The Economist explains
JEREMY Grantham of GMO is in philosophical mood in his latest quarterly letter, ranging widely across issues such as climate change and the tax deductibility of interest. But what is attractive to this blogger is GMO's focus on the likely long-term returns from various asset classes. There is very little that can be usefully said about the short-term outlook for markets but it does seen possible to make better-than-random statements about the long-term, based on the valuation of the asset concerned. Since valuations revert to the mean, over time, one can attempt to buy low and sell high.
As an illustration. Grantham shows what the model was forecasting for asset classes back in December 2001. Emerging markets were the asset to back, it claimed back then, while US equities should be avoided. Sure enough, emerging market equities were the best performers out of the 11 asset classes analysed over the following 10 years, while the S&P 500 was 10th.
Frustratingly, GMO doesn't give its current range of forecasts. Grantham gives us a few hints saying that
The majority of global equities are now within spitting distance (a technical term) of fair value. Only the S&P 500 is materially overpriced, with an imputed return on our 7-year forecast of about 1% real.
This will not be too big a surprise to those who follow the Shiller p/e which is currently at 22, well above the historic average. Many people question the relevance of this measure but it's been a guide to all the big stockmarket peaks, and it corresponds with the q ratio, which also shows the market is overvalued relative to the replacement cost of net assets.
Even so, Grantham reckons the "high-quality" stocks in the US can deliver 5.5% real, and the rest of the world can offer about 6% real, which is around the historic average.
He also says that
the interesting overpricing that exists in global markets is in debt markets - those that are seen to be lower risk than the rest. In some markets like the US and the UK, the long bonds can be so murdered by inflation that holders should end up concerned about return of capital and forget about being paid for the risk.
It is hard to disagree with this analysis; indeed the use of low bond yields as an instrument of financial repression was the subject of the latest column. But it would be good to know what the GMO forecasts are for other asset classes, notably emerging market debt, or commerical property.