I met James Montier at the London Value Investors Conference a few weeks ago. He was speaking in a sparkling line-up. I was spectating. There wasn't much time. So we agreed to a quick interview when everyone else was having their lunch. Then, in the interests of skipping small talk, we went straight into the thing on both of our minds the currency wars.
On the day we met, Australia had just unexpectedly cut its base rate from 3% to 2.75% in the 511th base-rate cut by a central bank since the global financial crisis began. That means that there is now no major country that is not involved in some kind of effort to push down the relative value of its currency to help out its domestic economy. Given that, how on earth are we supposed to invest?
That, says Montier, is "hugely difficult". This is, in fact, the "hardest market" he has ever encountered in his 25-year career. That's because "the traditional safe-haven assets (bonds) are expensive, but the risk assets (equities) are expensive too". You have to own some set of assets "cash, bonds or equities, in essence" but current prices make it "really tough to allocate assets".
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The truth about the currency wars
However, the key point about the currency wars is that they should really be seen as a byproduct of quantitative easing (QE) that's what really weakens currencies. Governments think they are somehow in thrall to the "bogeyman" of the bond vigilantes so they have to be careful to keep debt and inflation under control. But "there is no evidence that the bond vigilantes exist" these days.
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Why? Because there is a constant buyer of last resort. "If I'm a UK citizen and I'm worried about US inflation and I sell my US bonds it doesn't matter diddly squat for US bond yields" if the Federal Reserve is standing by to pick up everything I feel like selling. There is huge "tail risk" in the market, of course if the Fed or the Bank of England or the Bank of Japan stop buying, then there could be a huge spike in yields. However, until then, where QE really shows up is in the currency markets.
"As soon as I sell my US bond I'm changing my dollars back into sterling" pushing the US dollar down along the way. That in turn becomes a problem for anyone not doing QE their currencies end up relatively high and they have to act as Australia just has. So QE has created the currency wars.
On the plus side, Montier thinks that the country that fights the best war (not Australia yet it still has positive real interest rates) might find it actually works. Think, he says, of the countries that came off the gold standard in the Great Depression: "the scale of their experience... was heavily related to how quickly they came off".
Surely, I say, the fact that everyone is at it at once will make it hard for it to work for anyone this time around? It is a "constant game of leapfrog", agrees Montier.
The oddest thing in the world
We then move on to fiscal policy. Rather unexpectedly, Montier thinks that the "oddest thing about the world right now" is how little governments are using their ability to run up as much debt as they fancy. We were all sucked in by former Fed governor Alan Greenspan into believing that monetary policy can control everything. But it "has pretty damn limited impact fiscal policy is much more effective".
No one will do it because they are all terrified there is some dangerous level of debt-to-GDP ratio beyond which we cannot go. But there isn't. After all, what is debt? "Just an irrelevance essentially," says Montier. "It's what we owe ourselves. It doesn't matter." And there is no "crowding out" risk here (whereby government spending inhibits private-sector spending).
Look at net investment everywhere. "It's negative in Japan. It's low in America. It's non-existent in Britain. Nobody's investing in real good old-fashioned businesses and unemployment is at 7%-8% in most places so there is no risk of crowding out."
Should we and I ask this tentatively then abandon so-called austerity? Of course, says Montier. Austerity is a "ridiculous idea". He can't see why people think it is "not healthy" to spend, spend, spend, and monetise debt along the way. You might see higher inflation in the end, but there certainly won't be hyperinflation and anyway, "economists have never been able to show that inflation is a particular problem".
Hmmm. I'm working (as you might have noticed) on not interrupting my interviewees as much as I would like to, but I can't let that one pass. I think it is easily shown that inflation is a problem. That's partly because it is redistributive in a bad way and partly because it is yet another factor in the gradual erosion of trust across society.
Maybe so, says Montier. But even if inflation were a problem for economies, he'd still need to see that there was inflation before he worried about debt. I say that I think there is serious inflation in Britain inflation obscured by statistical meddling. I introduce him to my idea of a school fees index'.
A school is a community in itself. It has to pay for everything that a normal community has to pay for food, staff, transportation, energy, facility upkeep, etc. But the interesting thing about it is that a school passes on all of its costs directly to the purchasers of its services. So look at how school fees rise and in my view, at least you can get a pretty good sense of how fast prices are rising in Britain at the moment. And they are rising at about 5%-6%.
Montier doesn't disagree. But even if one could prove that level of inflation, he says, he still thinks "10% unemployment is more of a problem" than debt or inflation. So you just keep the debt rising until most people are employed? Yes, he says because you can then repay: "that debt can disappear when times are good".
I don't buy this either, for the simple reason that the British government at least has never actually got around to this bit of the equation and that makes me very nervous.
Where can we invest today?
Still, bickering over inflation (before lunch) and what may or may not happen in the future isn't going to get us anywhere (especially given that, in the end, no one really has any idea on this one), so we move on to investing. What do we buy?
Bonds are a "no no". Inflation may be low enough not to be a worry for the economy as a whole, but right now you are getting only the tiniest of returns on most sovereign bonds. And history tells you that will end in tears. Cash is pretty hopeless too hold it now and you guarantee yourself a negative real return of a couple of percent a year.
That leaves us with stocks. They're a real asset, but they come with a problem: "they're an expensive real asset". So you have to look around for what is cheap. Value plays in Europe are no longer as cheap as they were and much of Europe remains "inseparable from junk".
America is far too expensive, and while emerging markets look mostly "OK" (how's that for an endorsement?), "how safe are they?" They are in the main very dependent on China as, for that matter, is Australia and China's growth is "dying". The only question now is just how smooth the transition from 11% growth to 5% will be.
"History has not been kind to economies that have tried to alter their rates of growth" and the transition from high growth to low growth is generally "rough".
I ask where he keeps his own money. In the GMO Global Asset Allocation Fund, as it turns out, "which is about 50% invested and 50% in cash". The invested 50% involves mostly high-quality stocks of one kind or another, plus a little European value, some emerging markets, and a "little bit of Japan" although Montier isn't too keen on that. Not only has it "gone up a hell of a lot", he says, but "I don't even believe in the case".
The best you can do right now is "to build something that is robust that is going to survive different environments". That means being comfortable with holding cash for its optionality (in other words, you can use it to buy other things if they fall in price) and with holding equities.
After all, while the current market moves feel more like a "last hurrah" than anything else, they could also be telling us we are in year five of a multi-year bull market.
Who is James Montier?
James Montier grew up in Sussex, in southeast England. He got a degree in economics from Portsmouth University, then went on to get a Masters in the same subject from Warwick. He went into investment banking, and has worked in London, Tokyo and Hong Kong.
Montier specialises in behavioural finance, which looks at how our psychology affects our investing. He has written several books, including Behavioural Investing: A Practitioner's Guide to Applying Behavioural Finance; Value Investing: Tools and Techniques for Intelligent Investment; and The Little Book of Behavioural Investing.
At Socit Gnrale, as co-head of Global Strategy, he predicted the financial crash (along with colleague Albert Edwards), but unlike many of the bears, he also got his timing right on the bullish side, when he told investors to start buying value stocks not long before the stock market bottomed out in March 2009.
He left Socit Gnrale that same year to join US asset management group GMO, run by another respected value investor, Jeremy Grantham. Montier is a visiting fellow at Durham University and a fellow of the Royal Society of Arts.
