Grantham: Stocks Will Continue Upward until the Election
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Jeremy Grantham says equity valuations are heading toward the “two-sigma” level that is the requisite threshold for a true bubble. At some point – which is not imminent – he said a “trigger” will precipitate the reversion back to mean levels. The market will continue to deliver positive returns until the next election, according to Grantham.
Grantham cited two major causes for the looming bubble: post-Bernanke U.S. Federal Reserve policy and a “stock-option culture” that has both elevated corporate margins and stifled normal levels of capital expenditure investment required to grow the economy.
Grantham is the chief investment strategist and co-founder of Boston-based Grantham Mayo van Otterloo (GMO). He spoke to an audience of advisors as the opening keynote speaker at the Morningstar Investment Conference in Chicago on June 24th.
With 600 colleagues focusing on the day-to-day work of delivering results to GMO’s investors, Grantham focuses on macro issues such as investment bubbles and nine other substantive topics he is “totally free to obsess over.” I will describe the other nine issues, but first let’s look at what Grantham said about equity valuations.
On career risk, the GMO seven-year forecasts and regression to the mean
Grantham said that the market is driven by career risk where investors’ job descriptions are to keep their jobs. They do this in the stock market by following Maynard Keynes advice: “never be wrong on your own” and “if you are going to be wrong, make sure you have plenty of company.” This process guarantees that investors herd together and drive asset class valuations way beyond fair value.
Based on regression to the mean, GMOs seven-year forecast assumes valuations will normalize over a seven-year time horizon, with both lowered profit and P/E levels. Grantham forecasted a -2.3% seven-year return for U.S. large-cap stocks. Over that period, the earnings growth will revert to 5.7% real annually.