Wealth

Prowling for Value in a Haywire Marketplace


We invest in stocks—and other markets—based on an idea we pioneered called fundamental indexing. Instead of weighting companies in an index according to their market capitalization, we weight them according to how big they are as a business, by measures such as aggregate profits, sales, and dividends. The size of the company's business becomes your anchor. So when a stock soars and its business doesn't, trim it. When a stock plunges and its business doesn't, buy it.

Most of my money is away from stocks at the moment, in long-short strategies [that aim to profit from betting certain stocks will fall, while also buying stocks expected to appreciate], investment-grade bonds, and the long Treasury Inflation-Protected Securities (TIPS). I see all sorts of wonderful buying opportunities in the coming 12 to 24 months. They're not here now. You buy assets when they're cheap, when investors are frightened. The growth side of the market is priced for a very benign environment. The deep value side is saying: "Whoa, things could still go haywire." I'd much rather buy stocks priced as if things could go haywire than stocks priced as if everything is fine.

I think we will have another recession, and the catalyst will be the lapsing of the Bush tax cuts at yearend. Stock sectors priced at levels that reflect fears of a second round of the global financial crisis—and that are most likely to perform well—are utilities, consumer discretionary, industrials, and financials.

Other areas that merit careful consideration for purchase in a renewed recession are emerging markets, commodities, and real estate investment trusts. Emerging markets will falter. Commercial real estate will get hit hard again. Commodity prices will fall. Current discussions are all about China, which means the bargains probably aren't there. Malaysia, Russia, and Turkey get hardly any attention and are priced accordingly. We'd overweight those markets.

Long-term, inflation-linked bonds are interesting. Very few people are worried about inflation over the next 12 months. Very few would be so sanguine about our ability to dodge the inflation bullet for the next 20-plus years. TIPS are a long-term safe haven and anchor to a portfolio. The yield is about 2 percent. At 2 percent, they don't sound very interesting. But that's a real [inflation-adjusted] yield. If inflation is more than 2½ percent over the next 20 years, then long TIPS utterly dominate long Treasuries.

A strategy really out of the mainstream and scary would be to go long on BP (BP) and short on Apple (AAPL). BP's contractual obligations toward the cleanup are surprisingly modest, and if the government asks them to pay too much, they'll dig in their heels. Apple, on the other hand, is priced at more than 80 percent of ExxonMobil's (XOM) market cap. Great company, great prospects, but are they likely to produce more than 80 percent of the profits of ExxonMobil in coming decades?

The Stat: Rob Arnott is chairman and founder of money management and analytics firm Research Affiliates. He is also manager of the $22 billion Pimco All Asset suite of tactical allocation mutual funds. Pimco was the first licensee of the fundamental index concept.


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