Stattman says that looking at Shiller PE as a measure, for instance, the S&P 500 is currently trading near 25 times earnings where historically it trades at 16 times earnings. This is an overvalued market that could decline. Furthermore, particularly given many countries, both developed and under-developed, have unsustainable social contract, offering too much in terms of benefits, this could lead to lower pension returns, Stattman said during a panel at the Morningstar Conference in Chicago today.
“We could see interest rates rise a good deal over the next several years,” Stattman said.
“Interest rates will eventually need to rise, and some is priced in,” said Inker. “We can see interest rate rises without freaking out the market.”
Inker vs Stattman on volatility
Inker wonders how much of the market is influenced by “artificial pressure caused by QE?” He doesn’t know the answer, but we could find out in the near future with a potential bubble in bond prices.
Inker worries about liquidity risk in bond markets. “Will liquidity be there when we need it?” he asks, not knowing the answer but noting that liquidity has been dropping. Inker has been selling short puts in his portfolio in an environment where implied volatility is low, but realized volatility is lower. Inker doesn’t like selling volatility in the US. His fund sells puts in EU and Japan where volatility is much higher. “Selling a put is taking the same risk as you do buying the stock market,” Inker said, a statement that some in the derivatives industry might disagree with. Selling puts can represent unidentified leverage risk.
Stattman and Inker on unfunded liabilities
Both participants expressed concern about the debt crisis and the unfunded liabilities that ‘have been promised to future generations’. “There is a demographic tidal wave we all know is there,” said Stattman, citing a historic bubble of people retiring in the next three to five years that creates a statistical payments bubble that could trigger a debt crisis. “This means we know we won’t get the benefits that we’re promised.” For his part Stattman is looking for political change to materialize, which would be preferential to having difficult decisions forced on the population without much warning.
“We have to break those promises to someone,” said Inker. “It would be nice if we could make those decisions early on because we will need some time to adjust. Sooner or later the hand gets forced. We are likely to face tough choices at bad times,” he said of the debt crisis and demographic entitlement bubble identified by economists such as Larry Kotlikoff.