NOTE: I will be releasing European market valuations shortly. I will now be able to do it on a monthly basis like I do with my US stock market valuation articles (this month it will be super late). Below are some numbers from GMO:
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 last month’s, one can see a clear trend. As valuations have gone down, GMO now is increasingly bullish. They expect international high-quality emerging markets and U.S. high-quality to have near historic real returns of 6.0%. CAPE above 20 indicates returns will be closer to 2% for the S&P500, which is close to GMO’s estimate of 1.8% of large cap US stocks. Besides emerging markets, bonds are expected to do better or at least the same, as they did last month.
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 (46.7% of Total Assets)|
(Not sure why KO and PFE are shown twice; could be a glitch with Yahoo Finance.)
GMO’s forecast from last month, here.
GMO has made some downward revisions, likely due to the massive market upturn over the past month and growing concerns about Europe. I am not sure why they are so bullish on emerging markets to begin with, as signs of macro problems such as inflation and higher valuations lead me to believe that they will not have the returns that many people are expecting.
At the end of ’09, bulls were screaming “Buy China.” However, from Jan. 1, 2010, to present, FXI (iShares FTSE/Xinhua China 25 Index) has returned -16% vs S&P 500’s positive return of 9.5%. I am not cherry picking data — I specifically picked early 2010, because that is when the media seemed to be getting really bullish on China.
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 Jeremy Grantham’s recent quarterly letter, he explains why he thinks returns in emerging markets will be so high. Here is the quote:
Emerging markets are hard to evaluate because they are clearly going through many phases of development in areal hurry. So what is normal profitability? Probably not the old levels. They are moving toward developed status and probably toward our developed world’s level of profitability. (Yes, James Montier, that would be a change and, therefore, I admit, far from certain.) In a global finnancial 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 bullish views. Last month’s monthly valuation article, was slightly more bullish as valuations have come down considerably. However, Grantham has put fair value of the S&P500 at 950, which would imply a very large drop from current levels for larger US stocks.
Other gurus are more bullish. Charles Royce stated in a recent interview that he expects the market to return 6-8% in the coming years. The market has gone down considerably since then, and therefore one would assume that Charles Royce would raise his estimates. Bruce Berkowitz, and John Paulson seem to be very bullish on the market with their investments in financial companies. Warren Buffett seems to be bullish on the economy and valuations and his recent statements on CNBC.
Seth Klarman on the other hand believes that this will be another lost decade for stocks. Prem Watsa also believes that we are in big trouble and has hedged his portfolio. Robert Rodriguez is very worried about the budget deficit and called 2012, the most important year in our lifetime.