Had Mark Twain been an astute investor instead of a foolish one, he might have quipped: “Reports of Value’s Death May Be Greatly Exaggerated.” As it happens, it was Rob Arnott, chairman of Research Affiliates, who tweaked Twain’s famed “death” quote in naming a white paper he released last month.
“…the stage is set for potentially historic outperformance of value relative to growth over the coming decade,” he argues.
In an interview with ThinkAdvisor, the “Godfather of Smart Beta” expands on his forecast for value’s big comeback “for the patient investor,” as well as providing his outlook for the U.S. economy and stock market. Further, he opines on President Donald Trump’s decision that has extended the long bull market.
Founder of Research Affiliates, Arnott has made a career of testing the conventional wisdom. In the interview, he maintains that profit opportunities are created when conventional wisdom is wrong.
Right now, he is predicting both a recession and a bear market in the next two to three years, and his forecast for growth investing is plenty gloomy, especially for FAANG stocks, the majority of which, in the long term, will likely be a “whole bunch of losers,” he contends.
Arnott founded Research Affiliates in 2002 to focus on innovative approaches to quantitative investing strategies. Today more than $190 billion in assets are managed using the firm’s strategies, licensed to companies including BlackRock, Pimco and Schwab.
In 2018, Arnott stepped down as CEO to devote more time to research and portfolio management. He manages the Pimco All Asset and All Asset All Authority funds and the Pimco RAE suite of funds.
ThinkAdvisor recently interviewed Arnott, speaking by phone from company headquarters in Newport Beach, California. He talked about the evidence of market bubbles and revealed that more than half his personal portfolio is invested in emerging markets.
“Value-oriented smart beta strategies [rebalancing based on elements other than market capitalization] in both the developed and emerging markets offer investors promising opportunities outside the many bubbles in today’s global markets,” he writes in “Bubble, Bubble, Toil and Trouble,” a July 2019 paper.
Here are highlights of our interview:
THINKADVISOR: What’s your forecast for value investing?
ROB ARNOTT: Value is so cheap that it will turn at some point — today, in three months, two years from now. But my confidence in its winning near-term isn’t high — I’m cautiously optimistic — because so many things could go wrong. The longer the horizon, the greater my confidence. Over a one-year horizon, I give it 60%/40% odds; for a three-year horizon, 70%/30% and over five and 10 years, 80%/20% and 90%/10%.
Why are your long-term expectations so high?
Historically, when value has been as cheap as it is today, 100% of the time it’s beaten growth and outperformed in every geography of the world over the next five years. So that gives me pretty darn high confidence that for the patient investor, value should win over a five-year horizon.
Are investors distracted by the giant tech stocks? Is that part of the reason for value stocks’ lagging?
Not just distracted; it’s more than that. They believe that the tech revolution is going to crush value stocks. They viscerally believe that the revolution will be massively beneficial to tech stocks and massively disadvantageous to other segments of the market, especially the value segments.
Your thoughts on that?
The fallacy in that view is very simple: The market already reflects those expectations in current prices. Value is cheap because people are expecting value stocks to have horrible growth in the years ahead because the encroachment of technological innovation will crush their businesses. Yes, that will happen to some companies, but not to whole swaths of the economy.
This fear is the conventional wisdom. Broadly, how does conventional wisdom affect investing?
The markets already price it into every asset. At best, conventional wisdom is useless. At worst, it can lead us astray by giving an explanation of what’s already happened masquerading as a forecast. The market is moved on surprises, not on conventional wisdom. I’ve found that yes, conventional wisdom is often right and yes, it’s often wrong. When it’s wrong, you have profit opportunity. So finding the gap between conventional wisdom and reality is a wonderful source of alpha.
What or who should be given credit for the long bull market?
It’s a series of things. The question is: How many of them are likely to deliver continued gains? Most look like they’re pretty well played out.
Earnings this past decade have grown considerably faster than historic norms. But that surge doesn’t presage a continuing surge. That, actually, would be a little dangerous — not just to investors but to capitalism because the prosperity is inadequately shared.
What would the repercussions be?
You run the risk of fanning populist flames. That can be ether conservative populism, which, in an extreme scenario, can bring in fascists or liberal populism, which can bring in folks like Mao Zedong.