Hilda Ochoa-Brillembourg, the lead founder and chairman of Strategic Investment Group, explains where the financial markets stand and what you need to know as an investor.
Where are we Now?
Sometimes the drama of big political events and market responses open up unexpected investment doors. About thirty years ago, with the Berlin Wall torn down and President Gorbachev announcing Glasnost and Perestroika, I was having dinner with Strobe Talbott, then the Russian specialist at Time magazine. It was a time of great historical change. Several years later, Francis Fukuyama would come out with his brilliantly written book, The End of History, a well-argued ode to the triumph of capitalism, democracy and free markets. I was not convinced that we had reached a steady state of rationalism and individual empowerment. Having seen already many market cycles, but very much as a passing even poetic thought I told Strobe “I view Gorbachev as the odd lot trader of capitalism”. Strobe, more a political philosopher than a market analyst, asked me to explain what I meant by that comment. I explained to him the odd lot theory. That is, that when orders for smaller, odd lots of stocks increased the markets are most bound to come down. Odd lot orders signaled the most marginal of investors are buying stocks in the small amounts they can afford. There are no more investors left to buy them.
The Swing of the Pendulum
It’s not that I thought we would not benefit from a peace dividend. I thought we would. It was more that I believed the political pendulum would begin to swing unambiguously into a free market framework for another 20 years or so and lead the way to anarchy. In my mind the historic shift triggered by the opening of global trade and the emergence of developing economies, what would be eventually called the era of the Washington Consensus or Pax Americana would create great world wealth, but I feared that the fall of communism, which had organized dissident groups into well-disciplined party bureaucracies, would leave those dissident groups unsupervised. Some of the newly freed players would do well. Others would not. Those that failed to do well in a free market regime would be the seeds of less organized, dissident groups to funnel their resentments and frustrations against free markets, individual political empowerment and competition. The inevitable outcome of high growth is income inequality, particularly among those far from the epicenter of growth. The 2007-2008 great recession was the final explosion. Fragile achievements and the hopes of many were squashed.
From Anarchy to Extremist Radicalism
We are now in the second half of that 20-year period of anarchy. Anarchy is not the best of systems. Far from it. The frustrations engendered by anarchical behavior is usually followed by “law and order” extremist demands and responses. Those extremist outbursts from the right and the left political spectrum are the tone and the state of our civil discourse today worldwide. How we will transition to a new era of peaceful, rational compromise; who will lead the process; I do not know. It will probably be a leader or group of leaders who speak truthfully and rationally to their constituencies, who outwit and outperform the bullies. But they will require constituencies who are willing to listen to complicated truths and take responsibilities for life’s uncertainties. We are not there yet. Maybe in another ten years. The leaders most likely will appear in the developed world, but I would not rule out their coming from Islam. I am always ready to be surprised.
Life is complicated. You never know what will happen politically or in financial markets. Valuations tell you an important story. The most important story. But the world also follows the tenor of human feelings and demands. There are wars, civil unrest, cybersecurity and trade risks, demographic imbalances. These obstacles could be overcome through good faith negotiations and persuasive, rational arguments. Eventually those will happen, but not without experiencing painful risks and losses.
You are Here
Where are we now? One of the funniest most unforgettable cartoons I have seen at the New Yorker, was the one showing a comatose, half naked man crawling through the desert sands, facing an X in a blank sign that said, “you are here”. As global investors we are not quite there. Equity valuations are high in the U.S., but much lower in Europe, Asia and the emerging markets. Fixed income is still expensive, but finally yielding a real rate of return, as well as some recession protection. Yes, both equity and fixed income markets could fall by 15-20%, but they are not at the level where the probable correction would be 30-50 % and lead to major failures. Where we were in 1998-99. Increasing interest rates produce corrections that might allow you to buy some cheaper stocks and bonds. And corporate profits continue to be at record high levels. That is the good and the bad news. Good because they can sustain current valuations. Bad, because they are more likely to fall than to continue at such high levels. And fall they will if trade negotiations do not lead us to lower tariffs and more free trade.
Broad global diversification and measured use of active risk-controlled trading strategies are a sensible way to approach these types of markets. These are markets in which you can produce modest but sustainable alphas. Beta risks have to be more diversified, and diversification is not overpriced. Not a bad investment outlook. I have seen much worse.
HILDA OCHOA-BRILLEMBOURG, CFA, is the lead founder and chairman of Strategic Investment Group and co-founder of Emerging Markets Management. A Fulbright Fellow and Fulbright Lifetime Achievement awardee, she received a Master of Public Administration from the Kennedy School of Government at Harvard and completed doctoral studies, all but dissertation, in Business Administration in Finance at Harvard Business School. Ochoa-Brillembourg served as Chief Investment Officer at the Pension Investment Division at the World Bank from 1976 to 1987 and continued as a Manager of the World Bank Pension assets until 1995. She is a lifetime member of the Council on Foreign Relations, an American Enterprise Institute National Council Co-Chair, the Committee for Economic Development Board, Harvard’s Kennedy School Dean’s Executive Council and Dean’s Alumni Leadership Council, and was a longtime member of the World Economic Forum. She has served in multiple public company and nonprofit boards, and she is the founder and chairman of the Orchestra of the Americas.