Add Jeremy Grantham to the (small) list of observers who believe the stock market is expensive. However, the chairman of global asset manager GMO believes that “these overpricings can go much further.”
In other words, stocks could continue to rise and become even more expensive – but keep an eye on the exits. Here, Mr. Grantham provides some helpful indicators to watch for.
“A clue to timing would be when we begin to hear more passionate new era arguments: profit margins will always be higher; growth will snap back to 3 per cent for the developed world; and new ones I can’t think of … maybe ‘when the discount rate is this low the Dow should sell at, perhaps, 36,000,’” he said in his most recent quarterly investment letter.
In the meantime, the risks of staying heavily exposed to stocks for too long might outweigh the potential rewards because valuations should – in theory – weigh on expected returns.
GMO believes U.S. stocks (not including so-called “quality stocks” that have low debt and stable earnings) are valued at a level imputing negative returns over the next seven years. As well, most global growth stocks are priced with an expected return that is close to zero. Emerging markets, Japan and European stocks look better, but are still moderately overpriced.
As for fixed income, Mr. Grantham is resolutely bearish: “Fugetaboutit! Most of it has negative estimated returns on our data, and longer debt, as always, carries [the] risk that may be slight in any period, but is horrific if it occurs – accelerating inflation.”