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James Montier is a strategist I admire at GMO. He is interviewed in Barron's today:
http://www.barrons.com/articles/coping-with-the-foie-gras-stock-market-1501305385.
(If you don't subscribe you can copy/paste the article title into your search bar and obtain access.)
As with the Bob Rodriguez interview posted previously, I thought that this would be of interest to the minority of forum participants who are value investors. As before, I know most of you are indexers and EMH-believers. I'm not trying to change your mind. Please carry on.
The Rodriguez post prompted mocking comments followed by insults traded back and forth. Folks, this is just investing, not politics and not religion.
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I agree with the general spirit of Montier's comments. That is, valuations are high across essentially all asset classes and thus prospective returns will be low. I don't think one should be dogmatic about when valuations are likely to fall (or how far they will fall). Montier seems unduly confident about a 7-year horizon to mean reversion.
He points out, "The U.S. market is at its second or third most expensive point in history," and "Nothing in the precepts of being a value investor tells you about the path or the timing. It just tells you about the final destination."
A study of history suggests that there will be large swings in valuation over time, and Montier states, "A sensible portfolio today has a sizable amount of dry powder: T-bills, bonds, TIPS [Treasury inflation-protected securities]. You have to say: “Look, I know cash is giving me a lousy return, but it has an option value (italics mine) that comes in when there are dislocations in markets.” Now, the risk of that strategy is clearly that this time is different and there is no more volatility."
Personally, I think the risk of large negative equity market returns is much greater than the risk that volatility has disappeared forever.
Some of the non-mocking comments following the Rodriguez interview asked what an investor might do if he/she was concerned about high valuations and their attendant risks. This Montier interview addresses that question, and GMO's preferred asset allocation is provided in the table embedded in the article.
My portfolio is 25% equities, almost all foreign, but without the emerging market overweight suggested by GMO. It is about 16% LT US government bonds, about 10% intermediate-term, high-quality bonds, with the remainder in ST, high-quality bonds (and a small TIPS position).
My portfolio is a poor choice for an investor who will go to sleep for the next 30 years and then wake up to spend the money. That investor should invest primarily in equities. I agree with Montier that, "It might be true (i.e., the S&P 500 might be cheap) only if you believed there was absolutely no mean reversion—in that case you’d be looking at a 3% real return from equities, zero from bonds, and, say, minus 1% or 2% from cash."
If there was no mean reversion, I'd expect at least 3.25% real per annum from the S&P 500 (and more from foreign equities) with 0.98% (real) from 30-year TIPS, less from most other bonds.
My current portfolio will earn less than that. However, it has an option value. The LT and intermediate-term government bonds are likely to rise if equities fall substantially, and the ST issues will hold their value. I'll have funds (dry powder) to buy equities at better valuations, assuming that day comes again. If not, I will suffer an opportunity cost.
However, the opportunity cost (estimated prospectively) is low based on return estimates above.
http://www.barrons.com/articles/coping-with-the-foie-gras-stock-market-1501305385.
(If you don't subscribe you can copy/paste the article title into your search bar and obtain access.)
As with the Bob Rodriguez interview posted previously, I thought that this would be of interest to the minority of forum participants who are value investors. As before, I know most of you are indexers and EMH-believers. I'm not trying to change your mind. Please carry on.
The Rodriguez post prompted mocking comments followed by insults traded back and forth. Folks, this is just investing, not politics and not religion.
***
I agree with the general spirit of Montier's comments. That is, valuations are high across essentially all asset classes and thus prospective returns will be low. I don't think one should be dogmatic about when valuations are likely to fall (or how far they will fall). Montier seems unduly confident about a 7-year horizon to mean reversion.
He points out, "The U.S. market is at its second or third most expensive point in history," and "Nothing in the precepts of being a value investor tells you about the path or the timing. It just tells you about the final destination."
A study of history suggests that there will be large swings in valuation over time, and Montier states, "A sensible portfolio today has a sizable amount of dry powder: T-bills, bonds, TIPS [Treasury inflation-protected securities]. You have to say: “Look, I know cash is giving me a lousy return, but it has an option value (italics mine) that comes in when there are dislocations in markets.” Now, the risk of that strategy is clearly that this time is different and there is no more volatility."
Personally, I think the risk of large negative equity market returns is much greater than the risk that volatility has disappeared forever.
Some of the non-mocking comments following the Rodriguez interview asked what an investor might do if he/she was concerned about high valuations and their attendant risks. This Montier interview addresses that question, and GMO's preferred asset allocation is provided in the table embedded in the article.
My portfolio is 25% equities, almost all foreign, but without the emerging market overweight suggested by GMO. It is about 16% LT US government bonds, about 10% intermediate-term, high-quality bonds, with the remainder in ST, high-quality bonds (and a small TIPS position).
My portfolio is a poor choice for an investor who will go to sleep for the next 30 years and then wake up to spend the money. That investor should invest primarily in equities. I agree with Montier that, "It might be true (i.e., the S&P 500 might be cheap) only if you believed there was absolutely no mean reversion—in that case you’d be looking at a 3% real return from equities, zero from bonds, and, say, minus 1% or 2% from cash."
If there was no mean reversion, I'd expect at least 3.25% real per annum from the S&P 500 (and more from foreign equities) with 0.98% (real) from 30-year TIPS, less from most other bonds.
My current portfolio will earn less than that. However, it has an option value. The LT and intermediate-term government bonds are likely to rise if equities fall substantially, and the ST issues will hold their value. I'll have funds (dry powder) to buy equities at better valuations, assuming that day comes again. If not, I will suffer an opportunity cost.
However, the opportunity cost (estimated prospectively) is low based on return estimates above.
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