Grantham: Investment Outlook “Not Bad At All”

GMO’s Jeremy Grantham has released his fourth-quarter letter, and, while the often-gloomy strategist focuses a good deal on the troubling flaws of the existing capitalist system, his investing outlook paints a fairly attractive picture.

“The majority of global equities are within spitting distance (a technical term) of fair value,” Grantham writes. “Only the S&P 500 is materially overpriced, with an imputed return on our 7-year forecast of about 1% real, and because the high quality quarter of the S&P is priced to deliver 5.5% real (about a fair return), the 75% balance of the S&P has 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% real, 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% real). (Today, after a dazzling rally, the forecast for the same global equity mix has dropped by 1.1%, to very slightly expensive.) This is not exactly whoopee time, but compared to the typical overpricing of the last 20 years, it’s not bad at all.”

Grantham’s advice is to be heavily underweight U.S. equities, with the exception of the top quartile of high-quality stocks, which are close to fairly valued; be slightly overweight in other global equities; be underweight “as much as you dare” in long-term bonds, especially higher-grade sovereign bonds; and for the long-term look at resources in the ground, forestry, and farmland.

Overall, Grantham says to be about neutral on global equities. “Yes, there is more than our normal fair share of potential negatives lurking around, but on our data: a) most of the negatives are reflected in stock prices; and b) all fixed income duration is dangerously overpriced,” he says, adding that equities provide good long-term inflation hedges.

Grantham also offers a list of some broader advice for investors. Among them: “Be patient and focus on the long term”, and “Resist the crowd; cherish numbers only”. On the latter, he explains, “The best way to resist is to do your own simple measurements of value, or find a reliable source (and check their calculations from time to time). Then hero-worship the numbers and try to ignore everything else. Ignore especially short-term news: the ebb and flow of economic and political news is irrelevant. Stock values are based on their entire future value of dividends and earnings going out many decades into the future. Shorter-term economic dips have no appreciable long-term effect on individual companies, let alone the broad asset classes that you should concentrate on. Leave those complexities to the professionals, who will on average lose money trying to decipher them.”