According to James Montier, now is the time to allocate away from U.S. equities and into emerging markets.
Q4 2019 hedge fund letters, conferences and more
Montier is a member of the asset-allocation team at Boston-based Grantham, Mayo, Van Otterloo & Co (GMO). Before joining GMO in 2009, he was co-head of global strategy at Societe Generale. He’s a regular contributor to GMO’s library of white papers and research studies on topics ranging from productivity to strategic asset allocation to contrarianism, and more.
But Montier’s message is not new for those who have followed GMO. For the last decade, GMO has consistently forecast poor performance for U.S. large-cap equities.
And it has been wrong.
Its widely followed seven-year forecast has predicted annual returns at or below zero for large-cap U.S. equities, but the actual returns were approximately 250% over the last decade.
Montier was a keynote speaker at the Inside ETF conference in Hollywood, FL, on January 28. His talk was titled, “Late Cycle Lament.”
As of December 31, 2019, GMO’s seven-year forecast was for real annual returns of -4.9% for large-cap U.S. equities and 8.2% for emerging market equities.
Montier said that one of the most common behavioral biases is over optimism, and it is, “pervasive and dangerous” late in the business cycle. It causes investors to overestimate returns and underestimate risk. He warned that investors are doing just that by allocating toward U.S. equities.
He acknowledged that 2019 was a banner year for equities, but was peculiar because growth outperformed value, as it has done for the last decade. The same was the case with U.S. versus non-U.S. and large-cap versus small-cap equities.
“That upended many deeply held investment beliefs,” Montier said.
Why did this happen and will it continue?
Montier acknowledged that GMO has not been fans of the U.S. equity market for a while, and that it has been painful. U.S. real annual returns were 7% while the rest of the world returned 2% over the last decade.
For the next decade, that is likely to reverse, he said.
He showed data that the current business expansion is the weakest, slowest and longest post-war expansion. Productivity has been slower than GDP growth and real wages have barely grown. The gains in the post-Reagan era have been captured by a relatively small number of people, he said – mostly the top 10% of income earners.
That inequality is not a good foundation for a repeat of strong equity performance, according to Montier.
But can earnings come to the rescue? He said they have grown slightly slower than GDP, so stock market performance hasn’t been about GDP or earnings growth.
“It’s about stocks and multiple expansion,” Montier said.
Montier cited a commentary by John Hussman, who quoted Robert Rhea that, in the last phase of a bull market, “speculation is rampant – a period when stocks are advanced on hopes and expectations.” You don’t want to buy when speculation is rampant and the market is rising due to multiple expansion, Montier said.
Comparing the US to the rest of the world, Montier said the difference is not due to sales growth, although margins in the U.S. were slightly higher. Buybacks have been a significant part of the U.S. outperformance (outside the U.S., corporations have been net-issuers), making them the biggest fundamental contributor to market performance.
The US outperformance was due to buybacks and multiples, Montier said. Can that continue? Looking at valuations, the U.S. has a Shiller P/E of approximately 27, while the rest of the world ex-U.S. is 15 and the emerging markets are at 13.
Read the full article here by Robert Huebscher, Advisor Perspectives
