This article is part of Morningstar's special report on What the Experts Say
The introduction of modern monetary theory (MMT) will lead to inflation returning with a vengeance and, therefore, an inflection point for stock and bond markets, according to Jonathan Ruffer, chairman of Ruffer LLP.
Hitherto a fairly fringe, left-wing idea in economics, MMT has been gaining traction in recent months with Democratic senators Bernie Sanders and Alexandria Ocasio-Cortez extolling its virtues.
MMT is the idea that a Government can spend large amounts of money in order to stimulate its economy without worrying about the resulting large piles of debt because it can print more money to pay the interest.
Ray Dalio, a hedge fund manager at Bridgewater Associates, said on LinkedIn recently it was only a matter of time and warned it would lead to hyper-inflation in the US.
Indeed, Ruffer expects central bankers to “do everything it takes to keep the economy going” and politicians will shun austerity and start to spend money. “MMT is absolutely the traditional way that money loses its value,” claims Ruffer.
This will lead to a sharp rise in inflation, which most now consider a thing of the past due to its quiescence in recent years, which is something Ruffer says he’s “been banging on about… certainly for six or seven years”.
Speaking at the Morningstar Investment Conference 2019, Ruffer said this moment in time feels like “an eve of battle moment”, similar to those that came around before the 2000 dotcom crash and 2008 great financial crisis.
When it will happen, Ruffer insists he does not know, but whether it comes tomorrow, next month or next year, the duo of Morningstar Bronze-rated mandates his company runs will benefit.
Inflation-Linked Bonds the Place to Be
The two largest holdings in both the LF Ruffer Total Return fund and Ruffer Investment Company (RICA) funds are long-dated UK inflation-linked bonds that mature in 2068 and 2062, accounting for 9% and 13% of each portfolio respectively.
While Ruffer says they’ve been “terrific performers” for the funds, the resulting underweight to equities has seen both well underperform the MSCI World in both 2017 and 2018. In the former, Ruffer’s offerings returned 0.9% and 1.2% compared to 11.8%, when converted to sterling, from global equities. Last year, Ruffer lost 6.5% and 11% compared to MSCI World at 3%.
But that doesn’t faze Ruffer, because if history is any guide – which, of course, it isn’t always – the funds should thrive when the market is falling sharply. And Ruffer thinks his funds’ track record means “people have been afraid to bet against us”.
In 1999, for instance, when most funds were packed full of unprofitable technology stocks at the height of the dotcom boom, Ruffer lost 0.2%. The following year, the market halved but Ruffer was up 30%.
Similarly, in 2006 and 2007, the team saw that the world was loading up on debt and borrowing money in both Swiss francs and Japanese yen. So, Ruffer’s portfolio moved into those so-called safe haven currencies, which at the time were slipping in value on a daily basis.
When the inflection point came in 2008 – what Ruffer calls “our clever-clogs moment” – Ruffer was up 35% as the market tanked. “This feels like an absolute replay of what followed 1999, what followed 2006/2007,” he says.
“Every now and again, tomorrow’s newspapers turn up the day before, and I think now is one of those moments.”
The Investment World is in Crisis
On market thoughts, Ruffer claims “the investment world is in crisis”, thanks to its myopic concentration on a handful of large, blue-chip S&P 500 stocks like the FAANGs. While he doesn’t necessarily think stocks are expensive, he says they’re certainly trading on a valuation which nothing short of an indefinite bull market would justify.
On a price/earnings basis, which Ruffer does not think is an accurate gauge of value because one can fudge earnings, the market was trading on just seven times when he came into the investment world in 1979; today it’s on around 20 times.
Both price/book and price/sales are the better ratios, Ruffer counters, because companies can fudge neither the value of its assets, nor its sales figures. Still, at 3.3 times price/book, the market has only ever been higher during the dotcom boom. A price/sales ratio of 2.1 times, meanwhile, is well past the level Ruffer was taught to sell at, which is around 1 times.
The worry is that much of the uptick in US stocks’ earnings per share metrics has been gained through share buybacks, rather than companies increasing earnings. “One can see that if a company [has the same sales] as it did last year, but with fewer shares, that’s very good for earnings per share,” Ruffer explains.
Buying back stock has been very easy and very cheap for US companies over the past decade, with interest rates having stood at all-time lows ever since the financial crisis. “And you make more money by doing that and just reducing the number of shares than you do by going out and building a factory,” says Ruffer.
So, the bull market in both earnings and share prices, which has become “super-charged” in recent times has been based on “smoke”, and Ruffer expects it will not continue.
