We're, 'working diligently to make sure that we’re well-protected against inflation': Research Affiliates CIO

Research Affiliates CIO Chris Brightman joined Yahoo Finance Live to break down what U.S. Secretary of the Treasury Janet Yellen's comments on needing to raise rates to prevent the economy from overheating means for the broader market and investors.

Video Transcript

- We want to bring in Chris Brightman. He's the chief investment officer at Research Affiliates. And Chris, looking at the action today, the pressure really being felt in the NASDAQ, with that index off over 2%, of course, is being spooked by the comments that we got from Secretary Janet Yellen earlier today, saying that we may need to raise rates in order to prevent the economy from overheating. How are you viewing these comments and what it could potentially mean for the market?

Chris, it looks like you might be muted.

CHRIS BRIGHTMAN: Apologies. Life with-- life with Zoom.

- I do it all the time. I do it all the time. No worries.

CHRIS BRIGHTMAN: I was just going to say, let's put a little bit of context here and note that the valuation gap, the difference in pricing for value stocks versus growth stocks, and of course, the fangs are the highest flying of the growth stocks, is almost unprecedented levels. So we go back a few months and we were literally at the largest valuation gaps ever seen.

We've retraced a little bit of that, but we still have, by historical standards, enormously wide gaps. So the ability for banks and for energy companies, and for cyclical stocks and smaller stocks to outperform the Fang stocks is just enormous. We have a long way to go before we even bring those valuations into normal territory. So that's one way to think about it.

And the other is what's going on with politicians coming after where the money is. I mean, where there's an effort underway to greatly increase the scope of government spending in the United States. In order to do that without inflation, we have to have tax revenue. Please, go ahead.

- And that's why I wanted to jump in. I just wanted to point out, though, when you talk about the energy stocks, we're going to talk about ExxonMobil. We can't be real careful with energy, right? Because I mean, if you at Royal Dutch Shell, it has not recovered. So there's a long way to go for oil stocks. But when we talk about government coming after revenue via taxation, you actually make a very easy to follow argument that investors should pay attention to regarding the United States and how much tax revenue versus Europe and tax revenue. Help us as investors understand what's coming down the pike.

CHRIS BRIGHTMAN: Sure. So in very rough terms, the United States collects about 30% of GDP in revenues, tax revenues from all levels. State, local, and federal. And Europe, most of Europe, collects far more. Say 55% in France and Belgium, and maybe 45% of GDP in Germany and Holland. And with that much greater revenue, they provide a much more generous set of social spending. And in theory--

Well, first let me just talk about the politics. The politics are that younger generations throughout the world, but also notably in the United States, are in favor of greater government spending. And empirically, you ask the question, could we go up from 38 to 48% of GDP in tax revenues? And the answer is, of course we could. But how you would get there is, I think it almost has to be a form of a value added tax. I have no problem with wealthy people paying their fair share and paying more than they do. I just doubt as-- not about matter what I want to happen, but just empirically, there's no country that manages to collect nearly 45% or 50% of GDP in tax revenues without a very large consumption-based value added tax.

And so I think we can try to collect a little bit more and some wealth taxes and raise the capital gains tax rate, but I think that's not going to do it, and we're going to see politicians looking for where the money is. And if you look at the cash flow being generated by companies like Google and Apple and Microsoft, that's where the money is.

- Well then, Chris, with all of that taking into account, the fact that we're facing higher taxes, the fact that there's fears of inflation, now have the comments from Secretary Yellen today. Are you changing your strategy at all as a result of this? Well, we're already, as value managers, we're already pretty well positioned. We've had a fabulous six month run. And as I say, while the valuation gaps aren't quite as large as they used to be, they're still enormous, and there's an awful lot of opportunity for that to run.

CHRIS BRIGHTMAN: One thing that we are doing is working diligently to make sure that we're well protected against inflation. It's no surprise, I think, that you see people everywhere scrambling to borrow money to buy real assets. Look at what's going on in the housing market. That's the sort of trade you probably need in your liquid portfolio, as well, to protect against the risk, not necessarily going to pan out, but the risk that we don't collect enough taxes and we do have a bit of an inflation problem in the years to come.

- All right, Chris, always great to get your perspective. Chris Brightman, chief investment officer with Research Affiliate.