Are equity investors right in assuming that inflationary risks for the market will recede?
Inflation will probably start to drop. That doesn’t mean interest rates may start to drop. I think that the equity market might be in the short term a little bit ahead of itself. The equity market thinks interest rates will go up and then come down. My view is interest rates will go up and be flat and not go back down unless we have a deep recession. The equity market has just been a very bad predictor of inflation over the course of this last year. But in terms of whether the market is at the low for even this year, I think it could quite possibly go near the low. I am not predicting any big fall.
Does that mean investors are downplaying stagflation (combination of high inflation-low economic growth) risks?
Absolutely. My view is that inflation will come down, but not to 2%. That is more likely to be in the 3% to 4% level in 2024. And then to be at the 2% level.
What does it mean for the Fed’s monetary policy?
The Fed will not go back to the low-interest rate regime that we’ve had over the last few years. Rates could stay relatively flat once they have peaked for a fairly long period of time. The worst thing for the equity market is unpredictability and volatility. Our overall investment thesis now is that it makes sense to start to move into fixed income and duration and income in general.
Investors seem to be more comfortable with a downturn or recession than inflation.
Countries like the US and Germany have a big fear of inflation because of their history. We don’t think we can control it. Emerging markets have managed inflation; developed markets have not. Americans, in general, think we need to get inflation down to 2-3%. Because once it’s at 4%, we have seen it take off before. Many people in the market have never seen inflation. But those of us who know that it’s devastating like the period of inflation, from 1968 to 1982. The market basically didn’t move in that period. So, there is a feeling among equity guys that if there is a recession, somewhere, the central banks can come into the picture again and they will lower interest rates. We are saying they can’t do that because they have to keep fighting inflation. The simple way to say that is that we don’t have the Fed put anymore. So that makes the tail risk on equity greater.
Where do you see more value: emerging markets or the US?
The relative valuation of the US market versus other markets does not make sense. The US should not be two-thirds of the market capitalisation of the world. It just logically does not make sense. When we look at emerging markets, we must be careful of looking at trend lines, because emerging markets have changed so dramatically and developed. It used to be very dependent on commodities. Now it’s more technology. We have been pretty bullish on India. India’s not very correlated with the rest of the world.
There is a lot of talk about long-term money moving to India that would have otherwise gone to China. Your thoughts?
China has never been a very good market for investors. What if I knew in 1995, what the GDP of China was going to be every year for the next 25 years? I would have put all my money in China, and still not done very well. So just knowing the economic growth doesn’t tell you how well the markets are going to do or how the share of earnings is going to go to shareholders. The reason that I have been positive on India for 18 years, is because companies there are earning money for themselves. It’s very unlikely that the government of India is going to come and basically take away an entire industry, like the education industry in China. There are risks in India too but the risk I mentioned isn’t there.
Analysts say this decade belongs to India. Do you agree?
They said that in the last decade too (laughs). You know, there’s this saying about Brazil that Brazil is the country of the future and always will be.
But India is aiming to make the country the region’s manufacturing hub with businesses looking for alternatives outside China. Isn’t that possible?
Even if India can improve its manufacturing, I don’t think India can replace China. I have been in China since 1982 and in India since around 2000. China basically grew by being a cheap provider of labour. India has the possibility of increasing its productivity. India’s done a very good job in infrastructure development. You have developed some roads and that is massive in terms of productivity. China has got itself in a situation a little bit like Japan did, where it just started making investments that there is no return on productivity. Western companies would love to manufacture in India instead of China. India could very well have higher growth than developed markets or China. I think it’s probably likely to be more sustainable for a longer period. But it is not going to be double-digit growth like we had in China for a period of time.
(The reporter was in Singapore at the invitation of Franklin Templeton)
