The price of 'real assets' (real estate, commodities, collectibles) relative to 'financial assets' (stocks & bonds) are at their lowest since 1926, and, as BofAML's Michael Hartnett suggests "buying humiliation and selling hubris" as investors are being forced to discount higher inflation and interest rates, as protectionism & redistribution themes are also aimed at boosting Main Street at the expense of Wall Street.
The Case for Real Assets
Our themes of “peak liquidity”, “peak globalization” & “peak inequality” (link) argue for small absolute returns from financial assets but big rotations across markets (Table 1).
The 2016-2017 policy flip from QE/ZIRP/NIRP to less monetary stimulus & more fiscal stimulus reflects rising political pressure to reduce wealth inequality. The protectionism & redistribution themes are also aimed at boosting Main Street at the expense of Wall Street. So investors are being forced to discount higher inflation & interest rates. And inflation is indeed moving higher: China’s PPI turned positive in September for the 1st time since 2012.
Policy, profit & positioning trends all argue for rotation from "deflation" to "inflation", from "ZIRP winners" to "ZIRP losers", from Wall Street to Main Street. As part of this rotation we expect real assets to outperform financial assets.
5 Reasons to buy Real Assets
1. Buy Humiliation, Sell Hubris: price relative of real assets (real estate, commodities, collectibles) to financial assets (stocks & bonds) at its lowest level since 1926; US stocks close to all-time highs versus US house prices; US bonds at all-time highs versus diamonds ; 10-year rolling return from commodities lowest since 1933.
2. Peak Deflation: real assets positively correlated with inflation; stocks & bonds negatively correlated with inflation; central banks are withdrawing stimulus as deflation fears subside; real assets hedge against inflation & monetary tightening; real asset relative performance has 82% correlation to Fed funds rate since 1950.
3. War on Inequality: commodities, real estate & infrastructure are natural beneficiaries of a “War on Inequality” waged via fiscal stimulus.
4. Cheap Value: real estate (REITs 3.3%, timber 2.6%, agriculture 2.6%) & infrastructure (3.2%) are higher yielding assets than global stocks & bonds.
5. Positioning: Asset allocation to real assets is low but on the rise (just 8.2% of total ETF market cap is exposed to real assets; pension fund up from 9% to 24% past 15 years).
Real assets are generally defined as tangible assets with intrinsic value that are far less liquid than financial assets. Our index of Real Assets tracks 3 broad categories:
- Commodities (precious metals, industrial metals, oil, agricultural commodities)
- Real Estate (US/UK residential property and farmland, i.e. not REITs)
- Collectibles (wine, art, diamonds and cars)
We have collated data on these assets back as far as 1920’s. Below we show their performance and volatility in comparison with US financial assets since 1950, 1980 & over the past 10 years (Table 2).
Note that infrastructure is also a real asset, but is excluded from our index due to its shorter time series as well as the fact that the value of infrastructure can only be measured by the value of companies that derive their value from infrastructure projects (and these companies are of course financial assets). The table shows that while real assets have been competitive performers since 1950, real asset price performance has suffered somewhat under the disinflation since 1980, and have really suffered relative to stocks & bonds in the deflation of the past 10 years.
Below we support the case for real assets with charts & data.
Buy Humiliation, Sell Hubris
The long-run price relative of real assets (real estate, commodities, collectibles) to financial assets (stocks & bonds) is currently at its lowest level since 1926 (Chart 2). Note that bull markets in real assets have coincided with war & major fiscal stimulus programs in the 1940s, the rise of inflation in the 1960s & 1970s and with 9/11 & China accession to WTO in the early years of this century.
Unprecedented monetary easing since the Global Financial Crisis has caused the prices of financial assets to soar, while real assets have lagged the appreciation. Other examples of the extreme outperformance of financial assets: US stocks are very close to all-time highs versus US house prices (Chart 3); US bonds are at all-time highs versus diamonds.
And as noted repeatedly this year, commodity returns are at multi-decade lows: the long-run return from commodities sank to -6.1% earlier this year, the lowest return since 1933 (Chart 4).
Investors should always buy humiliation and sell hubris: today the humiliation is very clearly commodities, while the hubris resides in fixed income markets.