Anyone with a passing familiarity of market history knows we have experienced this environment before. In fact, the late 1990s are strikingly similar along many dimensions, and they were far and away the most difficult years of my career; Jeremy Grantham—a superb contrarian investor—lost assets and credibility along with me and many other value investors. Julian Robertson, the legendary founder of Tiger Management, and godfather to legions of “tiger cubs” who subsequently launched their own hedge funds, famously closed his hedge fund in March 2000 at the exact end of the tech bubble!1
Such pain and angst is wasted if we don’t learn from it. We are now seeing conditions parallel the extremes of the late 1990s. The following parallels can serve as the drivers of future outperformance for the most hated asset classes, as well as a body blow to the return prospects for the most popular and comfortable markets:
- falling inflation expectations
- tumbling emerging market currencies
- extreme relative valuations for EM versus U.S. stocks and bonds
- protracted growth-stock bull market and underperforming value stocks
The last time all four of these were at, or near, historical extremes was in December 1998. After 1998, an equally weighted mix of inflation-fighting and diversifying assets2 outperformed a traditional U.S.-centric 60/40 portfolio by nearly 9.0% annualized over the subsequent 5 years and outpaced 60/40 in 11 of the next 12 years. That’s a lesson we remember.
The impact of these conditions is that, on the one hand, relative-return prospects for our inflation-hedging asset classes are now quite good. On the other hand, however, given their poor current yields, U.S. cap-weighted equities and nominal bonds are now offering poor real-return prospects.