GMO 7-Year Asset Class Forecasts: An Amazing Capstone To A Risk-On Year

“The good news first. The fourth quarter was an amazing capstone to a risk-on year. Virtually all risk assets rallied impressively. US, Non-US, and Emerging stocks, growth, value, large and small. Certain pockets in the equity markets posted double-digit returns in the quarter alone. Credit markets rallied, such as High Yield and Emerging Market Debt. You name it, and it was up,” says Peter Chiappinelli, Asset Allocation Portfolio Strategist at GMO.

“Now for the bad news. Much of 2019’s impressive run up for US large cap equities was based not upon fundamentals but upon P/E multiple expansion. Profit margins, in fact, declined substantially in the fourth quarter --- yet the “P’s” kept rising. And this expansion was on the back of what was already an expensive market. We ended 2019 with the Cyclically Adjusted Price to Earnings CAPE) for the S&P 500 at 31, putting it at extreme levels, well past the bubble levels of 2007 and within whispering distance of October, 1929.

"Back to the good news, however. The rest of the world, particularly value stocks in Emerging Equities, are trading at substantial, near historic, discounts to the US. So there is money to be made --- good money in fact, as our 7 year forecasts for emerging value stocks is over 8% real, with possible additional returns coming from their cheap currencies. But it gets better. Value stocks across the planet, in fact, are also trading at substantial discounts to their Growth brethren. We are also quite constructive on our alternatives portfolio, which can further exploit these valuation differences without taking beta or duration risk.