For a long time Dr. Antti Ilmanen felt like the boy who cried wolf. Investors have enjoyed more than a virtually uninterrupted decade of market gains. But in the opinion of the co-head of the Portfolio Solutions Group at AQR Capital Management, valuations were only getting richer and richer. Year after year the diversified investor has received a positive return. Year after year, the traditional market valuation metrics continued to rise and, consequently, the potential returns decreased.
Ilmanen points out, for example, a classic indicator, the Shiller P/E. 10 years ago the PER of the US market was 20 times earnings. Already above the historical average. But it is that at the peak of the euphoria last year it reached 40 times profits. “What people didn’t realize was that we were slowly storing up the problems for the future“, it states. “The demanding valuations were always a problem, they just kept getting fatter and fatter.”
Without realizing it, the investors signed a contract that compromised their future returns based on the image shown in their rearview mirror. The annualized returns have been juicy, but they masked, in his vision, the revaluation of the prices and the increasingly low potential returns. Until 2022.
And so, we arrive at the scenario that Ilmanen poses in his latest book: Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least. Investing in a world of low expected returns: doing the best when the market offers less. This is the sequel to the book. Expected Returns: An Investor’s Guide to Harvesting Market Rewards, published in 2011. More adapted to the current context. And the truth is that the expert could not be more successful with the timing of the market. When he was facing the first lines of the text, the market was immersed in full euphoria over the discovery of vaccines against covid-19. Now that the publication reaches readers, the tone is very different.
The Slow Suffering vs. Fast Suffering Theory
The investor has enjoyed years of prosperity but now the time has come to face the problems of the past. “The question of how and when central banks would step back has always been up in the air.. That point has finally arrived”, insists Ilmanen. And he has done it hand in hand with an inflation that the economy has not experienced in decades.
The expert insists. This correction was unavoidable. We knew it would come, that it was necessary. The question was whether it would be a slow or fast suffering. Now we know that it was the second case. Fixed income has seen the first impact, but as Ilmanen remembers, the markets are connected. The public and the private. Eventually, he asserts she, these declines will hit the housing market. We may even be seeing it at some points in global real estate.
but this is a global story, in his opinion, so the wave will end up shaking everything. “It reminds me of the mythical scenes of the coyote in the roadrunner cartoons. When he runs so fast that he hangs in midair. There are many markets at that point. They seem to be holding on, but they’re just waiting for gravity to do its thing.“, bill.
Finnish philosophy to be happier
But Ilmanen also has a second message. In fact, it’s the one he’d like readers to stick with. And it is that, there is a second face to this strong correction. Now the valuations start from a more reasonable point and the euphoria has tempered. Namely, investor expectations have been rationalized. And in the expert’s opinion, that’s good news. “Do you know why Finns are said to be the happiest? Because it’s part of our culture to have low expectations,” he jokes.
In his opinion, it is the philosophy with which the first half of 2022 should be approached. Even if bond yields and risk asset valuations are still above the long-term average. “The investor must accept reality and turn the page. In the long term, it is still the best option to take risk in the market”, she insists.
What would you recommend to the investor in this context? Don’t be complacent, but don’t throw in the towel either. In his opinion, there are assets that still offer diversification. It is a subject that he touches on in depth in his book. For example, illiquid assets and investment by styles.
What would you recommend to the investor in this context? Don’t be complacent, but don’t throw in the towel either. In his opinion, there are assets that still offer diversification. It is a subject that he touches on in depth in his book. For example, among different diversification alternatives, Ilmanen favors style investing (such as trend and value strategies) over illiquid assets.