Three good reads this weekend from Barron’s and the WSJ.
First, the Barron’s ETF Roundtable.
Next, an interview with Ben Inker at GMO, much of which resonates with our thinking:
What’s your current asset-allocation mix?
Our benchmark-free allocation fund is long only and built out of traditional assets, namely stocks, bonds, and cash. Right now, a little bit more than half of our money is in stocks spread across three basic groups: U.S. quality stocks, EAFE [Europe, Australasia, Far East] value stocks, which cover developed countries outside the U.S. and Canada, and emerging-market value stocks. Those are the only equities, when we look around the world, priced to deliver returns commensurate with the risks associated with equities. There is no reason to own international growth stocks or U.S. small-caps. However, figuring out whether we should be 52% in equities or 65% or 35% is a little harder.
How do equity valuations look?
Stocks are all priced more expensively than we’ve seen, on average, in history. So U.S. quality stocks have spent most of history looking more attractive than they do today, and it’s similar for international value stocks. They are still priced to beat cash and bonds. But depending on how quickly you think they are going to revert to historical averages—if you think they are going to revert at all—stocks may be more dangerous than normal.
Your firm, GMO, has been pretty bearish on U.S. stocks, even as they’ve had a big rally. What’s your take on that?
On one level, that is absolutely true—since the fall of 2010, we have forecast that the S&P 500 would have modest returns, and it has obviously done better than that. But we don’t necessarily consider this to be an error, in the sense that we know overvalued markets can get more overvalued before they come back to fair value. At any point where the market winds up overvalued, we will have underestimated the return over that seven-year period. Since our last completed forecast in September 2006, the S&P 500’s real annual return is 3.5%, versus the -0.6% we were forecasting. That difference can be completely explained by the fact that the S&P is trading at a high P/E [price-earnings] ratio on high profit margins. But a market that stays overvalued will outperform our forecast in the shorter run and underperform in the long run.
What are your biggest concerns with the stock market?Our problem is not strictly that it has gone up. Our problem is that the S&P 500 is up this year about 25% or 26% on earnings that are up 3%. So we’ve got a market that is rising because of P/E expansion. That would be OK if the market had started out at eight times earnings, but it didn’t start out there. So we have a market that is trading at an increasingly high P/E at a time when profit margins are already as good as we have ever seen. So the likelihood of strong profit growth from here is pretty dim. That’s a lousy market if the P/E is too high, profits are unlikely to grow strongly and all you can hope for is that the P/E goes up even more. We don’t like investing on that basis.are unlikely to grow strongly and all you can hope for is that the P/E goes up even more. We don’t like investing on that basis.
