Non-us equities offer the best opportunities, says jeremy Grantham
The bear market in US equities could easily have a further seven years to run, according to GMO chairman Jeremy Grantham. He is advocating overweight positions in non- US equities ex-Japan believing they offer the best arbitrage opportunities.
Within US equity markets, the S&P remains overvalued despite falls over the past three years, he added. Grantham, co-founder of global investment group GMO, said based on valuations, fair value for the S&P 500 is around 6,700 rather than the current 9,000 level.
P/Es, now at around 22 times, will eventually revert back to a mean of around 14 times, Grantham said, necessitating a further large fall in the market. The market could continue to rally through the spring but the bottom has certainly not been reached, he argued.
Turning to historical bear markets, Grantham said it becomes clear all 27 identifiable bubbles in asset classes overshot on the downside before reverting to the mean. This includes the S&P 500 in the 1930s and early 1970s and the Japanese markets in the 1990s. If the current bear market follows such a trend it has further to go.
Setting aside historical comparisons, Grantham said there is a great deal of uncertainty among investors who have yet to fully grasp the unrealistic nature of their assumptions for earnings growth, sales growth and profit margins. He believes it has become clear there is systemic over-statement of earnings in the US. The current stated level is around 5.8%, which he described as ludicrous. IRS estimates show a much bleaker picture of crushed earnings, he noted.
Nervousness also persists over quality of analyst research, the practises of investment banks, the quality and honesty of US executives, terrorism, troubles in the Middle East and a generally difficult environment.
Grantham, who like Tony Dye called the overvaluation of the US market long before the bubble burst in March 2000 and consequently lost around a third of his clients, said the continued optimistic stances of most professional equity managers are disingenuous.
He added that a large number of equity managers and analysts privately believe the US market has further to fall but that is not what they are saying in public. He said career and business risk inhibits groups and individuals from speaking out for fear of being seen as eccentric, thereby inhibiting clients from investing or even losing them entirely. Over the next seven years, an annualised return of 0.7% in real terms is the best US large-cap equities can return, according to Grantham. US mid and small-cap equities by contrast can deliver around 4% annualised, he said. However, that compares badly to potential returns available from non- US international equities, both small and large-cap, especially in emerging markets.
GMO also favours emerging markets for fixed interest, with returns on US and international debt and inflation-linked bonds unspectacular.
Consequently, in its global balanced asset allocation mandates, the group is more than 26% underweight US equities compared to its composite benchmark. It is just under 10% overweight in international equities, with an overweight in bonds and the remainder in property instruments and global hedged equity.
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