Rob Arnott, Research Affiliates founder and chairman, joins Yahoo Finance Live to discuss inflation and how upcoming readings may be misleading, tech stocks, and the market outlook.

Video Transcript

JULIE HYMAN: I want to talk about where people might be seeing values in this market right now. And for that, we want to bring in Rob Arnott, Research Affiliates founder and chairman. Rob, it's great to see you. The sort of elements that have been dominating the market as of late, inflation, and to a lesser extent, or should I say, to a fading extent, Ukraine. Let's talk about inflation a little bit, first of all, because I know that you've been examining that issue. And I'm curious if there are things that people aren't fully appreciating or fully examining about the question of inflation.

ROB ARNOTT: Absolutely. One of the things about inflation that's interesting is that there are a whole array of components to it, some of which are inherently smoothed and lagged. Roughly 1/3 of inflation is shelter. That consists of home ownership or renting or home away from home, hotels and motels. And last year, we saw hotels and motels up over 20% in terms of inflation. Well, that's a market rate. Home ownership, which is much, much, much bigger, is not counted in CPI as the value of a home. Homes were up 19% last year and up 32% in the last two years, 2020 and '21 combined.

Now what the BLS does with home ownership is to ask, what would the home rent for? Now if you're a homeowner, you typically don't know. But they survey thousands of homeowners, and they ask a very simple question, what do you think your home would rent for? Now, if you're like me, I have no clue. And so I would just pick a number out of the air. Now if you pick a number out of the air, and you're asked again a year later, you're going to say, what did I say last year? Last year, I said 4,000. OK, I'll say 4,100.

Now, it's still a guess, and it anchors on the past. So owners equivalent rent in 2020 and '21 combined went up only 6%, while the value of homes went up 32%. Where is the remaining 26%? It trickles into CPI over the next two to four years with a lag. So there's 1/3 of CPI shelter, which is likely to come in at high single digits at best over the next two to three years. So this is not transitory.

There's another thing that's often not understood, and that is, every month, when we see a CPI report, we're adding a new month, and we're dropping an old month. What's the old-- how did we go from 7.9 to 8.5? We dropped to 0.7 inflation for one month and replaced it with a 1.3. The next three months were going to be replacing months that are 0.8, 0.8, and 0.9. Big inflation last year in the second quarter. And so we're going to see an illusion that inflation is subsiding and receding, followed in the summer by an illusion that inflation is breaking out because we're replacing low inflation months, 0.5, 0.3, and 0.2.

So as we replace those months, we're going to see inflation seemingly recede and then take off. Now, 99% of financial professionals don't understand these nuances on inflation, including a lot of Fed watchers. And yet, they're very real and they're very simple. This is not transitory.

BRIAN SOZZI: Rob, I always enjoy-- switching gears a little bit, I always enjoy talking value investing with you. Since we last spoke, we've seen a real just dive in big cap tech stocks. As you zoom out, do these stocks represent good value here?

ROB ARNOTT: No, no. What we're seeing is the bursting of a bubble. This-- 2020, in many ways, resembled 2000, the tech bubble. During the tech bubble, six of the 10 largest market cap companies, most valuable companies, in the world were tech. In 2020, it was seven out of 10. At the beginning of this year, it was nine out of 10. So unless tech is going to supplant everything on the planet, that's a bubble. It doesn't mean every stock in that top 10 is in bubble territory. It just means that collectively, they can't all succeed to the extent that's baked into their prices.

I debated Cathie Wood last fall at the big Morningstar conference on, are there bubbles? And I posed a very simple question to her-- how do you justify a target of $3,000 for Tesla? She said, well, we're-- it's going to grow at 89% a year the next five years. And then at the end of five years, it'll be priced pari-passu with today's FAANG stocks. OK, 89% a year, that means 25-fold growth in just five years. Amazon grew 14-fold in the past 10 years in stupendous growth. So, in effect, she was assuming that Tesla would achieve twice as much growth in half as many years as Amazon. Implausible, and therefore, a bubble. So I look--

JULIE HYMAN: Well, Rob, if I may, leaving Tesla aside for a moment, I mean, Tesla shares have actually held up pretty well. A lot of this other stuff, though, we've seen the stocks fall quite a bit. So you said not all of them are in a bubble. Are you finding value within the tech sector right now? And if so, by what measure?

ROB ARNOTT: No, the tech sector is stretched by any measure. I view Apple, for instance, as being priced for aggressive assumptions leading into the future, but not implausible assumptions. Very possible that the growth will justify the price. Not so for Tesla, Facebook, Netflix, Amazon. A lot of these are priced for implausible long-term growth. And that means you turn attention to value. Value is pretty cheap in the US, even now, after recovering quite drastically in the last few months and even more so in international and emerging economies. And emerging economies value is really, really, really cheap.

BRIAN SOZZI: Always great to get some time with you. Rob Arnott, Research Affiliates founder and chairman, we'll talk to you soon.