James Montier and GMO are known for their conservative, cautious approach — a mindset that has helped the firm often recognize market and economic problems well ahead of others. So, what scares Montier right now? The lack of assets offering a “margin of safety”.

“I just can’t find any assets that have a particularly high margin of safety,” Montier tells Advisor Perspectives. “There is nothing that reaches out and screams, ‘Hey, I’m really undervalued.’ Therefore, you are in this situation where you’re stuck in this kind of foie gras market where you’re being force-fed risk assets. That is a very uncomfortable position to be in.” Montier says you have to balance that against the idea that we are in a period that is very different from the past, in that central banks are keeping rates extremely low. That means building a portfolio that can withstand potential rate hikes, and which can also survive if rates remain low for a long while more — no easy task.

“You have to recognize that this is the purgatory of low returns,” Montier says. “This is the environment within which we operate. As much as wish it could be different, the reality is it isn’t, so you have to build a portfolio up that tries to make sense. That means owning some equities where you think you’re getting at least some degree of reasonable compensation for owning them, and then basically trying to create a perfect dry-powder asset.”

Montier talks about how to create that perfect dry powder asset in an environment in which it is not naturally occurring. He also discusses why he thinks profit margins are going to revert to their mean, and why criticisms of the 10-year cyclically adjusted P/E ratio are off base.