Ben Inker - The Problem With Good Returns In The Near Term Is They Have To Be Paid Back Sometime | #183

Episode Summary

Executive Summary: Ben Inker of GMO argues the 2020s may favor non-U.S. assets after a decade of U.S. outperformance. He says U.S. stocks and bonds are expensive to fairly priced at best, while emerging markets, non-U.S. value, and alternatives offer better prospective returns. He also warns monetary policy is near its limits and that fiscal stimulus, inflation, and antitrust could reshape markets.

Main Topics: U.S. stocks: expensive valuations and low forward returns (Priority: 5/5): Inker says U.S. large caps trade at high P/E multiples and near-record profit margins, implying muted seven-year returns and possible negative real returns if valuations mean-revert. Bonds, discount rates, and portfolio risk (Priority: 5/5): He argues bond yields already bake in low returns, and if rates rise back toward normal, stocks could suffer more than bonds because equities are long-duration assets. End of the monetary-policy era (Priority: 4/5): Inker believes negative rates show monetary policy has limits, banks are impaired by them, and future downturns are more likely to bring fiscal stimulus and possibly inflation. Market concentration and the rise of big companies (Priority: 4/5): The discussion centers on increasing profitability of the largest firms, falling wages as a share of GDP, and the idea that monopoly/monopsony power has benefited dominant corporations. Non-U.S. and emerging markets as the best opportunity set (Priority: 5/5): GMO is most optimistic about markets outside the U.S., especially emerging markets, because they are far cheaper than U.S. equities and many value stocks are priced for very bad outcomes. GDP growth is a poor predictor of stock returns (Priority: 4/5): Inker explains that faster-growing economies often have low returns on capital and can underperform in markets; valuations and return on capital matter more than GDP growth. Portfolio construction, hedging, and alternatives (Priority: 4/5): He describes GMO’s benchmark-free, absolute-return mindset and the role of alternatives such as merger arbitrage and put selling to get paid for risk without heavy duration exposure.

Key Arguments: U.S. stocks are priced for roughly inflation plus 3.5%, which is far below many investors' expectations and may even be negative in real terms if valuation mean reversion occurs. Bonds cannot deliver historical return levels if current yields persist; holding a bond to maturity locks in the yield currently available. If yields normalize upward, equities can be hit harder than bonds because stocks are more duration-sensitive. Monetary policy has hit practical limits at very low or negative rates; the next downturn may require more fiscal stimulus. The biggest reason large-cap corporate profits rose is not just sector mix but a broader increase in market power and concentration. GDP growth does not reliably forecast stock returns; starting valuation and return on capital are more important. Emerging markets and non-U.S. value stocks are attractive because they are cheap relative to U.S. assets and priced for bad outcomes already. Currency volatility matters more in the short run than the long run, so GMO generally avoids hedging equities but prefers hedging non-U.S. bonds. A benchmark-free portfolio should own assets based on return and risk, not based on index weights; that can justify zero U.S. equity exposure when U.S. valuations are rich.

Data Points: S&P 500 expected real return: Negative real return over the next seven years - Inker's GMO forecast if valuations and profit margins revert toward normal S&P 500 expected nominal return: About 5.5% nominal - He estimated inflation plus 3.5% if inflation is 2% U.S. cyclically adjusted P/E: 28x - Compared with much cheaper non-U.S. markets EM cyclically adjusted P/E: 14x - Used to highlight the valuation gap versus the U.S. EM value portfolio valuation: 8.5x earnings, 6.5x cash flow, 1.0x book, 4.7% dividend yield - Example of cheap assets priced for very bad outcomes Top equity exposure in benchmark-free portfolio: About 43% equities - Current GMO benchmark-free allocation discussed in the interview Emerging market equity exposure: A bit over a quarter of the overall portfolio - Current allocation in GMO's benchmark-free strategy Alternative strategies allocation: About 30 percentage points - Liquid alternatives such as merger arbitrage, put selling, and systematic macro U.S. share of global stock market: 57% - Used to explain why benchmarked portfolios naturally overweight U.S. large caps Corporate profits as share of GDP: Near all-time highs - Described as concentrated in the biggest firms Next 50 companies' profitability: Rising over the last 30 years - Part of GMO's market-cap stratification analysis Next 3,500 U.S. stocks profitability: No increase over 30-40 years - Shows concentration of profits in the largest companies Wage share of GDP: Down - Presented as consistent with monopsony/market concentration 1997 EM drawdown example: Down 40% over the next nine months - Used to show cheap markets can still have severe short-term losses Swiss franc move example: Currency appreciated 15% in one day; stock market fell 15% - Illustrates risks of hedging equities when currency and local assets move oppositely U.S. GDP growth in the 1960s: About 3.5% real - Historical comparison to argue future U.S. growth may be lower Expected U.S. real growth: About 2% real - His forward-looking estimate based on slower workforce growth Workforce growth: About 20 basis points a year - Reason cited for slower economic growth Early 1980 valuation study: Cheapest markets outperformed in hindsight - Referenced to show valuation mattered more than GDP growth Germany bond example: 10-year bond yielding 1.8% - Illustrated that future bond returns are largely locked in at current yields Negative bond yield example: Minus 50 basis points - Holding such a bond to maturity implies negative returns Global market share in benchmarked portfolio: SP 500 is 57% of global stock market - Explains benchmark-driven U.S. exposure

Pivotal Quotes: "“U.S. stocks, as near as we can tell right now, are priced to deliver if valuations stayed about where they are, maybe 3.5% plus inflation.”" — Ben Inker: On the outlook for U.S. equities and why expected returns are muted "“I think we've hit the limit of monetary policy. I think the next downturn, we are very likely to see much more active fiscal stimulus.”" — Ben Inker: On negative rates, central bank limits, and the policy response to the next recession "“The single most important piece of information you could have had at the time turned out to be a piece of information you did have, which was the starting valuation of the markets.”" — Ben Inker: On why valuations matter more than GDP growth for long-term equity returns

Implications: Investors should reset return expectations, diversify beyond U.S. mega-caps, and consider emerging markets, value, and alternatives. The next regime may feature fiscal stimulus, higher inflation, and more volatility around currencies, rates, and policy.