explanation of GMO's forecasting methodology: assuming mean reversion to normal valuations and profitability over seven years. Two scenarios are used—traditional normal and 'partial mean reversion' with permanently lower interest rates. Even under the latter, U.S. stocks appear overvalued. Global Opportunities: Japan and Emerging Markets (Priority: 4/5): Inker identifies Japan as intriguing due to low valuations and potential profitability improvement from corporate governance reforms. Emerging markets offer cheap valuations with idiosyncratic risks that can be diversified away. Russia is highlighted as very cheap with corruption discount. Measuring Intangibles and Value (Priority: 3/5): Discussion of how traditional price-to-book is flawed due to intangible investments not being capitalized and stock buybacks destroying book value. GMO adjusts by reclassifying R&D and similar spending as investment to build economically meaningful balance sheets. Speculative Bubble and Catalysts (Priority: 4/5): Inker compares current market to 1999-2000, noting similar mentality that 'valuation doesn't matter' for some stocks (Tesla, DoorDash, QuantumScape). He argues catalysts for busts are often unclear even in retrospect, but the speculative excess will end eventually. Big Tech and Regulatory Risk (Priority: 3/5): Analysis of mega-cap tech stocks (Apple, Microsoft, Google). Inker notes their growth will slow as they become larger shares of their addressable markets, and they face regulatory risks. Valuations have expanded significantly (Apple from 13x to 39x earnings).

Key Arguments: Value's underperformance since 2007 is entirely due to valuation compression (value getting cheaper), not fundamental failure. The rebalancing effect still accrues to value. The current speculative bubble is comparable to 1999-2000, with many companies trading at 5-20x fair value. Catalysts for busts are often unclear even in retrospect. Traditional price-to-book is flawed because intangible investments aren't capitalized and stock buybacks destroy book value. Adjusted metrics show value is still valid. Japan offers intriguing opportunities due to low valuations and potential for profitability improvement from corporate governance reforms. Even with permanently lower interest rates (partial mean reversion scenario), U.S. stocks are overvalued and likely to deliver negative real returns over seven years. Emerging market diversification is key because risks are idiosyncratic - the same bad event won't hit all countries simultaneously. Big tech growth will naturally slow as companies become larger shares of their markets, and regulatory risks are rising. Oil companies can be good investments at the right price despite climate challenges - there's an appropriate price for everything. Listening carefully to those who disagree with you is crucial - there's usually some truth to their challenges.

Data Points: GMO AuM: $60 billion - Assets under management at GMO GMO aggressive long-short return (dot-com implosion): 80% cumulative net return - Achieved during dot-com bust for clients Value outperformance period: 1981-2006 - Value outperformed market by ~2.5 points/year in US Value undergrowth vs market (1981-2006): 5 points/year - Value stocks undergrew the market even during winning period Value underperformance since 2007: ~1.5 points/year vs overall market - Attributed entirely to valuation compression (2 points/year cost from widening discount) Current value vs growth valuation gap: 70% wider than 40-year average - If gap reverted to average, value would beat growth by 70 percentage points Apple PE multiple expansion: 13x to 39x - Over last 3-4 years, ~300% of return from PE expansion Russell 2000 outperformance trigger: Vaccine news (late 2020) - Triggered large move in small caps, though they weren't cheap to begin with Real interest rates (TIPS yield) in 2000 vs now: 4% then vs near zero now - Key difference between current bubble and 2000 - low-risk assets offer much lower returns now Expected earnings growth in 2000: 15% annualized - Analyst expectations at peak of internet bubble - highest levels ever

Pivotal Quotes: "At the end of the day, everything is worth the present value of the future cash flows. And what we have seen time and time again is The market will forget that. And as the market forgets that, it will do some sort of objectively silly thing. But in the end, those cash flows or the lack of them is a Profound discipline to the market, which will pull things back." — Ben Inker: Explaining the fundamental discipline of valuation, even during speculative episodes "Under the surface, the value effect is still there, but it's hidden by this changing valuation. So, we think if we could get a stable valuation gap between value and growth, value would win." — Ben Inker: Core argument for why value will eventually outperform - the valuation compression is unsustainable "I truly believe value as a style has been really out of favor. Deserves to outperform. I also believe that the price-to-book and even PE-based style indices are a really poor way of getting at that, and they have way too many effective data errors showing up as either very cheap companies or very expensive companies." — Ben Inker: Nuanced view: value strategy is sound, but traditional value indices are flawed due to accounting issues

Implications: Value investors should not abandon the strategy despite prolonged underperformance; traditional value indices may be flawed due to intangible asset accounting. Investors should focus on Japan and emerging markets, adjust for intangibles, and be prepared for a potential bust in speculative stocks. The key unknown is whether low rates are permanent, which would justify higher overall valuations but not the extreme spread between growth and value.