It’s great to see the experts disagree on one of the fundamental approaches to investing: Whether to take a bottom-up approach and focus on the performance of individual companies, or take a top-down approach and focus on big things, like central bank policy.
The folks at GMO, the global asset manager, have always centred their quarterly investment letters on the big picture – looking in particular at stock market valuations and Federal Reserve policy, often with bearish conclusions. The latest release, where GMO’s chairman Jeremy Grantham has handed the investment outlook portion to Ben Inker, GMO’s head of asset allocation, doesn’t deviate from this approach.
“By keeping rates very low and taking government bonds out of circulation, the Fed is trying to entice investors into buying risky assets,” he said in his note. “The question we are grappling with today is whether we should take the bait.”
His answer: No. But he outlines the problems with this approach. If the Fed is pushing investors into stocks and GMO doesn’t want to be pushed, the alternatives – cash and bonds – aren’t attractive either.
“Today, stocks are expensive relative to our estimate of long-term fair value,” Mr. Inker said. “The trouble is, so are bonds and cash.” His solution is to underweight stocks, with GMO absolute-return portfolios having an equities exposure ranging between 48 per cent and 58 per cent, which is low.
But it is interesting to see that Eddy Elfenbein, the respected and widely followed blogger at Crossing Wall Street, takes an entirely different approach. In his latest note, released less than a day after the GMO note, Mr. Elfenbein rails against what he calls the 40,000-feet approach.
“One of the mistakes I often see is that investors try to invest from 40,000 feet above their targets,” he said. “By this, I mean they pay far too much attention to things like politics, season effects or the Federal Reserve.”
“I realize this will sound like heresy, but the Fed’s role in the movement of stocks is far, far over-rated. What’s more important is earnings and (to a lesser extent) valuations.”
He points to the success of McDonald’s Corp. , whose share price has risen over the past decade with its growth in earnings. And he notes that Home Depot Inc. has vastly outperformed rival Lowe’s Companies Inc. since the start of 2009 – when the overall stock market began to recover from the previous bear-market selloff – even though the two companies are very similar.
“Don’t mistake what I’m saying: Monetary policy is important but even if you knew exactly what the Fed was going to do, that should barely impact your investments,” Mr. Elfenbein said. “Most investors would be much better off if they ignored all the news about the Fed or politics. People need to believe that someone is in control of the market, and that someone must be in Washington. I hate to break it to you, but they’re not running the market.”