GMO's Market Outlook: 'Disappointingly Overvalued'

Ben Inker

Opportunities across US and foreign assets classes are unattractive, according to Ben Inker, the head of asset allocation at the Boston-based global money manager Grantham, Mayo, van Otterloo & Co. (GMO).   Neither the equity nor fixed income markets hold the potential for investors to earn acceptable inflation-adjusted returns, Inker said.

Inker delivered the keynote address at a conference on the global outlook and investment strategies held at Babson College on March 25.

Markets were “desperately overvalued” in mid-2007, prior to the financial crisis, Inker said.  Since then, they have gone from “very interestingly cheap” in March of 2009 to today’s level, which he called “disappointingly overvalued.”

I’ll discuss Inker’s forecasts for various asset classes, but first let’s look at GMO’s unique approach to investing.

Don’t look like an idiot

Asset allocation is at the core of GMO’s approach to investing, because GMO believes that is how it can achieve a unique competitive advantage.

Inker said that his firm does not believe in efficient markets or that prices “fully express all of the market’s knowledge about the future cash flows of assets.” 

But there are ways that markets are reasonably efficient, he said, and one of the ways is “career risk.”

“The market tends to be priced in a way that if you want to try to outperform, you have to take a risk of looking like an idiot,” Inker said.  To outperform, you have to deviate from your benchmark, and that increases the risk of underperformance and, in the extreme, looking like and idiot and getting fired.

As a result, markets exhibit herd-like behavior, which in turn encourages momentum and other self-reinforcing behaviors, such as money flowing into whatever strategy has been doing well, Inker said.  That merely ratchets up valuations within better-performing asset classes and sectors, he said, creating a self-fulfilling prophecy.

Valuations can increase, but not forever.  Ultimately what brings them back in line are replacement costs, Inker said.   If you can build a plant less than what it would cost to buy one in the market, companies can and will raise capital, thereby driving down market prices.  “Replacement cost holds everything,” Inker said.  “It is the gravitational pull of the market.”

The trouble is that there are no reliable guidelines for how long that will take, Inker said, and he noted that GMO typically invests too early when it sees undervaluation.