Jeremy Grantham, chairman of global asset manager GMO LLC and one of the world’s most respected market commentators, acknowledges that it is exciting for asset allocators to work within an environment where all assets are badly mispriced. The opportunities for either avoiding expensive investments or loading up on cheap ones! Unfortunately, today’s environment doesn’t yield such opportunities. He argued in his latest note to investors that the majority of global equities are close to fair value – with one very notable exception: The S&P 500.
Mr. Grantham, who likes to look at longer-term return forecasts, estimates that the broad U.S. equity index has an imputed annualized return of about 1 per cent over the next seven years, after factoring in inflation, which is awfully close to dead money. Worse, strip out high-quality stocks – companies with low debt and stable earnings, which have a reasonable estimated return of 5.5 per cent over the next seven years – and the rest of the index is expected to deliver a slightly negative return.
“The rest of the world’s equities were (when I sat down to write this in January) on average slightly cheap at close to 7 per cent [after inflation] so that non-U.S. equities plus U.S. quality stocks offered a slightly higher average return than normal (a normal mix is about 6.1 per cent real),” Mr. Grantham said in his note.
“This is not exactly whoopee time, but compared to the typical overpricing of the last 20 years, it’s not bad at all.”
But the biggest so-called opportunity? Avoid fixed income, particularly developed-market bonds and especially U.S. bonds, which have been the go-to investment during turbulent times recently.
As he explains: “In some markets like the U.S. and the U.K., the long bonds can be so murdered by inflation that holders should end up concerned about return of capital and forget about being paid for the risk. On the plus side, if economies collapse, the bonds with some duration may protect your money in the short term. This is a trade-off between possible short-term safety against probable long-term risk and negative return.”