Not With A Bang But a Whimper


Jeremy Grantham had some good comments in GMO’s third-quarter letter to investors.

I have come to believe, however, very reluctantly, that we bubble historians have, together with much of the market, been a bit brainwashed by our exposure in the last 30 years to 4 of the perhaps 6 or 8 great investment bubbles in history: Japanese land and Japanese equities in 1989, US tech in 2000, and more or less everything in 2007. For bubble historians eager to see pins used on bubbles and spoiled by the prevalence of bubbles in the last 30 years, it is tempting to see them too often. Well, the US market today is not a classic bubble, not even close. The market is unlikely to go “bang” in the way those bubbles did. It is far more likely that the mean reversion will be slow and incomplete. The consequences are dismal for investors: we are likely to limp into the setting sun with very low returns. For bubble historians, though, it is heartbreaking for there will be no histrionics, no chance of being a real hero. Not this time.

I’ve had a similar view for a while now. Stocks are expensive based on any criteria you want to use — the traditional P/E, median company P/E, P/S, cyclically-adjusted price/earnings ratio… Find any traditional value metric, and the market is expensive.

Yet you don’t have the irrational optimism or generally good fundamentals that you see during a bubble… what Grantham calls “excellent fundamentals irrationally extrapolated.”

Think back to 2005. Expectations for home prices were ridiculous and completely divorced of economic reality. Yet you did have a booming economy, falling bond yields and an overall strong macro environment. The same was true in 2000. Tech stock prices had gotten ludicrously overvalued based on ridiculous growth assumptions, yet the late 1990s economy was also one of the biggest booms in U.S. history. It’s hard to say those conditions are in place today. The economy is growing at a tepid rate, and investor sentiment is downright horrid. Fear is far more prevalent than greed.

So, we’re unlikely to get that bubble burst “reset” that we got in 2000 or 2008… yet stocks are too expensive to generate acceptable returns going forward. So, what does this mean, and how do we allocate capital?

I’ve argued for years that stock returns will likely be flattish for the next decade, which is why I’ve focused my attention on income strategies and alternative investments. Grantham would agree, and his team is forecasting returns on U.S. large caps of -3.1% to 0.3% over the next 7 years.

We’ll see how it shakes out. But a larger-than-usual allocation to alternatives seems like the sensible move, all things considered.

Charles Lewis Sizemore, CFA is the principal of the investments firm Sizemore Capital.

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