GMO’s Montier: Bearish on Stocks but Bullish on Monetary Theory

In a recent interview with Barrons, GMO strategist James Montier shared his concerns about the U.S. stock market and his bullish view on modern monetary theory (MMT), which he has found to be “good model for governments’ interactions with the market.”

Here are some highlights:

  • Montier breaks MMT down into the following components:
  • “Money exists because it’s created by the state. The U.S. dollar has value because you have to pay taxes in it.”
  • “If a country issues debt in its own currency and has a floating exchange rate, it is monetarily sovereign and can’t be forced to default on its debt.”
  • “Bankers make a loan, then gather the deposits to offset it, or go collect reserves.”
  • “MMT is aligned with functional finance, which simply says fiscal policy should aim to generate full employment rather than a balanced budget.”
  • Although MMT is often accused of ignoring inflationary pressures, Montier says the theory is “very clear about the binding constraints on spending: You don’t have endless supplies of people, machines, factories, and at some point, you push demand above productive capacity. That creates inflation.”
  • Private debt matters. “A household can’t print its own money. Therefore, it needs to be able to repay debts.”
  • “In macro-accounting, the government’s debt is actually the private sector’s asset.”
  • Among those that criticize MMT, Montier argues that economist Larry Summers has been the most hypocritical, citing contradictory comments he made regarding the ability of governments to create new money to pay debt. Montier says of Summers: “he was the most intellectually dishonest of the various critics that I saw.”
  • MMT sheds light on global markets, according to Montier, because “cash and bonds are not vastly different instruments, right? Bonds are really just deferred cash. You are paid a premium for your willingness to hold them.” He adds, “Fiscal deficits are actually good news from an equity point of view… This is interesting and not widely understood.” Even so, he points out, the pricing of the U.S. stock market is “pretty damn extreme.”
  • Montier cautions against confusing labor productivity with innovation: “Calling it innovation is shying away from the important question, which is, why the hell have wages been so damned slow and low for so long?” He describes an “unhealthy combination” that now exists in which the manufacturing and information sectors are strong, but construction and health care have seen no productivity or wage growth. “It’s one of the more distressing aspects of the economy today,” he contends.
  • Although earnings per share are widely considered to be strong, Montier says the data shows that they are merely tracking GDP because of “massive buybacks.”
  • “Half of the outstanding corporate debt is now rated the lowest investment grade,” says Montier, “which really is quite worrying. At some stage, we’ll encounter a downturn. As an equity investor, you’re junior to this paper that needs to be paid.”
  • On his bearish view of the U.S. stock market, Montier points out: “The market should trade on a cyclically adjusted price-earnings measure of about 171/2 times, not the 28 times the S&P 500 trades at today. The U.S. market remains far and away the most expensive market in the world.” He adds that when “things are priced to perfection, any shortfall leads to rapid repricing. It’s second-guessing the herd.”
  • Regarding how investors should be positioned, Montier argues, “it’s incredibly hard to build portfolios today,” but adds that emerging market shares hold appeal because of their pricing. “They’re hairy, they’re scary, they’re often terrible companies in terrible countries, but they trade on single-digit P/Es, which makes for a big margin of safety.” He concludes, “with the world so damned expensive today, you have to own quite a lot of dry powder.”