Once we get used to things going a certain way, we tend to think they’ll just keep going. And the longer they keep going, the easier it is to get complacent and the harder it is to prepare for things going differently. But in life and in investment -- as experienced investors well know -- few things last forever. As esteemed investor Howard Marks of Oaktree Capital recently remarked: “Just when it looks like the trend will happen forever is probably the time it has to stop, because it has done so for so long. This is an area for contrarian thinking.”
Contrarian thinking isn’t easy – nor is it always right. But it is useful. Good investors should be forcing themselves to do what doesn’t come naturally. What’s natural and comfortable for most people is to think the future will be like the present. What’s hard and uncomfortable is to break from the common narratives and think of alternatives. Even if the contrary thinking isn’t right, it does help to avoid sleepwalking into the future -- especially when it comes to the mostly widely held beliefs, where history tells us the biggest surprises come.
Rob Arnott of Research Affiliates recently reminded Barron’s readers that it once looked like the 10 biggest stocks during the technology boom of 2000 could do no wrong, but they then went on to deliver, on average, negative returns for the next 19 years. His pithy reminder: “People forget that disruptors get disrupted.”
So if we look at the world today, what are some of the mostly widely held narratives where we might want to think alternatively? One is the ascendancy of U.S stocks – and especially the largest ones – which have trounced the rest of the world. U.S. stocks have had a golden era over the decade since the financial crisis. But as Ben Inker of investment manager GMO said in his last quarterly letter, it hasn’t been all U.S. stocks. It’s been the largest – perhaps because of increasing industry concentration. Small companies haven’t done as well.
Inker thinks the environment that gave rise to U.S. large-cap stocks can’t continue, and that going forward, they’ll be among the worst performing assets. His favored asset class? Emerging markets – especially emerging market value stocks. In other words, the worst will become first, as GMO’s 7-year forecast shows below. Interestingly, Rob Arnott also expects emerging market stocks to be the highest-returning asset class of the future, while U.S. stocks and U.S. bonds will be the worst.
And speaking of U.S. bonds, that’s another area where most of the world seems to be crowded on one side. Bonds do great in periods of low inflation or deflation, and that’s what we’ve had for a long time – along with an incredible four-decade bull market for bonds.
But can it continue? It’s hard to believe it can go on forever. It’s true that there are some powerful long-term deflationary forces: Population growth is declining (thereby lowering growth), and technology and the wizardry of businesses like Amazon are all massively deflationary. But it would be wise not to write off inflation altogether, contrary though the thought is. For one thing, if unemployment in the U.S. persists longer, wage gains could take off. Regulation of big tech also could throw some sand in the wheels of deflation. And of course, there are tariffs. Anything that is de-globalizing and fractures the world’s supply chains into regional ones could lead to higher prices.