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Investors should be worried about inflation expectations becoming untethered, stocks and bonds crashing: CIO

Chris Brightman, Research Affiliates CIO joins the On the Move panel to discuss the markets response to inflation.

Video Transcript

- Let's start with the markets, though, and whether we should be concerned about inflation. We've got the latest CPI figures coming out tomorrow. Chris Brightman is joining us now. He is the CIO at Research Affiliates. And you are concerned about inflation, Chris. Right now we're seeing inflation trade below 2% And I guess I should ask you first of all, what figures do you pay the most attention to when it comes to inflation? Are you looking at core? Are you looking at the headline? And why are you so concerned?

CHRIS BRIGHTMAN: Well, as to what figures we look at, I try to look at all of them, both core and headline CPI, but also the Fed's preferred measure core CPE or-- having said that, a few tens of basis points difference between those two inflation measures CPI and core and PCE and/or fleeting differences of 50 basis points between the core and the headline numbers are not really what I think I or investors need to be worried about. It's a movement away from a stable rate of inflation around 2% up to 5, 8, or even double-digit inflation is the kind of event that will wreak havoc on investors' portfolios.

- When you talk about double-digit inflation, we always subtract things like food and energy. But that's what's going up right now. How much of a threat in simpleton terms for someone like me does that pose to a person who's trying to make intelligent investment decisions right now?

CHRIS BRIGHTMAN: Well, you know, the-- whether you're looking at the personal consumption expenditure deflator or CPI that's kind of a measure of a basket of consumption goods on average across the economy. All of us individually consume a different basket of goods.

So some of us worry about the inflation in college prices. And others of us maybe worry more about the inflation in, say, health care expenditures, depending on your age and family circumstances. But again, I think the problem that investors ought to be worried about is that inflation and inflation expectations become untethered. When that happens, both stocks and bonds crash.

RICK NEWMAN: Hey, Chris. Rick Newman here. Surely you're aware there have been many predictions of problematic inflation for the last many years, going back to the Feds starting quantitative easing in 2008 and 2009. All the government borrowing was supposed to cause inflation, and it hasn't. So what's different this time?

CHRIS BRIGHTMAN: Good question. I'll note that several years ago, I was writing to explain to investors why quantitative easing wouldn't and wasn't inflationary. Essentially, quantitative easing is just shuffling bank reserves for Treasury bills both paying about the same rate of interest. When you need to start being worried about inflation is when the government chooses the path of monetization to actually fund real purchases of government goods and services. And we're seeing that in a very large measure today.

But there's no reason to be concerned about the Treasury and the Fed getting together to send stimulus payments directly to people's bank accounts while we're in this present situation of disaster relief and the economy operating far below potential. What I worry about, though, is that our politicians learned the wrong lesson.

If monetization is a wonderful tool for addressing the problems we have today, why not solve other problems? Why not use it to solve the problem of inequality? Why not fund huge investments in infrastructure or climate transition using monetization? That's the path I think that leads to inflation.

And you know, we've heard, you know, very considerably from the progressive left endorsement of ideas like MMT. We've also got the chair of the Federal Reserve strongly endorsing another round of money printing to address the present problem. So I-- I just perceive that the risks of inflation in the out years are very elevated.

And the wonderful situation that we have today is a inflation hedging portfolio probably is a lot cheaper and has higher expected returns regardless of the policy environment given the very high prices we have for domestic stocks and bonds.

- What does that inflation hedging portfolio look like right now, Chris?

CHRIS BRIGHTMAN: Sure. So we have a business of providing asset allocation advice. And we create web tools and do a lot of research on this subject. And our capital market expectations, 10-year forward expectations for the returns of stocks and bonds and other liquid securities, suggests the return from a traditional 60-40 portfolio, say 60% S&P 500, 40% Bloomberg Ag, is going to provide returns in the low to mid-single digits not much better than inflation over the next 10 years.

But you can probably earn mid to high single digit returns with a portfolio similarly constructed of 60% risky assets, 40% lower risk assets, by increasing your diversification and particularly into asset classes that provide inflation protection.

To be very specific, I could suggest to be illustrative instead of 60% S&P 500, put 20% into emerging market equities, 20% into developed ex US equities, EFA to use a bit of jargon, and maybe about 10% each to REITs and commodities. And for the 40% allocation, instead of nominal core bonds, maybe split that between a 20% allocation to tips and a 20% allocation to emerging market bonds where interest rates are not 0 or negative.

- All right, Chris. Some actionable advice for folks out there. Really appreciate it. Chris Brightman is Research Affiliates CIO. Good to see you. Thank you.