William Bernstein: Be Open To New Factor Tilts

July 02, 2013


IU.com: So how do you see this playing out? Is there a possibility of a relatively serious inflationary episode playing out?

Bernstein: It’s always possible. The bottom line is that there will be inflation when the money supply grows dramatically, and that’s not happening. And the reason it’s not happening is that all the money that’s being printed by the Fed that’s growing rapidly is pretty precisely balanced against the collapse of credit—the bank money, which is the vast amount of money that’s in circulation at any one time, of course.

IU.com: And how that resolves is not yet clear, is what you’re saying?

Bernstein: I could tell you that I knew, but I’d be lying. We’re in terra nova. I don’t think anyone really knows the answer to this and how it plays out. And if we get inflation, the real question is, How does the Fed respond? If we have someone with Paul Volcker’s iron will, then we have nothing to worry about. We get tight money, which is good for investors—especially fixed-income investors, short-term fixed investors, I should say. And it’s good for the economy in the long run. And if we get someone who’s weak-willed—an Arthur Burns—then we’re in trouble.

IU.com: You’ve talked about making peace with Treasury bills in the here and now. Is that still how you see the fixed-income portion of a portfolio at this juncture, when there seems to be signs of some sort of reversion to the mean?

Bernstein: This reversion to the mean is basically at the middle part of the yield curve. Long rates haven’t increased that dramatically, and short-term rates haven’t budged at all because the Fed is still holding the basketball under water.

IU.com: I can hear some people saying, “Don’t be so sure this basketball is going to rush to the surface.” This financial repression may well be with us for longer than many of us think, and that even after the events of the last month, when the Fed has changed its posturing, you can still hold your breath. What do you think of that?

Bernstein: I think it smacks of “This time it’s different.” And sometimes things are different. And things have been different in Japan in the past 20 years. But I don’t think we’re Japan. I think we’re better at cleaning our books, writing things off. The reason I think Japan has suffered such a prolonged period of deflation is because it hasn’t recognized its bad loans.

IU.com: That still remains the case, is what you’re saying?

Bernstein: Yes.

IU.com: So, short-term T-bills remain appropriate on the fixed-income side, and on the equities side, would you hew to the classic broad-market passive investment frames of reference you’ve long embraced?

Bernstein: Yes, but I’ve always believed in factor tilts. And there are some new factors. There’s profitability and momentum, and I think those will hold a premium in the future.



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