Every Month ValueWalk analyzes GMO’s market forecasts for the coming seven years. The report is dated 2/29, but is usually not released until mid month. It should be noted that the analysis was comprised by GMO on February 29th. Since then the S&P 500 (INDEXSP:.INX) has and global markets have risen, and treasury bonds have decreased significantly. Yields on the Ten year have risen 28 basis points in the past week along. High yield bonds (HYG) are also down this month.

At the bottom of this article is a chart containing GMO’s seven-year forecasts for a variety of asset classes. Comparing these numbers to prior months, one can see a clear trend: as valuations have gone up, GMO now is getting bearish. They expect emerging markets to have 5.0% annual real returns. They also like intl large and high quality large cap. The Shiller PE (CAPE) is far above 20. Anytime the number is above 20 future real returns should be close to 2% for the S&P500, which is close to GMO’s estimate of 0.4% of large cap US stocks. John Bogle recently stated that investors should expect real returns of 1-2% over the coming years.

Besides emerging market debt, bonds are expected to have negative returns.

Jeremy Grantham describes what GMO means by high-quality U.S. stocks in an interview with Morningstar: “It’s high return, stable return and low debt.” And, “Quality is quality; we kind of know what it is. It’s a great franchise company.” However, no exact metrics have been stated.

I assume they (GMO/Grantham) are referring to blue chip stocks, with strong balance sheets and high dividends, stocks such as Coke (KO), Proctor & Gamble (PG), Johnson & Johnson (JNJ) and other Dow components that have pricing power. However, I have never seen the exact criteria for what qualifies as high quality.


Below are the top 10 holdings from GMO’s Quality mutual fund, which likely would give the best quantitative definition of high quality:

Top 10 holdings

Security Net Assets
Microsoft Corporation (MSFT) 5.78%
Johnson & Johnson (JNJ) 5.74%
Cisco Systems Inc (CSCO) 5.15%
Philip Morris International, Inc. (PM) 4.89%
The Coca-Cola Co (KO) 4.37%
Oracle Corporation (ORCL) 4.31%
Pfizer Inc (PFE) 4.02%
Apple, Inc. (AAPL) 3.72%
Wal-Mart Stores Inc (WMT) 3.38%
Google, Inc. (GOOG) 3.21%

It also is hard to group all emerging market countries together. The economies of Russia and India, for example, are far different just based on demographic trends. However, the media just sticks them all together regardless.

However in a recent   quarterly letter by Jeremy Grantham (CIO of GMO), he explained why he (and presumably his firm) thinks returns in emerging markets will be strong. Below is a quote:

Emerging markets are hard to evaluate because they are clearly going through many phases of development in areal hurry. So what is normal probability? Probably not the old levels. They are moving toward developed status and probably toward our developed world’s level of probability. (Yes, James Montier, that would be a change and, therefore, I admit, far from certain.) In a global ?nancial crisis it is also important to remember that their cumulative foreign reserves are remarkable, twice that of the developed countries. But, all things considered, I believe they will outperform other non-high-quality equities for the next seven years and are likely to produce a semi-respectable return for a risky group of about 4% to 5% a year real.

Overall, this chart is slowly gravitating towards more bearish views. This largely agrees with our monthly valuation article, which states that stocks are getting more expensive and less attractive.  Grantham has put fair value of the S&P500 at 950, which would imply a massive drop from current levels.

Below is the full chart from GMO embedded in scribd: